Will Draghi disappoint EUR/USD bears?

• The ECB is set to cut interest rates in its all-important September meeting.
• A new bond-buying scheme is also on the cards.
• Significant stimulus is already priced into the euro – which may rise after the decision.
• No less than five scenarios await EUR/USD traders.

Is the upcoming stimulus package already priced into the euro? That is the question on EUR/USD traders' minds. Everybody knows that the European Central Bank is going to cut interest rates – but its size, the commitments to do more, and perhaps QE which are set to make a difference. We lay out five scenarios – each one with a different outcome for the world's most popular currency pair.

1) A 10bp cut

In this scenario, the northern hawks on the Governing Council succeed in preventing going beyond the minimum stimulus the bank hinted to. It would also show that Draghi is losing influence in his last couple of months in office and undermine confidence in the ECB's ability to reach its inflation target.

Such an outcome would be positive for EUR/USD. A rate reduction has been a foregone conclusion for long weeks. A cut without a commitment to do more could send the euro surging in reaction.

The probability of this outcome is low.

2) 10bp with a commitment to do more

If hawks succeed in blocking a deeper rate cut, they may still give ground on forward guidance. Draghi may secure a pledge to have one last go at stimulus in his final meeting in October.

A willingness to introduce more stimulus – but unknown its nature – may be insufficient to convince markets that Draghi is doing "whatever it takes." After initial confusion, the common currency may advance – on impatience ahead of the next meeting.

The scenario – a "buy the rumor, sell the fact" one – has a high probability.

3) 20bp cut

A deep cut in interest rates would exceed expectations and indicate that the ECB is serious in tackling low inflation. It would also show that Draghi and his colleagues are unmoved by banks' concerns about profitability. Even if the reduction is accompanied by exemptions to individual banks – a tiering system – the euro has room to fall.

However, EUR/USD slide may be limited as uncertainty about the future – and fears that the ECB is done for now – may confuse.

The scenario has a medium probability.

4) 20bp with a commitment to do more

If the bank provides substantial stimulus now and also commits to doing even more soon, markets will assume that the ECB is preparing the printing presses – more QE.

In this scenario, which has a low probability, EUR/USD may suffer significant losses. Some would interpret the delay in QE as only a temporary measure meant to provide enough time to iron out the details – and not as hesitance.

5) Rate cut + QE

This extreme outcome has a very low probability as the ECB may just be unprepared to lay out the details of the new money-printing scheme. However, it cannot be ruled out as the flow of downbeat data continues at full pace. The severity of the German recession and the lack of appetite for fiscal stimulus in Berlin may push the German hawks into the dovish camp.

An announcement that includes buying bonds may send the euro into a complete free-fall. QE – even at a modest scale of €20 billion – may outweigh the impact of any whichever rate cut the ECB enacts.

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