All eyes on tomorrow’s ECB meeting

Investors are now preparing for tomorrow’s ECB meeting with elevated expectations about what Mario Draghi has in his bag of tricks. The Euro has been rising against most crossed since the last ECB meeting held on August 2 and many commentators believe tomorrow’s meeting will make history with confirmation of ECB bond buying and so debt monetisation.

The last ECB meeting was a disappointment and the Euro fell sharply after traders re-evaluated Draghi’s words that he wouldn’t bring out the widely expected “bazooka” – it’s doubtful he will make the same mistake tomorrow and will likely put “meat on the bones” as to specific measures that will be taken. Investors are expecting the ECB to announce a sovereign bond-buying programme, with unlimited funds, particularly as a few days ago, Jorg Asmussen – a German ECB executive board member, stated that markets are pricing in the risk of collapse within the Eurozone and that such “systemic doubts” are not acceptable. Equally importantly, Angela Merkel, once opposing wholesale ECB bond buying does not seem to be against it anymore.

As the sovereign crisis intensifies, European leaders understand the urgency in doing something to save the Euro project and at this point some ECB help is now needed as the austerity measures imposed all over Europe aren’t working very well and interest rates on government debt are too high in some peripheral countries such as Spain & Italy.

Mario Draghi, ECB President

Instead of going the way of having to justify intervention with a dual mandate that the ECB currently doesn’t have, Mario Draghi has been pushing the reasoning behind bond buying to sceptical European leaders. As long as markets are pricing in the risk of collapse it seems that Draghi believes it a duty for the ECB to intervene; buying sovereign debt to eliminate such risk. The problem is that it seems really difficult, or even impossible, to separate between the risk of collapse and a country credit risk with the unpalatable side effect that any involved country may act as a “free rider” benefitting from any bond purchases and avoiding the hard route of austerity…

Mario Draghi has stated before that before engaging in any bond buying, a country has to be under an agreed “adjustment” program. Basically, the country has to stick to structural reforms and agree to implement the austerity measures that Portugal, Greece, and Ireland had to.

So, investors and traders’ ears will be wide open when Mario Draghi speaks. Investors will carefully analyse every word coming from the press conference and extreme volatility is expected. At the last meeting, the Euro started rising with the first Draghi’s sentences but then suddenly dropped sharply (see below) – traders should tread with caution tomorrow. 

On September 12, the German constitutional court rules on the legality of the European Stability Mechanism and so there is always the possibility that until that point the ECB may wish to just point the guns without opening fire.

Trade light & nimble!