Thursday, June 5, 2014

ECB cuts refi rate 10 bps, repo rate now at minus 0.10%

    The European Central Bank (ECB) cut the rate on its benchmark refinancing rate by 10 basis points to 0.15 percent along with a 35 basis point cut in its marginal lending facility to 0.40 percent and a 10 point cut in its deposit rate, pushing in into negative territory at minus 0.10 percent.
    The ECB said in a brief statement that its president, Mario Draghi, would comment on the reasons for the decision at a press conference at 2:30 pm CET today and "further monetary policy measures to enhance the functioning of the monetary policy transmission mechanism will be communicated in a press release to be published at 3:30 pm CET today."
    The ECB, the central bank for the 18 nations that share the euro currency, has been preparing financial markets and investors for the rate cut and other extraordinary measures for months.
    By cutting its deposit rate to minus 0.10 percent from zero, the ECB becomes the first major central bank in the world to effectively charge commercial banks to leave their money at the ECB, a move that should encourage banks to lend more rather than just park their money in a safe place.
    In the past, Sweden's Riksbank and Denmark's Nationalbank have also experimented with negative deposit rates.
    Sweden cut its deposit rate to minus 0.25 percent in July 2009 in the midst of the global financial crises and held it there until September 2010.
    Denmark followed suit in July 2012 when it cut its deposit rate to minus 0.20 percent to reduce the attractiveness of holding Danish assets to investors from the euro zone that were seeking safe haven from the sovereign debt crises that raised questions over the survival of the single currency. But by April this year, investors were starting to return to the euro zone and the Danish central bank raised the rate on its certificates of deposit by 15 basis points to 0.05 percent.
    The ECB council had its first discussion of how to respond to the prospect of an extended period of very low inflation at its meeting in April when Draghi acknowledged that a negative deposit rate and various forms of quantitative easing had been discussed.
    The ECB council then continued the discussion in May, when Draghi said policymakers were comfortable acting in June when the ECB staff would issue the latest economic forecast.
    Inflation in the euro area fell back to 0.5 percent in May after briefly rising to 0.7 percent in April from 0.5 percent in March.
    In its previous forecast from March, the ECB cut its inflation projection for 2014 to 1.0 percent from 1.3 percent, well below the ECB's target of just below 2.0 percent.
    The inflation forecast for 2015 was maintained at 1.3 percent and 1.5 percent in 2016.
    Since then, Paris-based OECD cut its 2014 inflation forecast to 0.7 percent from a previous 1.2 percent in its 2015 inflation forecast to 1.1 percent.
    Improving economic activity had been expected to start to slowly push up prices, but it has also recently become clear that the recovery of the euro area may take longer than expected.
    In the first quarter of this year, the euro area' Gross Domestic Product expanded by a less-than-expected 0.2 percent from the previous quarter for annual growth of 0.9 percent.
    In March, the ECB revised upward its 2014 growth forecast to 1.2 percent from 1.1 percent and the 2015 growth forecast to 1.5 percent from 1.3 percent. The OECD has forecast 2014 growth of 1.2 percent and 2015 growth of 1.7 percent.
    The strength of the euro's exchange rate has also concerned ECB policy makers. By remaining strong, it keep import prices, and thus inflation, in check, and also makes life harder for exporters from the euro zone.
    The euro had been appreciating against the U.S. dollar since March last year, surprising many observers as it was clear that the U.S. economy was starting to improve and the U.S. Federal Reserve in May 2015 signaled that it was starting to prepare to reduce its asset purchases.
    But rather than a sign of how investors' viewed future interest rates, it became clear that the strength in the euro was based on the return of investors to some of the bonds of periphery euro area countries, such as Spain, Portugal or Greece, as confidence in their eventual recovery and continued membership of the euro area grew.
    But in early May, after Draghi signaled that the ECB was ready to cut rates today, the euro finally started to weaken. After hitting 1.39 to the U.S. dollar on May 8, it fell to 1.36 early today and fell further to around 1.35 following the rate cut.
    Prior to today's rate cut, the ECB last cut its rate in November 2013 after a cut in May for a total rate cut of 50 basis points in 2013 after a 25 point cut in 2012.


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