Compare and contrast:
- In the US, after 7 years of ZIRP and QE, the expected December rate hike is supposed to push up inflation and confirm the economy is improving; it is naturally bullish for stocks.
- In Europe, a year and a half of NIRP and a year of QE, an imminent rate cut further into negative territory is supposed to push up inflation and confirm the economy is improving; it is naturally bullish for stocks.
Don’t think about that for more than 5 seconds or a certain famous scene form the movie Scanners will ensue.
Logic aside, according to a Reuters exclusive released moments ago, “a consensus is forming at the European Central Bank to take the interest rate it charges banks to park money deeper into negative territory in December, four governing council members said, a move that could weaken the euro and push up inflation.”
Odd – in the US it’s the rate hike that is expected to push up inflation, while in Europe it is the opposite. Must be some chapter on the geography of practical monetary policy in Krugman/Obstfeld that we missed.
And while Draghi already hinted that either another rate cut, or more QE, or both are coming in December, Reuters reports that “some argue that a deposit rate cut should even be larger than the 0.1 percent reduction currently expected in financial markets.” Must have been that S&P futs were down a whole 5 points.
“Let’s go for a big cut,” one Governing Council member, who asked not to be named, said.
The ECB cut its deposit rate to -0.2 percent in September 2014 and said it could not go any lower. However, other central banks have cut further, including the Swiss and Danish central banks to -0.75 percent, showing that deeper cuts are possible.
Three of the ECB policymakers said debate is now about the size of the rate cut with some arguing that a 0.1 percent reduction, already priced in by markets, would have little impact. Two policymakers said the bank should go for a bolder move, in line with its recent tradition of delivering policy moves in excess of expectations.
“There is no bottom to the deposit rate in the near term, it could be lowered quite sharply still,” he said. “There must be a bottom but it’s further out.”
Indeed, as Janet Yellen said when previewing the US NIRP: “rates won’t go much below zero.” The question is what does “much” mean.
Why the rush? “A rate cut aims to discourage banks from parking money at the central bank and start lending to generate growth. It can also weaken the currency as cash leaves the euro area in search of higher returns, boosting inflation as imports become more expensive. They are keen to exhaust the conventional and more direct monetary policy tool as they also consider amending the 60-billion-euro asset purchase program, a far more contentious issue that they have yet to agree on.”
Which, of course, is quite ironic because as we showed last month, the deeper European central banks have cut rates into negative territory, the higher saving rates have jumped:
We expect the ECB to be shocked when its latest deflationary rate cut pushes even more money into deposit accounts, much to the stunned confusion of central bankers everywhere.
More from Reuters:
Another Governing Council member also argued for a bigger deposit rate cut, saying it could go from -0.20 percent to -0.50 percent or even -0.70 percent after the Danish and Swiss examples. The rate setter said that “zero lower bound”, a term meaning the bottom for interest rates, either “no longer exists, or if it does it is well below zero”.
The risk in the cut is a squeeze on margins in the banking sector, already under pressure, and it is not clear that banks would boost lending to avoid the punitive rate for parking money with the central bank.
Another problem is that only relatively small central banks tried deeply negative rates and the potential side effects are not understood well enough to properly model.
Further complicating the matter is the ECB’s earlier communication that the deposit rate was at lower bound so a cut would break the guidance putting some pressure on the bank’s credibility.
And when a cut to -0.7% fails to stimulate spending and borrowing, the ECB can just cut to -1.0%, -7.0%, or more.
Finally, as BofA noted last month, if the ECB were to cut rates in the same month as the Fed hikes, it would be the first time this has happened in over two decades, going back all the way to May 1994.