ECB Primer - Lagarde to Speak Softly But We All Know She Carries a Big Stick

Good morning everyone. It's ECB Day although the market doesn't seem to happy about it with European Stocks dropping to their lowest levels in three weeks!

All eyes today will be on the ECB and Lagarde's Press conference at 12:45 and 13:30 (UKT) respectively. We all know that a discussion of a slowing in asset purchases is on the way, and the ECB's PEPP (Pandemic Emergency Purchase Programme) is due to end in March. Thus, there will likely be much discussion of when and how the taper will begin. 

This has important ramifications for European rates markets especially given that PEPP purchases have increased demand for a whole range of sovereign bonds. The Bund-BTP spread, a closely watched gauge of Eurozone risk sentiment which shows the difference in yield between an Italian 10y bond and a German 10y Bund, currently sits near its lowest levels around 100bps. Lagarde is unlikely to want to disturb this low level as this would have implications for "financial conditions" which the ECB monitors very closely. 

Bund-BTP Spread (107bps currently) - Source: Borsa Italiana

You can see that this spread widened dramatically in March 2020 as risk assets plunged. No doubt, Lagarde will be keen to avoid any widening which could make it more difficult for governments (particularly those at the periphery like Italy, Spain etc) to borrow. 

What is Expected Today? 

The ECB is expected to reduce its purchases a touch today to perhaps 60-70bn Euros a month (from around the 80bn a month we see currently) as the justification for providing the emergency stimulus is beginning to fade now the economic recovery is well underway. This move would signal the ECB is monitoring the situation closely and doesn't want to add too much fuel to the fire of the hot levels of inflation we are currently seeing. 

Likewise, with economic growth having been faster than expected in Q2 at 2.2%, there is less of an incentive for the ECB to maintain these "extraordinary purchases". 

On the inflation narrative, Lagarde is likely to stick to the transitory script, but no doubt some of the hawks in the ECB (see graphic below) may start to challenge this given inflation in the Eurozone is at the hottest in 10 years at 3%. 

Source: ITC Markets

So, if the central bank does decide to slow the pace of asset purchases today, there is likely to be a slew of commentary from Lagarde that this is (to paraphrase Churchill), not the end of stimulus, not even the beginning of the end of stimulus, but it is perhaps, the end of the beginning of stimulus. 

What's the Trade: 

If we see the tapering of asset purchases today, I'd become a lot more constructive on EURUSD in the near-term, although much still depends on the US in that equation. I'd therefore rather play this versus GBP and Long EUR-GBP. 

Looking at the charts, we can see the RSI on the hourly has moved into oversold territory as we've seen an aggressive move down in EURGBP in the last few hours. I therefore think the balance of risks is to try a tentative long with a tight SL. 

I also favour this trade as I am permanently bearish on GBP given the mounting risks from trade disruptions as a result of Boris' intransigence about HGV drivers from the EU. 

Initiate Trade: BUY EURGBP at 0.856, TP 0.861 and 0.864 in extension, SL 0.853