(Bloomberg) -- The European Central Bank’s best bet for reviving inflation expectations is an interest-rate cut rather than more quantitative easing, according to Danske Bank.
A sizable decrease in rates -- Danske wants to see the deposit rate cut by 20 basis points to minus 0.6% -- would be most effective at forcing excess liquidity onto the market and weakening the euro, senior analyst Jens Naervig Pedersen said in a note to clients. Without such a move, a new round of bond purchases would simply add to excess liquidity that gets parked back at the central bank.
“There is currently a lot of dead money ending up back in the ECB because a deposit rate of minus 0.40% is quite attractive when big parts of the government bond market trade at lower levels,” he said. “A cut in the deposit rate would heat up the cold potato.”
With the economy slowing amid global trade tensions and a manufacturing downturn, most analysts predict the ECB will signal more action at its July meeting and lower its deposit rate by 10 basis points in September meeting when it has updated economic forecasts. A growing number of observers expect quantitative easing also to make a comeback soon.
Danske also said that if the ECB introduces a tiered system of charges on bank deposits, to ease the pain on banks, that would erode the stimulative effect of a cut. If it opts for a shot of temporary quantitative easing, that might not be very effective as the tool is more potent when it is deemed to be permanent.