As a follow-up on our initial thoughts on today’s ECB decision, here are a few more comments:
The decisions taken:
- The ECB cut its refi rate by 25 bp today against our expectations that December was the most likely timing.
- The ECB also decided to cut the marginal lending facility – the upper end of the corridor – by 25 bp, but left the deposit rate – the lower end of the corridor – unchanged at zero, which means that the corridor is now asymmetric.
- Moreover, the ECB extended its unlimited liquidity provisions, including 3-month LTROs, to July 2015, at least.
- Finally, the forward guidance framework from July now applies from the current lower level of monetary policy rates, ie the ECB intends to keep key interest rates at present or lower levels for an extended period.
A bit more colour: ECB clearly worried about “a prolonged period of low inflation”
At the press conference, Draghi gave the impression that there was a broad majority in favour of easing monetary policy again, but that some Governing Council members preferred to wait until the December meeting. As for the timing, there might have been a feeling of “If we know what to do, why wait another month?” The decision actually confirmed that the Dragi ECB is not that boring.
The December meeting will be important since new staff projections for inflation will be presented. Today, Draghi indicated that the ECB expects inflation will remain subdued for a prolonged period before rising back towards the 2% target. We will know more about what “prolonged” means at the next meeting. To us, inflation is likely to remain below 1% in the coming months and below 2% in 2014 and 2015. It needed the sharp drop in inflation rates to push the ECB towards more stimulus. That actually shows that the ECB did not do enough before. Or that the policy mix of monetary and fiscal policy was (and probably still is) not right.
Asked about the potential for more easing, the ECB president repeated that all options were on the table including a negative deposit rate and more LTROs. Draghi even remained open for another cut in the refi rate. It seemed there had been discussions about a deposit cut today but no explicit discussions about a new LTRO.
ECB probably done with rates; liquidity will remain ample
Given our views on growth (slow but ongoing), inflation (low but bottoming out) and the EUR (weaker over the medium term), we consider it most likely that today’s rate cut was the last one in this cycle. We also maintain our view that another LTRO is most likely not to be implemented. However, the ECB will maintain a clear easing bias for some time and liquidity will remain ample. On the real economy side, the cut could actually increase the economic divergencies in the Euro area, because in countries like Germany lower rates feed through to private households and companies more than in crisis countries where the transmission mechanism is broken.
Markets taken by surprise
The cut took the market by surprise as most analysts seemed to have put ECB action in December instead of November. After the release of the decision and before the press conference, rates came down (about 5bps in the 10y German Bund & 10bps in 1y1y EONIA) and the Euribor strip bull flattened.
The cut basically means that liquidity draining through the LTRO repayments will have more of a limited effect on short rates, as EONIA effectively will be capped at 25 bps instead of at 50 bps. The decision to extend the fixed-rate full allotment for another year as well as Draghi´s comments that the refi rate could be cut further put additional downward pressure on rates once again settles the low for long theme firmly on the curve.
The dovish Draghi could put carry and roll trades back on the radar again on the EUR curve. However, investors will have to move further out the curve as the flattening will make these kind of trades less attractive, in particular vs the US curve.
Nordea