- The ECB Cuts rates to negative territory
- ECB cut it deposit facility to -0.10 percent from zero
- The Euro swings higher as it is unlikely the ECB will cut again anytime soon.
Yesterday Mario Draghi and the European Central Bank (ECB) pulled out the “big guns” in an all-out attack to combat deflationary pressures in the Eurozone. The ECB set new ground and put rates in negative territory and then, shockingly, the Euro strengthened.
This is leaving many of us analysts scratching our heads and we do not think this trend is going to change anytime soon. Here is why. There is a lot of skepticism that this move is not enough and will not be effective. This is not a question of supply of funding in the EU. Demand in the Eurozone is already very weak.
Yesterday, the ECB cut it deposit facility to -0.10 percent from zero. This is the first time any major central bank has done this. The bank also cut its main rate from .25 to 0.10 and it slashed its marginal lending rate 35 basis points where it now sits at 0.75 percent.
The euro has seen a low at 1.3505, a February low after the bank made this dramatic move. The euro then reversed its move lower sharply and climbed hitting 1.3660 in early trade today in Asia. Please see the below chart. The last thing the ECB needs right now is a stronger euro because it could push the single currency block over the deflationary edge. Last month inflation fell to 0.5 percent, which is way below the ECB target of two percent.
This move exceeded our expectations and there are doubts it will manage to push inflation higher. This move and other measures are not enough. The ECB has brought a knife to a gun fight. We could see the opposite happening now, and the Eurozone being pushed into the deflationary area. Why? Banks will push these added costs onto their customers.
In all likelihood, we do not expect this rally to change over the next several weeks. The effort to improve liquidity will keep euro denominated assets in demand. The markets, right now, agree with this assumption. Equity markets pushed higher, touching multi year highs and, already low bond yields, pushed lower as the 10-Year Bund hit 1.416 percent. It was at 1.438 percent the day before. Spain’s 10-Year rate also fell from 2.880 to 2.827 percent after the news.
Another reason the euro rose was that Draghi implied rates would stay put for the foreseeable future, in other words they would not go lower again. This means investors are not expecting new policy decisions and will rise or remain steady. The euro related capital flows will remain positive and we will see short positioning. In turn this should keep the position squaring, regarding the Eurozone currency intact for some weeks and the euro could rise to $1.39 to 1.40.
There is a chance this move could provide some long term support to the economy. The measures to support growth and reduce end risks across the zone will be positive for their currency as well. There remains, one big caveat here. The ever improving U.S. economy. This could put deflationary pressures on the euro. As the economic conditions continue to improve in the US, the Fed could become more hawkish. This is what the ECB is hoping for. Right now, a strong euro is bad for the European Union.