ECB Preview: Deposit Rate Cut Seen Shunting Euro Higher

The ECB is seen delivering further monetary stimulus this Thursday as low oil prices and lackluster demand keep inflation and inflation expectations down.

Recent history though warns traders to be cautious as the Governing Council might surprise and opt for rather less action with oil prices 40% above their 2016 lows.

Frankfurt – The European Central Bank (ECB) is seen expanding its monetary stimulus this Thursday, giving the existing asset purchasing program a further boost after it prolonged the program till March 2017 back in December last year.

The decision of the ECB to expand the current asset purchasing program would be in line with its extra dovish rhetoric of late, as the Bank struggles to meet its inflation target of close to, but not exceeding 2%.

“It will therefore be necessary to review and possibly reconsider our monetary policy stance at our next meeting in early March, when the new staff macroeconomic projections become available which will also cover the year 2018,” ECB President Mario Draghi said in the introductory statement after January ECB Governing Council meeting in Frankfurt.

The general consensus is that the ECB will cut the deposit rate further into negative. What else the ECB will deliver is an open question, with the Bank unlikely to build up any kind of market expectations after the blow back in December which hammered the credibility of both the ECB and Draghi and sent the euro jumping more than 400 pips higher against the US dollar.

A repeat this time round would more than likely send the euro higher, stifling any hopes for inflation or a boost to export competitiveness.

After ramping up expectations, delivering only a partial package would only be surpassed by actually doing nothing. That, however, is unlikely to be the case this Thursday, even though currency traders buying euros might desire that scenario, as the last action which fell well short of expectations back in December resulted in the eighth strongest intra-day gain for the euro in its 16-year history.

Moreover, oil is currently trading some 44% higher from it 2016 lows, possibly allowing the ECB to play it cautious in its anti-deflation fight.

Deposit rate cut priced in

Looking at the market, Eonia forwards have slipped below the -50 basis points threshold on a nine-month horizon, implying that the market is now pricing in the possibility of three 10 basis points deposit rate cuts.

“We think it is now beyond any reasonable doubt that the ECB will announce a cut in the deposit rate. Our forecast is for a 10bp cut to -40bp to be followed by another 10bp cut in the June meeting,” Rabobank analysts predict.
Although the long-term effects of negative interest rates are in uncharted territory for most, central banks in Europe do it in goodwill to bring inflation back to target, regardless of the negative direct impact of financial sector profitability, taking just one such aspect into account.

“There is great uncertainty about the behavior of individuals and institutions if rates were to decline further into negative territory or remain negative for a prolonged period,” a recent study from the Bank for International Settlement said.

Central banks such as the ECB, Swedish Rijksbank, Danish central bank or/and Swiss National Bank all have run negative interest rates for some time


More asset purchasing

The ECB was right in voicing increased concerns about the economy back in January. Since the January ECB meeting the euro zone economy has actually done what the ECB had feared and slowed down.

As feared by Draghi, inflation in the euro area dipped back to negative territory in January and the euro zone economy appears to be suffering under a weaker external environment and political uncertainties in a couple of member states.
Fresh economic forecast is therefore likely to deliver even darker picture of the future. Both in terms of inflation and growth projections.
Some market participants think that the ECB’s asset purchasing program might get a boost, although this wasn’t the case last time in December. The ECB opted for the program extension in terms of its duration rather than boosting monthly asset purchases.
“We expect an additional amount of EUR10-20bn in monthly purchases,” Rabobank analysts further predict, saying adding more asset classes to the mix, removing the deposit rate threshold, extending the maturity range of government bonds including 1-year maturity bucket and/or abandoning the capital contribution key are all the possible options.


Source: World Business Press

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