The ECB’s Trichet signalled a clear change in tone at Thursday’s press conference, not only removing the reference to upside risks to inflation, but also highlighting that downside risks to growth had intensified. Indeed, Trichet even re-emphasised in the Q&A session the significance of these changes, saying that the balance of risks have changed. The ECB appears to have removed its tightening bias and we now expect the EUR to come under further pressure.
This more dovish stance is also highlighted in the ECB staff forecast revisions, where both growth and inflation projections have been revised significantly lower. Indeed, the ECB growth projections now see GDP at 1.4% to 1.8% in 2011 from the previous 1.5% to 2.3% forecast range. The projections for 2012 are also lowered to 0.4% to 2.2% from 0.6% to 2.8% previously. Trichet also said that inflation could be below 2% in 2012.
Trichet has also called for labour market reforms and has continued to urge EMU governments to implement structural reforms alongside the implementation of further fiscal consolidation. Trichet also said that it is essential that banks retain earnings and rebuild their capital base, which is consistent with the recent warnings from the IMF. The steps and measures suggested by Trichet are all of a deflationary nature in our view, suggesting downward pressure on the EUR.
EURUSD has broken lower through the bottom end of the trading range with the major up trendline support at the 1.3945 level currently being tested. A break below here will open the way for a decline towards the 1.3835 area initially, with the medium term focus likely returning to the 1.36/1.35 area. We maintain our 1.36 year end forecast for EURUSD.
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MORGAN STANLEY
SALES AND TRADING