Courtesy of Mish.
As expected the ECB, cut its lending rate 25 basis points to 0.50%.
Yesterday, I suggested the ECB may try a “shock and awe” move. They did, just not the move anyone expected.
Instead, Mario Draghi said the ECB was Prepared to “Cope With Consequences of Negative Deposit Rates“.
Shock and Awe
Bloomberg reports
The euro fell for the first time in five days against the dollar after European Central Bank President Mario Draghi said policy makers may take the unprecedented step of charging banks to hold excess reserves.
“The euro was quite upbeat until Draghi made his comment that the ECB would be able to cope with any consequences of negative deposit rates,” said Daragh Maher, a currency strategist at HSBC Holdings Plc in London. “Previously, the language of the ECB on this front has characterized it as uncharted waters. Today, it seems the ECB is more open to the idea. The euro was clearly spooked by the mere concept of negative deposit rates in the euro zone.”
For an analysis of what this means, with a tip of the hat to Steen Jakobsen at Saxo Bank for the link, let’s flashback to a decision to cut the deposit rate to zero in July of 2012.
Dancing in the Dark Experiment
The Financial Times says ECB Dances in the Dark
It’s clear the ECB has gone into experimental mode.
A positive deposit rate was the last thing anchoring money market rates to zero — or vague profitability. This is because banks could arbitrage the difference between the rates they received at the ECB and the rates money market funds were able to invest at.
By cutting the deposit rate, the ECB is killing this arbitrage. There will not be any profit associated with taking money from non-banks and parking it at the ECB for a small profit. Non-banks won’t even be able to get zero.
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