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Forex: Will additional liquidity measures be taken outside of an ECB Rate Cut?

FXstreet.com (Barcelona) - The ECB Monetary Policy Meeting is just around the corner, and after being discussed for quite awhile now we will soon finally know the outcome of the meeting. Due to the lackluster economic data released around the globe over the last few weeks, some analysts believe we will not only see a rate cut by the ECB, but possibly additional measures to provide liquidity.

According to analysts at RBS, “The ECB announce policy today and 60% of those surveyed by Bloomberg say they cut 25bp. This is the first time for a while that the consensus has swung in favour of a cut. Up until now, despite the deteriorating economic and lower inflation outlook, rate cut expectations have been seen as an outside chance only. The ECB has been seen waiting for the stronger periphery bond and equity markets (seen as a positive response to the ECB's OMT policy) to feed through to better financial conditions and confidence in the periphery.

Furthermore they added, “The ECB has also claimed that cutting rates further will have little impact, as the problem is not rates but the transmission of monetary policy in the periphery. The EUR has rallied into the ECB meeting; this is likely to have discouraged short sellers and squeezed some of the short speculators. As such, with less global risk appetite, we may see a rate cut today by the ECB see the EUR retrace gains and fall back to around 1.30.”

Still other analysts point to the recent strength of the EUR/USD, and believe recent strength could be due to the fact market participants are waiting to see if any additional liquidity measures will be implemented.

According to Kathy Lien at BK Asset Management, “The European Central Bank has done a great job of setting expectations for this month's monetary policy meeting. They are known for preparing the market for any upcoming changes in policy with the hopes of minimizing volatility when the actual change is made.”

She went on to add, “Therefore a simple rate cut by the ECB may not be enough to kill the euro rally. The key is what else the central bank says they will do. If the ECB indicates that they are one and done, meaning that one rate cut is all they plan to give and nothing more, the euro could actually rally because the real impact on yields would be nominal. However if the ECB suggests that they are willing to do more like accept a negative deposit rate, ease collateral rules on loans or Quantitative Easing, the EUR/USD could fall quickly but we think this scenario is unlikely. “

Other analysts agree that the ECB may implement additional liquidity measures, and are pointing towards the lower inflation readings in recent months as a possible catalyst which will allow them to do so.

According to Kathleen Brooks at Forex.com, “We agree with consensus and expect the ECB to make its first rate cut since July 2012. The ECB has been reluctant to cut rates in the past, with some members arguing that a cut would only have a limited economic impact. However, we think that weak April inflation data in both the core and the periphery will be enough for the ECB to vote for a rate cut. Inflation in the currency bloc fell to 1.2% from 1.7% in March.”

She then commented, “In reality a rate cut is unlikely to have any economic impact. Thus, the ECB may also announce a programme to boost credit to small and medium-sized businesses, similar to the Bank of England’s Funding for Lending programme.”

From a technical perspective, the choppy conditions are likely to continue until the pair can break out the recent trading range. Initially, the eur/usd needs to build value and close above 1.3200 (resistance from mid April) in order to open the doors towards 1.3260 level (previous support, now resistance on daily chart). First support sits at 1.3130 (previous resistance, now support on daily chart), followed by 1.3080 (the 9dma). In conclusion, there appears to be some conflict between the daily and weekly charts, which makes things even more difficult ahead of the ECB meeting.

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