ECB pares the way for more QE by year-end, expect further EUR downside

The ECB surprised markets last week, strongly hinting additional policy stimulus at its December meeting, when the committee updates its economic projections. A time extension of the PSPP program by 6-9 months is the most likely policy action this year. Proactive ECB action will likely act as a catalyst for a renewed push lower in the EUR, helping EURUSD break its multi-month range and re-instating some conviction in a renewed EUR downtrend. 

A 10bp deposit rate cut, to which the market now assigns a 40% probability to happen in December, remains the most effective way to sustainably weaken the EUR. Instead, it would be more likely deployed next year, following QE extension in December. The likely trigger for a deposit rate cut would be a further material appreciation of the euro, possibly in a scenario where the Fed remains on hold for longer. EURUSD is expected to depreciate to 1.03 by year-end.

On the data front, the German IFO report (Monday), Spain's preliminary GDP (Friday), and euro area flash inflation (Friday) will be the key data points. Market participants expect a moderation in the German IFO business climate index, in line with a moderation in the German GfK consumer confidence index (Wednesday). 

For Spain, the Q3 "flash" GDP estimate is expected to come in at 0.75% q/q, down slightly from 1.0% q/q in Q2 but see upside risks to the forecast, especially given the strength of the latest labour market report. Finally on inflation, euro area "flash" HICP inflation is expected to have edged up to 0.0% in October from -0.1% in September, while core inflation is likely to have remained unchanged at +0.9%. The outlook of short-term inflation expectations will be of key importance to the ECB heading into the December meeting. 

"We continue to see very little inflationary pressures in the euro area and find further policy accommodation necessary to anchor medium-term inflation expectations", notes Barclays.