Low European Inflation Could Force ECB to Cut

A year after Mario Draghi said European Central Bank interest rates had reached bottom, euro zone money markets are discounting a fair chance they could be lowered again – regardless of rising interest rates across the Atlantic.

The low bank-to-bank lending rates further highlight the divergence of monetary policies in Europe and the United States, where markets see a one in four chance the Federal Reserve may hike rates for the first time in a decade on Thursday.

Analysts calculate the probability that markets attach to another ECB rate cut at about 20 percent. But even the bias in direction shows unusual defiance of Draghi’s policy guidance.

The new market leaning comes on the back of a weakening in the inflation outlook despite the ECB launching a trillion euro bond-buying program in March to pump new money into the economy.

Also, at the last ECB meeting, Draghi showed openness toward an expansion of the quantitative easing (QE) program. Vice President Vitor Constancio told Reuters in an interview that the ECB has scope to buy more assets. But no policymaker has signaled any new interest rate move.

Market rationale is a deposit rate cut from the current level of minus 20 basis points could be more effective than increasing QE in depreciating the euro, which has strengthened again in recent months, keeping inflation near zero.

via Reuters

Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency trader focused on North America and emerging markets. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza