ECB policymakers are still concerned about the currency and underlying inflation, but will almost certainly announce a tapering of QE before year-end.

Thursday’s European Central Bank meeting minutes showed the governing council resolved to begin tapering off the bank’s quantitative easing program although concerns over the exchange rate and underlying inflation pressures mean policymakers are likely to proceed with caution.

"A view was put forward that conditions were increasingly falling into place that would allow the intensity of monetary policy accommodation to be adapted and would provide an opportunity to scale back the Eurosystem’s net asset purchases."

But the minutes appeared to go down poorly with currency markets in the first instance, where traders had hoped the ECB would show a greater tolerance for a stronger exchange rate, more confidence in the outlook for underlying inflation and perhaps a more hawkish bias in their policy discussion.

While members acknowledged that a strengthening Euro area economy and weakness elsewhere in the world would all mean a stronger exchange rate, the governing council emphasised concern over the pace of appreciation in the exchange rate and reiterated concerns over weakness in underlying inflation pressures.

“From today’s perspective, the available evidence continued to indicate that the progress towards a durable and self-sustaining convergence of inflation to the Governing Council’s medium-term inflation aim was not yet fully convincing and that patience was still needed.”

ECB meeting minutes typically have a muted impact on markets. However, this time, traders were watching closely for hints of how the central bank will proceed with the wind down of its quantitative easing program. Changes in the attitude of policymakers toward the sharp rise of the Euro in recent quarters were also be a key focus.

“It was considered that the euro’s appreciation to date could, to some degree, be seen as endogenous and as reflecting more positive euro area developments, pertaining to both stronger growth and reduced perceptions of political risk,” the minutes read.

A Dovish Taper?

Sunday’s independence referendum in Catalonia and concerns over the outlook for Euro area inflation are both reasons for why some economists had come to expect a “dovish taper” from the ECB on October 26.

“Signs that tapering could be more ‘punchy’ that what markets currently expect would lend support to a strong EUR heading into the Oct ECB meeting...For EUR/$ we wouldn’t rule out a move above 1.20 on the prospects of a more aggressive ECB QE taper plan.” says Viraj Patel, a strategist at ING Group, in his morning note.

A dovish taper would see the central bank exit its quantitative easing program over a drawn out period of nine months or more, commencing in January, with the initial announcement coming this month.

“The minutes confirm that most members were concerned about the possibility of a further rise in the euro exchange rate. But those concerns will have eased given the currency’s depreciation since then,” says Jennifer McKeown, chief European economist at Capital Economics.

The Pound-to-Euro rate was quoted 0.36% lower at 1.1216 a short time after the minutes were released, a minor improvement on the pair's performance during early trading in London Thursday.

Meanwhile, the Euro-to-Dollar rate was quoted 0.13% lower at 1.1743, a marked deterioration on its performance around the beginning of trading in London.

The Pound-to-Euro Rate, UK Politics Less Relevant

At the time of writing, the impact of the ECB's meeting minutes had been slightly positive for the Pound-to-Euro rate however, the danger is that should the market's interpretation of the minutes change, it could add further downside pressure to the GBP/EUR rate. Developments in domestic UK politics are seen as less of a factor at present, despite the backgound noise.

Earlier concerns over a potential challenge to Prime Minister Theresa May’s leadership and an increasingly clouded outlook for UK economic growth have both conspired to hamper Sterling during the last week.

“The closing speech from Prime Minister May at the Conservative Party conference had been perceived as an important opportunity to reassert her leadership,” says Lee Hardman, a London based currency analyst with MUFG. “However, the speech has been received poorly, which will heighten speculation over a potential leadership challenge in the near-term. This additional uncertainty could weigh modestly on the pound.”

From Florence in September, Theresa May offered to cover any EU budget shortfall between March 2019 when the UK departs the union and the end of Brussels’ fiscal period in 2020.

The PM had been expected to sweeten this proposal at Wednesday’s Conservative conference speech after the earlier offer was deemed insufficient to move Brexit negotiations along from the so called divorce and on to the subject of future trade.

Not only was the speech poorly received by some within her own party and the usual critics without, no sweetener was forthcoming.

“For GBP markets, two channels of political uncertainty have arisen from the Tory Party conference: (1) more confusion over the government’s Brexit transition deal strategy – with reports that some senior ministers want it to last for more than two years versus Boris Johnson’s stringent ‘red lines’; and (2) ongoing questions over PM May’s leadership,” says ING’s Patel.

The resumed fall of the Pound comes after a month long period of respite in September, brought about by the Bank of England having suggested it could raise interest rates as soon as November - if the economy remains on a stable footing and inflation continues to march northward of the BoE’s 2% target.

This week's Conservative conference event and the absence of a sweetened offer from Westminster heightens the risk of uncertainty around May's leadership and no progress in the forthcoming round of negotiations between the UK and Brussels.

“While neither are likely to actively weigh on GBP, we are wary that it may limit the effects of any BoE policy-driven upside in the near-term,” says Patel. “We look to fade any GBP/USD move down to 1.3150 and prefer a buy-on-dips strategy.”