Will the ECB embark on negative rates?

Although a rallying euro is likely in the near future, due to a slacker monetary policy by European banks, it is not necessarily conducive to sustained eurozone growth.

The European Central Bank (ECB) is open-minded and could be argued to be technically ready to lower its deposit rate into negative territory; however the side effects of an actual rate-cut are likely to risk hurting the beleaguered banking sector.

Carefully calibrating the rhetoric is what has kept a cap on the euro against both the US dollar and the British pound of late, but if the central bank is trying to send the euro lower by talking about the possibility, they may be out of luck; either the market still doesn’t believe that it will happen or the idea of it is priced in. I suspect the former.

ECB president Mario Draghi has intimated that low interest rates will prevail for a sustained period, and this has been confirmed for at least 12 months. Good news for tracker mortgage holders, not so good for the savers.

Official figures show that eurozone debts are deteriorating despite the reforms that are in place. eurozone government debt has risen to 92.2% of GDP, up from 90.6% three months earlier. Political clashes, ambiguity over bad bank assets and growing uncertainty over the capability of the ECB are threatening to topple the confidence in the eurozone that has been built over the past year.

Outright Monetary Transactions

OMT is an ECB program under which the bank makes purchases (‘outright transactions’) in secondary sovereign bond markets, under certain conditions, of bonds issued by eurozone member-states. While the OMT programme has yet to be tested, the mere idea of it succeeded in calming the markets last year, and perhaps helped bring about an air of harmful complacency with respect to individual government and country reform.

Access to the debt markets has been given a degree of priority, and while stable markets are a boon and ultimately invite investment and confidence – the underlying issue of the teetering zombie banks – existing public and private debt remains unaddressed. Bank funding conditions in the third quarter are still expected to deteriorate.

Turning a corner

Some areas appear to be picking up, albeit coming off a fairly low base. Germany’s most recent data release featuring service and manufacturing output rose more than expected. The overall composite numbers for the eurozone rising to a level not seen in two years is encouraging, and suggests we may see a return to positive growth of around 0.2% on the quarter.

Having established four consecutive weeks of gains from mid-June until mid-July, the EUR/GBP currency pair is currently consolidating and, so long as the 85p level holds firm, there is a propensity for the euro to rally back to this year’s highs just above the 0.8815 level. Any drop below the 85p level should be well supported around 84p.

Against the greenback, the new five-week high at 1.3250 may be a tad overdone; a breakthrough here will be likely to find it difficult to overcome the 1.33 metric. Yet with the uncertainty over the US Federal Reserve’s quantitative easing tapering, and rising equity markets pulling capital from its safe haven, we could well see a weaker dollar in the coming weeks.

The western Europe economies may be turning a corner, but the likelihood of a tighter monetary policy from either bank is not in our immediate future. In any case, a stronger euro is the more likely outcome given the lack of tools available to the ECB; but such a scenario is not necessarily conducive to a continuing recovery.

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