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News | Question of the Week, WC 17th June
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Question of the Week, WC 17th June

Q:What will the ECB actually do?

Now that everyone agrees that the ECB will push ahead with further easing, it is worthwhile asking what they’ll actually do. First things first, we reckon that the central bank will cut the deposit rate first, before resorting to a revival of the QE program. Our base case is that the ECB will cut its deposit rate by 10 basis points in September, to -0.5%, though we agnostic between whether they opt for a more aggressive cut, for example by 20bp to -0.6%. We suspect that the central bank will try to validate market expectations which currently are almost exactly for a 15bp cut. For now, we are taking the under on that.

If we are right, the ECB likely will prepare markets next month by re-introducing the bias towards “lower” rates in its forward guidance. At the very least, it is fair to assume that markets will be looking closely for a such a change at the July meeting. Meanwhile on the technical side, a further cut in the deposit raises questions about the so-called rate corridor—the spread between the deposit rate and the marginal lending facility rate—and the notion of a tiered interest rate on excess reserves. It would make sense to cut the marginal lending facility rate by the same amount as the deposit rate, to keep the corridor constant.  That said, the importance of the MLF rate has diminished in light of the significant additional liquidity provided to banks via the TLTRO, which potentially come with a negative rate. With respect to a tiered interest rate on reserves, we reckon that the ECB will have to introduce such a system if they decide to further reduce its deposit rate. The most logical step in our view would be to create benchmark system so that banks of different size are exempted from negative rates based on their current level of reserves relative to their own, or a peer group’s, historical level. That said, this is a very technical issue in the end, so it is anybody’s guess how the ECB intends to approach it, if at all.

Claus Vistesen, Chief Eurozone Economist

Pantheon Macroeconomics

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Posted: 21st Jun 2019

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