ECB Rate Setters Converge On December Deposit Rate Cut

A consensus is forming at the European Central Bank to take the interest rate it charges banks to park money deeper into negative territory in December, four governing council members said, a move that could weaken the euro and push up inflation.

Some argue that a deposit rate cut should even be larger than the 0.1 percent reduction currently expected in financial markets, the policymakers said.

They are keen to exhaust the conventional and more direct monetary policy tool as they also consider amending the 60-billion-euro asset purchase program, a far more contentious issue that they have yet to agree on.

The ECB last month raised the prospect of more monetary easing at its Dec. 3 meeting to combat ultra-low inflation, which is at risk of undershooting the target of nearly 2 percent as far ahead as 2017 due to low commodity prices and weak growth.

A rate cut aims to discourage banks from parking money at the central bank and start lending to generate growth. It can also weaken the currency as cash leaves the euro area in search of higher returns, boosting inflation as imports become more expensive.

The ECB cut its deposit rate to -0.2 percent in September 2014 and said it could not go any lower. However, other central banks have cut further, including the Swiss and Danish central banks to -0.75 percent, showing that deeper cuts are possible.

Three of the ECB policymakers said debate is now about the size of the rate cut with some arguing that a 0.1 percent reduction, already priced in by markets, would have little impact.

Two policymakers said the bank should go for a bolder move, in line with its recent tradition of delivering policy moves in excess of expectations.

“Let’s go for a big cut,” one Governing Council member, who asked not to be named, said.

“There is no bottom to the deposit rate in the near term, it could be lowered quite sharply still,” he said. “There must be a bottom but it’s further out.”

Two of the Governing Council members said there was no doubt that the ECB would act in December because inflation is still close to zero while a third one said the deposit rate cut was the least contentious proposal on the table.

Eonia forwards ECBWATCH, a key indicator of market expectations, suggest a 60 percent chance of a 10 basis points cut in December while analysts see both a 10 basis point cut and an expansion of the asset buys.

The ECB is working with around 20 different action proposals, mostly relating to asset purchases, and its committees are expected to narrow down the options in the weeks leading to the December rate meeting after circulating them among the euro areas 19 central banks, a source familiar with the situation said.

A simple extension of the asset buying program would have a limited impact and it is complicated to add new assets to the plan as each asset class has particular set of issues, one policymaker said.

Including corporate bonds could disrupt the market, for equities the ECB’s share would be too small for it to have a meaningful portfolio, while including a wider range of public agencies’ debt raises tricky policy questions, he added.

Overnight deposits with the ECB have risen to 187 billion euros from just 28 billion a year ago, a sign that the ECB is struggling to unblock the lending channel.


Another Governing Council member also argued for a bigger deposit rate cut, saying it could go from -0.20 percent to -0.50 percent or even -0.70 percent after the Danish and Swiss examples.

The rate setter said that “zero lower bound”, a term meaning the bottom for interest rates, either “no longer exists, or if it does it is well below zero”.

The risk in the cut is a squeeze on margins in the banking sector, already under pressure, and it is not clear that banks would boost lending to avoid the punitive rate for parking money with the central bank.

Another problem is that only relatively small central banks tried deeply negative rates and the potential side effects are not understood well enough to properly model.

Further complicating the matter is the ECB’s earlier communication that the deposit rate was at lower bound so a cut would break the guidance putting some pressure on the bank’s credibility.


One Governing Council member added that while some policymakers argued at last month’s rate meeting that easing would be pro-cyclical given the economic recovery, ECB President Mario Draghi countered the argument saying that getting inflation back to the target was the bank’s only goal and a boost to growth would be a residual effect.

Although several Governing Council members have been critical of further policy easing, Germany’s Bundesbank, a big initial opponent of quantitative easing, has been relatively quiet since the last ECB meeting.

One policymaker said that Germany’s silence was due in part to its recognition that its own growth momentum and export markets were slowing.

“As you know we don’t target the exchange rate and the Germans will never admit that a cheaper exchange rate would suit them, but that’s why they are silent,” the policymaker said.

Although the impact of putting the deposit rate deeper into negative territory is not totally clear, the ECB is likely to point to Denmark, Sweden and Switzerland as “the canary in the coalmine”, said one policymaker.

“It’s a nice image, except that we all know what happens to the canary,” a non euro area central banker said in response.

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell