ECB Goes Negative

The ECB prides itself on not being a slave to the markets, which is a criticism often levied against the Federal Reserve. Yet today the ECB did what the market had anticipated based on hints and word play of ECB officials. The main refi rate was cut 10 bp to 15 bp. The lending rate was cut 35 bp to 40 bp. This is likely to serve as an effective cap on EONIA. The ECB also set the deposit rate at -10 bp. It is the first major central bank to change banks to parking funds with its deposit facility.

Draghi has gone on to announce a series of other measures. These include extending the full allotment of repo operations, the formal suspension of sterilizing the previous bonds purchases conducted under SMP, and a package of targeted longer-term loans linked to new lending. These longer-term loan facility would initially be capped at 400 bln euros.

Draghi also indicated that the expedite the preparation to buy asset- backed securities (ABS). The only door that Draghi appears to have closed is that he noted that interest rates are now at their lower bound. It is not clear that this is in reference to the deposit rate, but it seems clear that the next big step is the ABS purchases. In this context, it is notable that the ABS market in Europe is having its busiest week in three years. Nearly 4 bln euros of debt are estimated to be sold this week.

The new staff forecasts were revealed. Inflation forecasts were cut across the board: This year CPI was cut to 0.7% from 1.0%. Next year’s CPI forecast was cut to 1.1% from 1.3%. Inflation in 2016 is now projected to be 1.4% rather than 1.5%. The growth forecast was cut this year to 1.0% from 1.2% but rasied in 2015 to 1.7% from 1.5%.

The Euribor futures strip rallied, with 2016 -18 implied rates falling 3-5 bp. Peripheral bonds have rallied, with the Iberian peninsula 10-year yields off 6-7 bp, while Italy’s 10-year yield is off 9 bp and Greece off 14 bp. European stocks have rallied, with the DAX setting new record highs. Emering market shave also advanced.

The euro fell to around $1.3560 on the initial announcement of the rate cuts and the negative deposit rate. News of the other measures pushed the euro to almost $1.3500 and it has now stabilized around $1.3540. The $1.3560-80 may be the pivot level, above which the intraday shorts may be squeezed.