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 The low bank-to-bank lending rates further highlight the divergence
of monetary policies in Europe and the United States, where markets
see a one in four chance the Federal Reserve may hike rates for the
first time in a decade on Thursday.
Analysts calculate the probability that markets attach to another
ECB rate cut at about 20 percent. But even the bias in direction
shows unusual defiance of Draghi's policy guidance.
The new market leaning comes on the back of a weakening in the
inflation outlook despite the ECB launching a trillion euro
bond-buying program in March to pump new money into the economy.
Also, at the last ECB meeting, Draghi showed openness toward an
expansion of the quantitative easing (QE) program. Vice President
Vitor Constancio told Reuters in an interview that the ECB has scope
to buy more assets. But no policymaker has signaled any new interest
rate move.
Market rationale is a deposit rate cut from the current level of
minus 20 basis points could be more effective than increasing QE in
depreciating the euro, which has strengthened again in recent
months, keeping inflation near zero.
"A deposit cut is a possibility," said Antonio Garcia Pascual, chief
European economist at Barclays, adding though that it was more
likely that the ECB would just expand its bond-buying program.
"The context for a potential deposit rate cut would be against the
background of an appreciating euro which would be unwelcomed by the
ECB because it would be unhelpful for inflation and for exports and
the euro area recovery."
Factors behind moves in the euro are complex and go beyond the ECB's
monetary toolkit.
Still, a quick look at the charts shows that after the ECB moved the
rate it offers on overnight deposits into negative territory in June
2014, effectively turning it into a penalty for not putting money to
work, the euro <EUR=> weakened by 5 percent against the dollar in
the subsequent three months.
Another cut in September last year, after which Draghi said of
interest rates that "we are at the lower bound, where technical
adjustments are not going to be possible any longer," led to a
further 5 percent, three-month weakening in the euro.
By contrast, the euro is 8 percent stronger than when QE started six
months ago, although a Fed hike might hurt it again.
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PROBABILITY CHECK
Analysts say expectations of a deposit rate cut are reflected in
forward Eonia bank-to-bank lending rates.
One-month Eonia rates projected six-months to one-year into the
future are below -18 basis points, compared to the ECB deposit rate
at -20 bps.
The gap between spot Eonia rates and the deposit rate has never been
so low. On average, it has been 8 bps in the past two years and
occasionally it has narrowed to 4-5 bps.
Alexander Wojt, European rates strategist at Morgan Stanley, takes a
5 bp spread as a starting point, implying expectations that the ECB
deposit rate would be about 22 basis points in six-month's time.
This translates into a 20 percent chance of another 10 bps cut.
"You could argue two things: one, that we are pricing in ...Eonia to
trade closer to the deposit rate," Wojt said. "The reason why we
don't like that interpretation is that that's not the way Eonia has
been behaving."
"An alternative interpretation, which we find more likely, is that
... markets have started to price some probability for a deposit
rate cut."
Wojt said, however, that he considers the pricing too aggressive and
recommends investors to bet against it.
In fact, the consensus remains firmly on the side of rates staying
on hold.
"The wording by Draghi was clear when they did the last rate cut,"
said Commerzbank rate strategist Benjamin Schroeder.
(Reporting by Marius Zaharia; Editing by Toby Chopra)
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