ECB Cut: Pushing On A String
Hamstrung by a restrictive mandate that prevents discretionary intervention, the European Central Bank has, in recent years, been forced to exploit loopholes in its statute and adopt a gritted teeth approach to monetary policy. As a result, official policy has been cumbersome and reactive, rather than flexible and proactive. With this in mind, it came as a surprise that the ECB opted to cut the refinancing rate by 25bps to 0.25% on November 7, which atypically caught the market off guard. While consensus had been converging on the assumption of a cut by end-year, many (ourselves included) were leaning towards a December policy move. In the immediate aftermath of yesterday's decision, the euro plunged to US$1.34/EUR and equities broadly rallied. The euro could have a bit further to slide in the short term, but we expect any relief for the export sector to be proved short-lived absent a more fundamental stimulus from the ECB.
Deflation Fears Prove To Be The Key Trigger
There are several dynamics at play which have forced the ECB's hand at the November monetary policy meeting. For one, the euro has proven stubbornly strong throughout 2013 (we had turned more bullish the euro at the beginning of the year), raising fears that the nascent economic recovery could be choked off before gaining any momentum. In addition, the ECB has become increasingly concerned about the possibility of an 'LTRO cliff' as euro area banks have been steadily repaying the loans acquired in December 2011 and February 2012, ahead of the three-year maturation.
|Recent Refi Cut May Have Little Traction|
|Eurozone - Refi Rate Moves (Vertical Axis) & % EUR Change 7-Days Either Side Rate Move (Horizontal Axis)|