ECB vs. Fed policy war, ECB’s fight against strong EUR

Economic and monetary developments in the period since the July ECB meeting, which Lagarde showed cautious optimism, will probably cause more caution tomorrow’s policy decisions. It seems that the ECB's job is getting harder after the Fed's new strategy. Because the Fed will continue to keep the money supply loose for a considerable period of time with the transition to its average inflation target strategy, and EUR that can be strong in such an environment narrows the action area of ​​the ECB in terms of stimulating the economy and gets harder for them to deal with it.

The recovery momentum of the economy, which contracted by 11.8% in the 2Q20 period, seems to have slowed down as indicated by the leading indicators in August. Although PMIs are still in the growth zone for the whole of the Euro Area, it is seen that some countries are contracting. Failure to break the rate of increase in virus cases may downside the momentum in 4Q20, and it should be noted that the economic projection updates to be made at this meeting are of critical importance for the Bank to determine its position on this issue. The ECB may consider additional monetary expansion in the future, if not at this meeting.

Expectations that the Bank will have some guidance on the strong EUR in the policy war with the Fed weakened the EUR before the meeting statements. The strong EUR will cause the current deflation problem to deepen during the recovery period and the export capability to decrease in an environment of increasing problems with China, the USA and the UK due to Brexit. The tax barrier imposed by countries such as the USA on imports may also cause a compelling effect for the Union in this period. At this stage, it seems unlikely that the Bank will take an additional step on interest, even if they do, it is likely that the deepening of negative interest rates will bring new problems and lay the foundations of a crisis originating from the financial system. The bank will further clarify the downside risks tomorrow and signal to increase monetary expansion.

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