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EUR: ECB’s rate reductions can lower long-term yields – Goldman Sachs

FXStreet (Delhi) – Research Team at Goldman Sach’s, suggest that the policy rate instrument in the Euro area has a sizeable impact on long-end rates, especially in the current environment of forward guidance and the ECB rate reductions can lower long-term yields as a supplement to QE (even if further rate cuts are not our base case expectation).

Key Quotes

“Our estimated impact on the 10-year swap rate from a 100bp monetary policy shock rises from around 55bp-65bp to 75bp-100bp when we consider the period since July 2013, where ECB forward guidance has been in place.13 Hence, central bank communication may enhance the effect of monetary policy shocks on long-term rates.”

“The ECB may wish to ease further on the back of falling oil prices, which are dragging down headline inflation and longer-term inflation expectations, and concerns about weakening global EM demand. A 10bp reduction in the deposit rate – and assuming this lowers the 2-year swap rate by a similar amount – would, on our estimate, imply a fall in the 10-year risk free rate in Europe of about 7bp-10bp. A 30bp cut (to -0.50%14) would imply a 20bp-30bp reduction in the 10-year risk free rate.”

“In comparison, 10-year risk free rates fell around 10bp during the ECB press conference on January 22 when QE was announced.5 This suggests that even a 10bp deposit rate cut may be a non-negligible supplement to ECB QE. Of course, given that overnight rates in the Euro area are already negative, the scope to reduce short-term policy rates is limited.”

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