ECB View: We expect 20bp of policy rate cuts as well as QE – We now expect the ECB to cut its policy rates, adding to the monetary stimulus already factored into our base case in the form of a re-start of QE. We expect a 10bp cut in all of the ECB’s main policy rates in September of this year, and a second 10bp reduction in Q1 of next year. This would take the ECB’s deposit rate down to a low of -0.6% and the refi rate into negative territory for the first time. We see the ECB’s deposit rate as being the key policy rate as it anchors interbank rates in an environment of excess liquidity.
Mitigating measures – The Governing Council has communicated that it will ‘continue to monitor carefully the bank-based transmission channel of monetary policy and the case for mitigating measures’. The reduction in the deposit rate as well as the refi rate will directly reduce the cost from commercial banks borrowing from the ECB in TLTRO-III, as well as increasing the cost for banks of keeping excess reserves at the ECB. Looking at other mitigating measures, we see complications in the ECB introducing a tiered deposit rate system and do not expect it to be introduced, at least initially.
Reason for change – We judged that additional monetary stimulus was necessary and introduced QE into our base scenario before the ECB’s June Governing Council meeting (see here). However, at the time we had doubts about whether the ECB was willing to cut policy rates further. These doubts have been extinguished by the ECB’s subsequent communication. At the June press conference, ECB President Draghi was explicit in asserting that the ECB was willing to cut policy rates as well as re-starting QE and strengthening forward guidance. At the ECB Forum in Sintra, Mr Draghi emphasised that a package of measures had positive re-enforcing effects in 2014-2015, and we think it may go for the same approach this time around.
It’s all about the currency – Previous policy rate cuts brought two benefits for the eurozone economy. Together with QE, they helped to reduce bank lending rates, while also stemming euro strength. On this occasion, we doubt that there will be a big impact on bank lending rates. Deposit rates most likely cannot fall much further (because here there is an effective zero bound currently) so banks may want to avoid future pressure on interest margins. However, like last time, rate cuts can help curb euro strength in an environment where the Fed is cutting rates and sterling is under pressure because of the ‘no-deal Brexit premium’.
Timeline to stimulus – We think the ECB’s first move towards stimulus will come at the July meeting. At that meeting we think the Governing Council will decide to change its forward guidance on policy rates to explicitly hint at the possibility of rate cuts. In particular, it could say it expects the key ECB interest rates ‘to remain at their present levels or lower …’. In September, we expect a 10bp cut in policy rates as well as a clear signal that the ECB is investigating the design of a new asset purchase programme. By December, we expect the ECB to announce a EUR 630bn QE package, to be implemented for 9-months from January 2020 at a pace of EUR 70bn per month. The second 10bp rate reduction will follow in Q1 of next year. (Nick Kounis & Aline Schuiling)