The ECB Can’t Get the Wording Right

The European Central Bank (ECB) decided to cut rates from 0.05% to 0% on Thursday. In addition, the ECB will also increase their monthly asset purchasing to €80 billion, starting in April. Included in this list of assets will be investment grade euro-denominated bonds.

What will all this mean? Hopefully, it might result in a boost to Europe’s economy. Cutting rates and pumping money into the system is usually what gets the job done. A rate cut tends to encourage lending, as borrowing money becomes cheaper. It is hoped that this injection of money into the economy will spur investment.

The ECB also pushed the key deposit rate to -0.4%. This would make it so that it actually costs savers to keep their money in the bank. Borrowers should, in theory, be the biggest beneficiaries of negative rates. However, not everyone agrees. Bankers and insurance companies claim negative rates are undermining their business models.

In addition to the stimulus package Mario Draghi, head of the ECB, commented that there would be no more cuts. Specifically, Draghi said,

From today’s perspective and taking into account the support of our measures to growth and inflation, we don’t anticipate that it will be necessary to reduce rates further.

It’s nice to see that honesty is not dead and gone. But Draghi may have done more harm than good. His comments have somewhat negated the very stimulus the ECB hoped to achieve. Not surprisingly, the euro rallied to unwanted gains following Draghi’s comments.

The euro jumped up as much as 3.7%, to €1.12 against the USD. Now, you might be wondering why this is a bad thing. A weaker euro makes their exports more competitive. Last year, the ECB projected that a 5% decline in the euro could boost Eurozone GDP by 0.3%.

The ECB has been trying to push inflation to target levels of 1.80%. They’ve spent €700 billion on asset buying in the past year alone. However, their attempts have not been able to raise inflation to acceptable levels.

Inflation in the euro area

Source: Eurostat

The effectiveness of their most recent stimulus remains unknown. But Nicholas Spiro, of Lauressa Advisory, called it perfectly, saying that ‘Draghi [misfired] his bazooka.

Draghi’s comments even affected us in Australia. The Aussie dollar traded as high as US$75.12 cents on Draghi’s comments. Yet it’s trended back down to around 74 cent since. Which begs the questions, is the AUD too high?

Some believe the AUD could go as high as US$80 cent in the coming months. However, whether this will happen or not is uncertain. The Aussie dollar has experienced a slight upward pressure since US$68.27 cent low this year.

In any case, Europe is hoping that negative rates are the answer. It’s worked for central banks in Japan, Switzerland, Denmark and Sweden. Maybe it will work for the ECB too.

Härje Ronngard,

Junior Analyst, Money Morning

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