Daily Insight – ECB ‘mini cut’ speculation

by: Nick Kounis , Maritza Cabezas

  • Reports that ECB is considering the possibility of a small cut of the deposit rate if risks rise
  • FOMC discusses options to strengthen forward guidance, while Bullard says tapering is on the table
  • China’s policymakers signal room for gradual renminbi appreciation

ECB considering cutting deposit rate to -10bp

According to a credible report from Bloomberg News, the Governing Council is considering cutting its deposit rate by 10bp – taking it to -0.1% – in case downside risks to price stability strengthen. The ‘mini cut’ would reflect that negative rates are unchartered territory for the eurozone, with concerns that it could squeeze bank profits and have an adverse effect on the credit mechanism. Such worries are based on the idea that lending rates would be adjusted downwards, but deposit rates would remain more sticky. On the other hand, over time, there is no reason why adjustments should not be made as expectations of a longer period of low rates settle. The benefit would be the same as any cut in rates. It would pull down interbank rates, with the EONIA likely to go down to zero and the 3M Euribor down to 0.1%. In addition, the move would likely disproportionately reduce 2Y and 5Y rates, leading to a steeper yield curve. A ‘mini cut’ does not seem to be imminent but it is clear that officials are preparing their options in case bolder action proves necessary, and asset purchases have also been openly mentioned as a possibility for the first time. The Bundesbank remains ardently opposed to such measures, but other officials could push these kind of policies through if downside risks were to really intensify.

FOMC considers strengthening guidance as tapering approaches

The minutes of the October FOMC meeting revealed that it is actively considering options to strengthen its forward guidance to keep short rate expectations anchored. This seems to be forward planning to try and decouple tapering of asset purchases – which the FOMC sees as likely at some point in the coming months – and expectations of higher rates. Lowering the unemployment rate threshold was considered to this end, but that did not have much support. However, officials did consider communicating that rates could remain on hold even after the threshold was reached depending on the economic circumstances. A perhaps more likely option according to the minutes was cutting the interest rates the Fed pays on excess reserves (the IOER, which is equivalent to the ECB’s deposit rate) from its current level of 0.25% as a way of signalling its intention to keep rates low. Separately, St. Louis Fed President James Bullard said that a December taper was on the table if the next jobs report was strong.



Markets react negatively to mention of tapering

Equities, Treasuries and gold fell on the back of the suggestion that a tapering of asset purchases was likely in the coming months, while the dollar strengthened. Meanwhile, the EUR/USD also dropped significantly on the back of the ECB mini cut story. We stick to our call of a March taper, as we think that the Fed will err on the side of caution. In addition we expect it to strengthen forward guidance. A cut in the IOER is obviously looking more likely. Our central scenario is that tapering will be a smoother affair than this summer’s dry run.

China’s policymakers set scene for renminbi strength

The reforms announced after the Third Plenum are ambitious and more concrete, but the timing is still unclear. Among other policies, the reform agenda considers adjustments to the exchange rate system. An “orderly” widening of the band is proposed, but no mention was made of the timing. This approach was reiterated by the Governor of the People’s bank of China on Tuesday. A widening of the band should be supportive of further renminbi appreciation with respect to the dollar. This is not the first time this year that such a move has been announced. There could be tolerance for further strength of the renminbi as the authorities seek to rebalance the economy, but in the transition China’s growth is also reliant on exports, so we don’t expect it to be an abrupt adjustment of the trading band.