What is With the ECB


Recently we highlighted  that market is discounting the monetary policy easing in Eurozone by 15 basis points. Should the deposit rate be lowered from current -0,20% towards -0,35% the result would be neutral for the market. However as sources report, ECB plans to differentiate the deposit rate.

Such actions should raise questions how to interpret the decision. Should ECB introduce two new rates: -0,3% and -0,4%, we have to analyze, whether the -0,3% would be deemed more significant results in EUR strength (as market call for -0,35% rate) or the focus would shift towards the -0,4% being a drag for exchange rate. We could also try to average the new possible rates, making the decision net neutral for euro.

Obviously, the final call will be dependent on the exact rules of how the ECB depo rates would work. It is said, that authorities plan to assign deeper negative rate to deposits of higher amount. We keep the assumption that Governing Council introduces both -0,3% and -0,4% rates. In such scenario commercial bank depositing certain amount (let’s assume 500mn EUR) would be charged with less unfavorable rate (-0,3%), and about that level with the less favorable one. One could ask what in means for euro. Let’s keep in mind that rates differentials (e.g. 2-year yields or money market spread) are largely driving EURUSD rate.

The yield are quoted for institutional investors, assuming their capital is floating, it’s the one that should be treated as excess and being charged with lower depo rate (funds or corporations are not allowed to deposit their funds in EBC, they have to count on commercial banks, who will treat excess amounts in EUR as breaching the limit and offering the institutional investors less favorable rates).

The other rumor says that ECB that higher deposit rate would be assigned to banks that are relying on deposits from households and the lower one towards other institutions.  However it seems to be a bit overcomplicated, which in concept would aim to avoid burdening households deposits. However, the effect of this would be the same - the hot money is the "wholesale" one and would be burdened with less favorable rate.

Summing up, should ECB introduce the -0,3% and -0,4% rates the effect would be more negative for euro rate than maintaining one rate at -0,35%.