ECB Cuts Policy Rate to 0.5%, Hints for Negative Deposit Rate

The ECB cut the main refinancing rate by -25 bps to 0.5% in May, in response to the easing inflation and rising unemployment rate in the 17-nation Eurozone. Risks of further easing remain to the downside and President Draghi signaled that the central bank would not avoid negative deposit rate. The special liquidity facilities are also maintained until at least the middle of 2014.

The post-meeting statement suggested that the rate cut was adopted amid low inflation and weak economic sentiment which has "extended into spring of this year". Policymakers expected that the easing should "contribute to support prospects for a recovery later in the year". On the economic developments, the bloc is in recession with at least 2 consecutive quarterly contractions in GDP while the job market conditions remained weak. Yet, the export growth would "benefit from a recovery in global demand". The central bank also viewed the pickup in financial markets since last summer should pass through to the real economy. In short, the ECB expected economy activities would "stabilize and recover gradually in 2H13. Yet, downside risks, including "the possibility of even weaker than expected domestic and global demand and slow or insufficient implementation of structural reforms", remain.

In addition to the rate cut, policymakers pledged to keep the monetary policy stance "accommodative for as long as needed" and "monitor very closely all incoming information". At the press conference, President Draghi reinstated that the central bank would "look at all the incoming data and stand ready to act if needed". Another attention was on the deposit rate which stayed at 0%. When asked about the outlook of it, Draghi stated that the ECB would keep an open mind on the likelihood of taking the deposit rate to negative.

The euro slumped although the rate cut was widely anticipated. The key reason was the possibility that the deposit rate would fall to the negative territory despite the various unintended consequence it would lead to. Needing to pay for holding euro deposits would trigger money to flow from the Eurozone to other higher-yielding assets. This would also encourage banks to lend money out rather than keep it at the ECB.

IMOH, Clement I.
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