The single currency advanced initially – EURUSD rallied from $1.3150 to above $1.32 – after the ECB announced a widely expected cut in its main refinancing rate from 0.75% to 0.5%.
For many, however, the cut in the refi rate was nothing more than a symbolic act.
“It is unlikely to be of any interest to anyone, with the exception of the treasury departments of eurozone commercial banks,” says Ulrich Leuchtmann, head of currency strategy at Commerzbank.
“For some time now money market rates in the eurozone have not been linked to the main refinancing rate but to the deposit rate.”
Indeed, EURUSD plunged sharply, dropping more than a big figure down through $1.31 after Draghi said in his post-meeting press conference that the central bank was not just technically ready but open to negative deposit rates, which would in effect charge banks to keep funds with the ECB.
The rate, at which bank funds deposited back at the ECB are remunerated, is at 0% and in normal times has been kept 1% below the main refi rate to discourage institutions from parking cash with the central bank instead of lending it out to the wider economy.
Previously Draghi has expressed concerns over the dangerous side-effects of implementing negative deposit rates, just two months ago describing it as “uncharted waters” and noting that “the unintended consequences of a measure like that can be serious”.
It would seem, however, that the ECB is now sufficiently concerned about the economy that it is prepared to consider the move in a bid to boost bank lending.
It is a moot point, of course, whether such a move would boost the real economy. It does not address the problem that banks are unwilling to lend when the economy is stuck in recession and that companies do not want to borrow when the outlook is so bleak.
Still, negative deposit rates would make the ECB unique among leading central banks, encouraging institutions to send funds out of the eurozone.
Simon Smith, chief economist at FxPro, believes Draghi might have softened his stance on negative deposit rates because it is no longer such an issue.
During the depths of the financial crisis, banks were parking millions at the ECB on a daily basis rather than lending it out elsewhere.
This year, however, Smith notes overnight deposits at the ECB have fallen by a half and excess liquidity in the eurozone – as measured by the excess of current-account balances beyond requirements and net lending back to the ECB – has also fallen by a half to €383 billion.
At the same time, banks have repaid, ahead of time, more than €400 billion in three-year LTRO loans to the ECB.
“There is less money sloshing around, so less of it is being deposited back at the ECB, which means fewer banks will be impacted by a negative deposit rate,” says Smith.
“By waiting until later this year to implement such a measure, the ECB could well be thinking of having it as a stick, rather than a carrot, so that banks don’t find themselves in the situation of having to deposit huge amounts back to the ECB again.”
For FX, the implications for the euro are clear. The prospect of negative ECB deposit rates – and the fact they have not been implemented elsewhere – could encourage well-capitalized banks to park money outside the eurozone, which explains the fall in the euro after Draghi’s comments.
However, if those falling trends in excess liquidity in the eurozone continue, then the negative consequences for the euro will diminish.
That, says Smith, is why we could well see negative deposit rates in the eurozone soon.