The European Central Bank (ECB) is at it again! In an event that’s more anticipated than the Captain America: Civil War trailer, Super Mario Draghi and his friends announced the latest changes to their monetary policy policies that sent forex volatility hunters all over the charts.
What exactly did they say and why the heck are all my friends and their neighbors talking about it? Let’s break it down to the most common questions.
What the heck did the ECB say?
Looks like the central bank is throwing the kitchen sink at the euro zone’s inflation problem. Recall that the ECB is fighting tooth and nail to boost economic activity by motivating banks to make it rain for businesses and consumers. This time Draghi and his gang are fighting on several fronts:
- The main refinancing rate was cut down from 0.50% to 0.00%.
- The deposit rate deepened into negative territory from -0.30% to -0.40%
- The marginal lending rate was cut from 0.30% to 0.25%
This means that the euro zone’s banks can now pay less when they borrow money from the ECB but pay more if they want to store their extra moolah with the central bank.
- Monthly asset purchases are bumped up from €60 billion to €80 billion a month starting in April.
- The ECB can now buy investment grade, euro-denominated bonds issued by corporations instead of only assets issued by banks and financial institutions.
- Four targeted longer-term refinancing operations (TLTRO II) will be launched in June. Each series will have a maturity of four years.
Hold up. What’s the difference between the rates anyway?
The main refinancing rate (also known as minimum bid rate) is the minimum rate that the ECB pays to buy short-term assets from banks. The deposit rate is what the banks pay to park their money with the ECB, and the marginal lending rate is the rate that banks pay for their short-term loans to the ECB.
What’s with the full court press?
Draghi explained that his gang ain’t fooling around, as they’re reacting to “significantly changed” conditions in the global economy and financial markets since its last meeting.
The ECB could also be responding to its lower growth and inflation forecasts. The central bank cut its 2016 growth forecasts from 1.7% to 1.4%, then 1.9% to 1.7% in 2017 and 1.8% in 2018.
Meanwhile, it expects inflation to hit 0.1% this year, significantly lower than its 1.0% projections in December, while 2017 and 2018 inflation are also expected to miss with respective growth rates of 1.3% and 1.6%.
The last but not the least explanation for the ECB’s aggressive changes is that it wants to communicate its commitment. If you recall, back in December market players said “meh” when the ECB only cut its deposit rates by 0.10% and extended its asset purchases program by six months. Guess they want to make an impact this time, huh?
So why the heck did the euro rally?
It was all rainbows and unicorns for the euro bears until Mario Draghi hit the stage. In his presser, he hinted that the ECB is done adding stimulus for the time being, and that the central bank isn’t likely to cut rates further unless new facts change their outlook or Peyton Manning decides against retiring after all. I’m kidding about the second part, but you know what I mean.
Not surprisingly, the prospect of no further easing from the ECB woke up the euro bulls and inspired sharp spikes in favor of the euro.
What’s next for the ECB and the euro?
Right now Draghi is predicting that inflation will stay “very low” for at least another year, and that interest rates will likely stay in negative territory for a while.
With not much optimism in sight, market players are speculating that the ECB is just kicking the can down the road, if not running out of ammunition altogether. Will the ECB soon sing the same tune as the BOJ and scramble to prevent a deflationary spiral, or will their latest changes actually work in stimulating economic activity?
Until we see significant (and sustained) progress in the euro zone’s economic indicators or we hear threats of more easing from the ECB, the euro will likely stay within its ranges against its counterparts. Just make sure you keep an eye out for any black swan events or catalysts that might inspire volatility for the euro!