What Did Draghi Say?

The euro's calm and largely flat session was interrupted by comments by the ECB's Draghi. His comments triggered a quick half cent mark down of the single currency to almost $1.3050, but remained confined to last Friday's ranges. Short term technicals allow for a bounce back toward $1.3100.

Draghi comments did not seem to break new ground, though they were quite dovish. Draghi said that policy makers are prepare to cut rates again if needed. This was clear from last week's press conference.  Recall that a news wire reported last week that a the council meeting there were some officials who were encouraging a 50 bp cut rather the 25 bp move which was ultimately agreed up.  

More importantly, Draghi has elaborated on last week's comments about the deposit rate:  "The Governing Council has decided for the first time to look openly at the possibility of reducing the interest rate on the deposit facility to less than zero."

Draghi quickly added that a negative deposit rate would have numerous consequences and that the ECB is going to study these closely.  " The Governing Council has decided to analyze these consequences in order to be ready to act if need." 

What is going on?  We suspect that Draghi wants to make it clear to the investment community as well as the member national governments that the ECB has not exhausted its tool kit.  Indeed, through the crisis, the ECB's tool kit has been expanded.   Neither the Federal Reserve nor the BOJ, nor any major central bank has adopted a negative deposit rate or the equivalent.

Studying the issue is a nice compromise formation.  It does not commit the ECB to do anything, but keeps the door open.  This is a great example of strategic ambiguity.  Even in a protracted recession and further disinflationary forces, we doubt the ECB would adopt a negative deposit rate.  A study will likely show the potential disruptiveness of such a move.

The cost may be steep and the benefits elusive.  A negative deposit rate is unlikely to spur new lending, especially given the soft demand as the economies contract.  A negative deposit rate would likely aggravate the liquidity trap and force other short-term rates negative.  It would also likely reduce banks interest income.  It would disrupt the collateral markets and money markets.  

The ECB's study will likely conclude that there will be unintended consequences from the a negative deposit rate and the ability to boost lending is far from clear.   But to whose benefit is it to close the door entirely?  Draghi continues to play well with limited cards.   Part of the expectations game requires the belief that there is more the ECB can do.  Without this expectation, the effectiveness of the current policy stance is compromised.