22 October, AtoZForex.com, London – In today’s press conference, Mario Draghi has stunned the market by hinting that he stands prepared to cut interest rates and increase QE to stave off the risk of a renewed economic slump in the EU.
“The implications could be very bearish for the euro and have important implications for other negative interest rate central banks,” argues Deutsche Bank in post-ECB environment.
Effectiveness of implications
Firstly, the transmission of deposit rate cuts packs a stronger punch and is more immediate than QE alterations.
“EURUSD has a much closer relationship with short-end than long-end rates as investors typically fund FX positions at shorter horizons,” DB points. Meaning if the ECB decides cut deposit rates, the implication will be much more effective in forcing the EUR lower.
Scope for lower rates
Secondly, the ECB is capable to cut interest rates by quite much. “While the market has now fully priced a 10bp cut by December, there is no reason to think the ECB has to stop there,” DB argues.
Deutsche analysis points to a scope left before zero lower bound is reached, as deposit withdrawals or cash hoarding is not apparent in the three other EU economies (Switzerland, Sweden and Denmark) where interest rates are lower.
The European Central Bank (ECB) might also mitigate the repercussion of deposit rate cuts for banks.
Such could be accomplished by “taking a leaf out of the SNB or Denmark National bank’s book and introducing exemption thresholds for excess reserves,” DB argues.
Further cuts in rest of EU
Finally, if additional deposit rate cuts do materialize, the result would lead to additional cuts to policy rates in Switzerland, Sweden and Denmark who remain wary of FX appreciation and/or the outcome of inflation.
“In that sense, it will probably be the smaller European economies, rather than the Eurozone, that reach absolute zero first,” Deutsche Bank concluded.
Consider reading: ECB keeps QE unchanged
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