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ECB meeting: ECB slashes deposit rate, extends QE to help raise inflation

FXStreet (Mumbai) - European Central Bank chief Mario Draghi admitted persistent low inflation rate reflects sizeable economic slack. The declining core inflation in the bloc called for further easing measures and Draghi had hinted that that more monetary easing was in the pipeline. In the last one week leading to today’s meeting, markets had speculated on the different easing tools that the central bank would choose to inject more funds into the system.

ECB slashes deposit rate further into the negative territory

Living up to its commitment to do all it could to pull inflation up “as quickly as possible, the central bank decided to slash deposit rate by 10 basis points. The deposit rate now at -0.30 per cent moves further into the negative territory and hopefully will help raise stubbornly low inflation. Banks will be charged more for parking cash with the ECB from 9th December on wards when the decision comes into effect. Today’s rate cut highlight the central bank’s intention to further weaken the euro exchange rate and thereby support economic growth through exports.

The central bank however left both the refi as well as the marginal lending facility rate unchanged. The interest rate on the main refinancing operations and the interest rate on the marginal lending facility were kept unchanged at 0.05% and 0.30% respectively.

Critics argued that with slashing rates further, the bank breaks its forward guidance. The ECB in its defence said that floor rates have been lowered as Switzerland and Denmark chose to cut rates deeper into negative territory. The ECB thus feels that it cannot be held responsible for going back on its word its word; it is the "lower bound" that has further dropped lower.

The critics of easing however feel that monetary policy is already exceptionally loose. Low oil prices have been blamed for the bloc’s inflation woes. However, core CPI that strip energy prices has stayed half the inflation target indicating that the scenario will be no better even when oil prices actually rises.

QE extended to March 2017; ECB to buy regional bonds

The ECB chose to extend its monthly asset purchases by seven months up to March 2017 or “beyond if necessary”. It was decided at the governing council’s meeting that the central bank would not only include euro-denominated regional and local debt in its QE programme but would also reinvest principal payments in the scheme. Draghi however did not clarify how much would be added to overall purchases which is currently touching 60 billion euros a month.

He considers extending the scheme and reinvesting proceeds to be sufficient. He noted "Our asset purchase program is flexible. It can always be adjusted. We decided the extension of our horizon and especially the re-investment of principal would be sufficient”.

He observed that risks to the world economy and to the inflation outlook remained skewed to the downside. He did not rule out the use of other instruments if required. GDP is expected to grow 1.5 per cent in 2015, 1.6 per cent and 1.7 per cent in 2017

Inflation forecast unchanged for 2015. The ECB expects inflation to come in at 1 per cent in 2016. It is expected Inflation forecast estimated at 1.6 per cent for 2017 as against 1.7 per cent estimated earlier. Domestic demand is expected to be further supported by monetary policy. Low oil price, he says will support household disposable income thereby supporting private consumption.

Markets disappointed

Markets were expecting some more with respect to stimulus measures. Investors were disappointed with the measures announced by a central bank that had previously always given them pleasant surprises. As the measures fell short of investors’ expectation, the stock markets tumbled. The euro however surged to a one-month high. The euro leapt nearly three cents against the dollar to $1.0818. Prior to the meeting the currency had traded at a seven-month low of $1.0525.

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