ECB to face a complicated challenge next week

The ECB faces a complicated challenge next week. The tightening in monetary conditions and the Greek saga leave the ECB with its finger on the trigger. Risks surrounding China certainly add to the dovish bias. But economic data remain strong and inflation data is behaving as the ECB forecast.

Without a Greek shock, the central bank will want to wait before acting to see if the bond market turmoil affects 'final' interest rates, ie, the cost of borrowing for non-financial private agents, and whether technical factors throughout the summer correct some of the recent increase in real interest rates. Still, the ECB needs to sound dovish enough next week to 'help the market' get there. If the week delivers a 'Greek shock' that calls for immediate action, it is expected to be concentrated in the periphery.

"We remain bullish rates overall, with negative net issuance likely to be supported by Draghi's dovish tone," says BofA Merrill Lynch.

The very large cash balances that appear to be building globally may also help the constructive bias, particularly heading into a period of low seasonal Euro govie issuance. 

"In the FX space, we expect limited sustained impact with Monday's Greek deal placing the emphasis on fundamentals once more," added BofA Merrill Lynch.