The €uropean


ECB: Ready to cut – But not to ease

Tomorrow, 2 April, the ECB ought to bring short-term rates to 1% from 1.5%.

Some forms of quantitative easing are possible.

        The European Central bank ought to cut the refi rate to 1% (from current 1.5) tomorrow, at its 2 April meeting. If the ECB does not reach 1% in April, it would very likely do so in May. But this notwithstanding the monetary authority will remain less profligate than its main counterparts, for instance the Federal Reserve or the Bank of England.

Holger Schmieding, Bank of America's European economist provides good considerations.

He argues that "Acknowledging the severity of the economic downturn, the European Central Bank has turned exceptionally dovish in the last three weeks. Even the proverbial hawks no longer seem to resist a further cut in the main refinancing rate. We now see a 2 in 3 probability that the ECB will deliver its final 50bp cut in the refi rate to a 1% trough at its 2 April meeting, otherwise the 1% target will be postponed to May."

However, Shmieding thinks that the deposit rate will not follow suit all the way:

"A 50bp cut in all ECB rates," he says, "would take the deposit rate to 0%. Many at the ECB seem to be uncomfortable with a zero rate policy, especially as the overnight rate now tends to be closer to the deposit than the main refi rate. We thus do not expect the ECB to reduce the deposit rate by 50bp as well. The ECB is more likely to leave the deposit rate at 0.5%, with some chance that the ECB may shave it to 0.25%."

There is also a discussion on whether the ECB will embark on quantitative easing or not. Shmieding believes that some steps are possible, but not to the extremes of the other central banks:

"The ECB is studying ways to deliberately increase the size of its balance sheet further, including "quantitative easing". However, outright purchases of private and/or public bonds pose more problems in the Eurozone than in the US and the UK. In the Eurozone, the market for commercial paper and corporate bonds is smaller and much less developed. Also, the Eurozone has 16 national governments with their own bonds rather than just one national government. Buying govvie bonds would raise tricky political questions which many at the ECB would apparently like to avoid."

Two steps, however, are likely:

"The ECB seems to be developing a hierarchy of options of how to enlarge its balance sheet if need be. Two options could be comparatively easy for the ECB, namely to introduce an ultra-long 12-month refinancing auction on top of the current 3-month and 6-month long-term auctions and to reduce the haircut which the ECB applies when it accepts corporate paper as collateral in its refinancing auctions. We see a good chance that the ECB will go down this route in April or May.

On the other hand, outright purchases of govvies for the time being is not on the cards:

"Buying private paper would saddle the ECB with genuine credit risk, buying government bonds would be politically tricky. The longer the recession lasts, the more ECB resistance against such very unconventional measures might weaken. We see a slightly better-than-even chance that the ECB will eventually announce a programme to buy corporate paper, probably in late 2Q. Outright purchases of government bonds are less likely. They would only be an option of last resort for the ECB, in our view."

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