The euro hits three-week highs against the dollar ahead of the ECB's interest rate and quantitative easing decision

 
Jasper Jolly
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Investors around the world will be listening to Draghi closely (Source: Getty)

The European Central Bank (ECB) is the only game in town today, as stocks rise across Europe and the euro hits a three-week high in anticipation of this afternoon’s announcement of monetary policy.

Against the dollar the euro had broken through $1.08 at the time of publication, after hitting lows in the last month of $1.0506. The pound/euro spot exchange rate was broadly flat for the day.

Germany’s Dax rose at the open before paring some of its early gains, with a similar story for France’s Cac 40 as the euro strengthened. The broad Stoxx Europe 600 index was also slightly up.

Read more: Eyes on Draghi as Eurozone inflation hits two year high

A change in interest rates is not widely expected, as ultra-low levels and a fragile recovery leave little room for manoeuvre.

However, investors will be listening closely for signs of how the bank’s asset purchase programme – also known as quantitative easing (QE) – will be extended beyond its current deadline of March 2017.

“An extension of ECB QE beyond March 2017 is seen as a done deal,” according to Luigi Speranza and Colin Bermingham, economists at BNP Paribas.

The pace and scale of the extension will be important. Investors and analysts are expecting the stimulus programme to begin to taper as the Eurozone recovery continues. In a speech last week ECB president Mario Draghi talked about “the return to more conventional monetary policy settings”.

Read more: Mario Draghi tells banks to stop complaining about negative interest rates

Many analysts expect no drama in the announcements, as any reduction in QE would be interpreted as the start of tapering. In 2013, US markets responded with a “taper tantrum”, sending bond yields soaring.

Analysts at Daiwa Capital Markets said: “Not least since a decision to buy the additional assets at a slower rate would be interpreted by financial markets as tapering, we expect the rate of asset purchases to be maintained at the current rate of €80bn per month until at least September 2017.”

The ECB began its QE bond purchases in March 2015 starting at €60bn a month. It increased the scale of the purchases to €80bn in March this year.

Quantitative easing is carried out through a programme of bond-buying by the ECB. The purchase of bonds (mostly government bonds) from private sector banks essentially aims to push banks to lend more money to businesses.

How to understand the European Central Bank's interest rates

The European Central Bank (ECB) has three rates:

  • The main refinancing operations: what banks pay to borrow from the ECB

  • The rate on the marginal lending facility: the rate at which banks lend to each other overnight

  • The deposit facility: the rate banks receive to leave money with the ECB overnight

In October 2016 the ECB kept interest rates unchanged from levels announced in March 2016. They stayed at 0.00%, 0.25% and -0.40% respectively at the October meeting.

If a rate is negative the bank will pay the ECB (rather than receiving money in interest). Negative rates are intended to encourage banks to lend money to businesses rather than holding it themselves or, as is the case with the deposit facility rate, depositing it with the ECB overnight.

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