- We think a rate cut is very likely on Thursday, and expect Mario Draghi to cut the refi rate to 0.50%. A deposit rate cut is very unlikely, in our view.
- The ECB might present an instrument targeting lending to SMEs. The ECB is likely to work in tandem with other institutions on this.
- The market is already pricing in an ECB refi rate cut and therefore there is a risk the ECB could disappoint.
At last month’s Governing Council meeting, a rate cut was discussed and now Draghi has opened the door for the ECB to deliver a rate cut on Thursday. He said, ‘we will monitor very closely....we will assess all incoming data in the coming weeks and stand ready to act’. He also said that there were downside risks to the medium term outlook.
The main reason that the ECB has held rates unchanged in recent months despite weak numbers, has been that the Governing Council held the view that as long as the medium-term outlook is intact, the ECB should not cut rates further. However, the medium-term recovery in the euro area is dependent on a strong global recovery, and since the last Governing Council meeting Chinese and U.S. data have been disappointingly soft, which has called into question whether the drivers of the medium term recovery shoulremain in place.
In addition, the correction in global commodity prices has made concerns about inflationary risks less valid. Germany has been one of the fiercest opponents of further stimulus, but the outlook for Germany has also weakened and its inflation fell from 1.8% to 1.1% in April, which may help to dampen resistance.
Finally, the markets are already pricing in a rate cut and the ECB hawks have not tried to alter these expectations. On 19 April, Jens Weidman said, ‘of course, we will reassess the adequacy of the rates if the data changes’ and the day after Jörg Asmussen said, ‘the effectiveness of rate cuts is limited, but it’s still possible to do this if data justified it.
The impact of a refi rate cut on the real economy would probably be limited, as short market rates are currently determined by the deposit rate. However, this should not deter the ECB from trying. The most important effect of a refi rate cut might be that it will help to reduce the weekly repayments of three-year LTRO loans and thus slow the decline in excess liquidity, thereby delaying a shift in short market rates towards the deposit rate.
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