While expectations for any easing by the European Central Bank have centered around the June meeting, at which the staff will revise its quarterly forecast, and not at today’s meeting, some of the recent data pointing to a moderate improvement in Eurozone growth may have cast an element of uncertainty around even that among some analysts.
But of course the ECB’s concern has not been about growth, which has been tacking relatively close to its forecast, but on the downside risks to the prolonged period of extremely low inflation. And you will recall that it is the misses on that front, including the magnitude of the miss in March despite the Easter effect (see SGH 4/15/14, “ECB: The Reality and the Rhetoric”), compounded with the strength of the Euro, that have kept an ease in June squarely on the table.
*** ECB President Mario Draghi, in what was clearly a carefully prepared “answer” to a question from a reporter at today’s monthly meeting, has validated expectations for an ease in June. Barring what would at this point have to be a significant and highly unlikely upward spike in the intervening inflation data, and even perhaps with that, the ECB Governing Council has made it clear that the staff projections will most likely be a trigger for further action. ***
*** What may be less clear to markets at this point is what that action could be. On that front we believe the very strong probability continues to be a cut in both the refi rate and an accompanying easing of the deposit rate into negative territory, of perhaps 10 or even 15 basis points. While many options have been thrown on the table, the rate cut tool as you will recall, and specifically negative rates, is the one seen as most directly impacting the Euro, while tools such as LTRO and SMP are seen as more directly directed to liquidity and money market tensions. And money markets, despite some volatility in the very front end of EONIA, are not really the problem the ECB is looking to address. ***
Draghi in fact pointedly turned an early, theoretical question from a reporter on negative deposit rates – specifically whether a cut in refi could or should not be accompanied with a cut in the deposit rate into negative territory – over to Governor Luc Coene.
Coene answered the question without any hesitation and a clarity that we believe confirmed the extent of discussion – and at this point consensus – around using this tool. In short, yes, it would be far more effective to accompany a cut in refi rates with a cut into negative deposit territory and drop the entire interest rate “corridor.”
Unsaid, but implicit, is that it would also be expected to be much more effective in pushing the Euro lower. Furthermore, the ECB we believe will go to lengths in June to emphasize the “two-step process” we have been flagging, namely that if a cut into negative territory does not do the job in lifting inflation after the next few months, the ECB will still have the option of embarking on large scale asset purchases.