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21.01.2020, 14:43

Euro: a battlefield of ECB and Fed

European Central Bank's president Christine Lagarde expected to announce the framework of the Bank's revamped monetary policy on Jan. 24.

Euro area economy is struggling with quite negative economic indicators when compared to the United States. Euro area GDP rose 1.2% y-o-y in 3Q2019 and 0.2% in this quarter compared to 3Q2018 (0.3%). US economy growth is stronger - 2.1% and 2.1% respectively. Inflation in Dec. 2019 ticked 1.3%, well below 2% target. US inflation the same month rose 2.3% with the same target. Unemployment rate in Europe is sustainably holding at 7.5% compared to 3.5% in the US.

At such economic circumstances further fiscal stimulus from ECB is needed. But the European regulator is heavily limited in own additional steps to soften monetary policy. Bringing interest rates further below in the negative territory from the current -0.5% will hit the anguishing banking sector in Europe. ECB will hardly overload its balance shit with more government bonds purchases while it is already close to the limit of 30% in the government bonds new issues acquisition. So, any changes in interest rates or amount of government bond purchases are seen unlikely.

Mrs. Lagarde could again focus on government's budget and tax policies rather than monetary policy of ECB itself. The other option is to lower inflation target of 2%.

European monetary policymaker needs to adjust its policy in line with the US Federal Reserve recent moves towards monetary policy softening and not QE liquidity injections in the banking sector to avoid strengthening of the euro seen last December. To support fragile growth in Europe ECB needs euro to be even weaker. Trade wars with the US will demand euro weakness against greenback. No doubt that the United States will be pressing on Europe to benefit in trade shortly as they did with China. Additional trade tensions among the US and European Union in 2020 is certainly expected.

In this stance euro could fall under pressure this week with EUR/USD. If the resistance level at 1.10600 will be subdued, European currency could slip to 1.10000-1.10500. However, twittering Donald Trump with weaker dollar posts could offset the effort. In the alternative scenario EUR/USD could hold the lines above 1.11000 with an upward pressure to 1.12000.

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