The ECB decision is Thursday

The UK drama has dominated the market's attention this week but the ECB will step into the spotlight on Thursday with Draghi's latest interest rate decision.

As an aside, Bloomberg recently had a good story on Draghi's 'whatever it takes' pronouncement six years ago; which was the genesis of QE.

Now it comes to an end after buying more than 2.6 trillion euros. Here's what's on the balance sheet:

The problem is that the eurozone economy isn't exactly humming. Eurozone GDP rose 1.6% y/y in the third quarter and it looks like the best days for growth are in the rearview mirror.

This week's German ZEW sentiment survey for December showed the measure of the current situation falling to 45.3 from 58.2. Trouble with the US over trade is also looming.

"Surveys of euro area business activity and sentiment indicators have softened perceptibly relative to their earlier highs," said ECB chief economist Peter Praet on Nov 26.

The underlying question is whether the ECB will blame economic weakness on temporary factors -- as they have done recently -- or concede that it's part of a wider slowdown.

If it's temporary, they will stay the course .If it's a wider slowdown they could push back the timeline for rate hikes. I don't see any chance whatsoever of QE being extended.

A key piece of communication is that the ECB has said it will keep rates unchanged "at least through the summer of 2019." It's plain language but it led to plenty of speculation about a rate hike in late 2019. The ECB's habit is not to tinker with these things until it's overdue so they may punt. If so, that would be a positive headline for the euro. At the same time, it might render that guidance useless because it's extremely unlikely the ECB will be hiking next September.

What they decide to do may depend on the latest batch of forecasts. In September growth was revised down and Draghi said confidence about inflation forecasts (which were unchanged) had diminished.

Forecasts for GDP growth:

  • 2018 2.0% vs +2.1% prior
  • 2019 1.8% vs +1.9% prior
  • 2020 1.7% vs +1.7% prior

Inflation forecasts unchanged:

  • 2018 1.7% vs +1.7% prior
  • 2019 1.7% vs +1.7% prior
  • 2020 1.7% vs +1.7% prior

Since then, there has been one obvious change with oil prices falling 20%. That's a negative shock for inflation and makes it likely there will be a downgrade, although the ECB could be stubborn.

A key message from the statement will be whether risks are still 'broadly balanced'.

"We expect forecasts to be trimmed only marginally, with risks still broadly balanced. Draghi should emphasize the temporary nature of the weakness, with the evolution of wages a source of hope when it comes to inflation," Bank of America Merrill Lynch says in its ECB preview.

The QE hitch is in reinvestments, or how the ECB plans to deal with bonds that mature but that's more of a concern in the bond market than FX.

The market is pricing in some additional pessimism from the ECB and that is altogether likely but pricing may be overdone and the euro could bounce. The ECB will want to give itself cover for ending QE.

"Repeated messages of optimism have more to do with the political need to do away with QE than with its actual assessment of the current situation," BAML says.

There is also some talk of TLTROs but leaks have suggested they aren't ready.

The bottom line is that the ECB should probably downgrade forecasts, tilt the balance of risks to the downside and extend forward guidance; but they probably won't because doing that at the same time as ending QE looks bad, and because they have a habit of hoping overly-optimistic forecasts work out.