The European Central Bank (ECB) cut its interest rate on main refinancing operations by 25 basis points, bringing it to an absolute level of 0.25%. This was unexpected, as yesterday only three of the 70 economists surveyed by Bloomberg expected a rate cut .….
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By David M. Lebovitz, Global market Strategist di J.P. Morgan Asset Management
This move was likely motivated by deflationary risks and a stronger euro, and further highlights that the ECB under Mario Draghi has become much more proactive than under any of his predecessors. Some key points from today’s statement and press conference are below:
– The ECB decided to lower the interest rate on main refinancing operations by 25 basis points to a level of 0.25%; because the ECB employs an interest rate corridor, the rate on the marginal lending facility was lowered by the same amount to a level of 0.75%. However, the rate on the deposit facility remained unchanged at 0.00%.
– This decision to lower interest rates was in line with the forward guidance that the ECB gave in July 2013, and according to Draghi is a function of diminishing pressure on prices over the past few months. Although Draghi admitted that Europe may experience a prolonged period of low inflation, he complemented that statement by highlighting that the ECB’s long-term forecasts show that this period will be followed by a gradual increase in prices toward the inflation target of 2%.
– The ECB also decided to continue its main refinancing operations at a fixed rate with full allotment for as long as necessary, and at least until 7 July 2015. This essentially means that banks will be able to borrow as much money as they want from the ECB at a fixed rate for the foreseeable future.
– Although Draghi did not explicitly address the recent strength of the euro, it seemslogical that today’s decision to ease may have in part been an effort to weaken the common currency. With rates so close to zero, the ECB may be attempting to stimulate growth and fight deflation via a weaker euro. The currency fell over 1% relative to the US dollar when the rate cut was announced.
This rate cut is positive in the sense that it highlights the ECB’s commitment to firmer inflation expectations given its single mandate for price stability. Eurozone inflation has fallen from an annual rate of 1.6% in June this year to a meagre 0.7% in October, and although Draghi noted during his press conference that he does not see deflation risk, he did note that prices could fall further and that he expects inflation to remain low for the foreseeable future. In addition, given the recent strength of the euro, it will be interesting to see if other central banks interpret today’s move as a direct effort to weaken the currency, which would be reminiscent of the conversation that surrounded the implementation of Abenomics in Japan. Finally, today’s decision begs the question of how the ECB will react if stronger growth and inflation fail to materialise, and whether a negative deposit rate, active use of outright monetary transactions (OMT), or other unconventional measures may be employed in the not too distant future.
Source: BONDWorld -J.P. Morgan Asset Management
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