Debt and money markets are readying for a cut to the European Central Bank’s deposit rate, regardless of what its policy makers say in public.
Traders are pricing in a possible reduction to the rate for holding overnight deposits, said UBS Group AG and Barclays Plc. ECB officials have declared it’s too early to expand stimulus and President Mario Draghi said more than a year ago that rates have reached their nadir. Economists predict changes to its bond-buying program, or quantitative easing, would come before any adjustment to more conventional monetary tools.
With inflation in the euro region once again negative, speculation has swelled that the ECB will tinker with policy, perhaps with the euro in mind. The currency’s recent appreciation has added to downside risks for growth and inflation outlooks, ECB Executive Board member Yves Mersch said. The central bank won’t hesitate to act if the inflation outlook weakens over the medium term, Mersch said Oct. 13.
The deposit rate was set at minus 0.2 percent in September 2014, after first being cut below zero in June that year. Draghi said at the time rates had reached its “lower bound.”
Yields on Germany’s two-year notes were at minus 0.26 percent on Friday, meaning buyers would get back less than they paid if they held the securities until they came due. The market is pricing in at least a 50 percent chance of a cut of 10 basis points, or 0.1 percentage point, to the deposit rate, according to UBS strategists.
Two-year yields would move down to the new deposit rate if it’s cut, UBS’s Patel said. Five-year yields would move in step, keeping the spread between the two at about 23 basis points, while the 10-year yield would move less, he said. Any such action from the ECB should be supportive for short-dated core bonds amid the rise in excess liquidity, and so Patel recommends buying five-year French securities.
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