Capital Key to the Euro

The euro was calm ahead of the ECB decision but the reaction on Thursday will depend how Draghi tweaks bond buying. GBP was the top performer on the day while the yen underperformed all currencies. NZD took another tumble in early Thursday Pacific trade after the RBNZ signalled further easing in its latest economic assessment.

The calculator below shows NZD is the worst performing currency so far this week.

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The ECB is running out of bonds to buy. The central bank has bought more than 900 billion euros in its various QE programs but its complex set of rules will need to be changed if it wants to hits its planned 1.7 trillion target.

Those rules are referred to as the capital key and various 'sources' reports suggest the ECB may tweak the rules on Thursday. Otherwise, the meeting is rumored to be focused on banking issues and a move on rates isn't believed to be on the table.

The problem at the moment is that the ECB can't buy sovereign bonds with a yield below the deposit rate of -0.4%. It also must buy bonds in ratios that correspond to the size of each Eurozone economy and no more than a predetermined ratio of each issue. What's limiting purchases is finding enough bonds to buy, particularly German bonds where maturities out to 7 years yield less than -0.4%.

There are constraints in other programs as well, such as supranational bonds and corporates. A main restriction is the ban on buying bank debt. Loosening that may solve financial sector problems and QE restraints but it could be seen as a backdoor bailout. The issue is that any solution to the shortage would create a liquidity or political problem.

The aim for Draghi will be to slowly expand the universe of buy-able bonds without creating a communications nightmare. It's a tricky task but it's also critical to his ability to go beyond the 1.7 trillion in promised QE.

The aim for Draghi will be a smooth delivery, rather than a combative approach. He may attempt to hide the changes in dull language but that's a dangerous game. If he can deliver some effective changes or lay clear groundwork to make them in the future, that should weigh on the euro.

Otherwise, the focus will be on his overall assessment of the economy. Watch for upbeat comments in-line with other central bank positivity as the Brexit panic recedes.

An interesting turn in GBP trading came Wednesday as the BOE's Forbes wrote an op-ed clearly arguing not to ease in August. It helped to lift the pound and threatens to undermine the market's near-certain belief in a move next month.

Technically, USD/JPY broke above the pre-Brexit high Wednesday. The gains came after a report the Japanese government could deliver a 20T yen stimulus budget. That's about double what had been rumored and another sign Abe and Kuroda are planning to go all-in.

Another central bank that's in focus is the RBNZ. Last week, they announced the special publication of an economic update. That was taken to be a sign of a downgrade in economic forecasts that will justify an August rate cut. The report is due at 2100 GMT.