5 Reasons Not To Cut Rates – ECB Preview

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Those expecting a third rate cut from Draghi might be disappointed. The ECB will likely repeat the “business as usual” stance that worked so well last month.

There are 5 reasons for the ECB to wait and see for another month.

After rate cuts in November and December, the European Central Bank left the rates unchanged in January, at the 1% low. Given the bad economic situation in the continent and all over the world, many expect Draghi to act and cut the interest rate to 0.75%.

Draghi’s willingness to act led the markets to price a 58% chance of a rate cut. But here are reasons to wait once again:

  1. Some positive signs: Europe’s No. 1 economy, Germany, has shown some positive signs: employment continues rising, business climate is improving and purchasing managers’ indices are rising. The rise in PMIs isn’t exclusive to Germany, but is seen in the euro-zone as a whole.
  2. Greek drama: Talks between Greece and the troika are quite close to conclusion. The deal might involve some complicated assistance from the ECB through its Greek bond holdings. The ECB wouldn’t want to take the center stage right now with a rate cut, and wouldn’t want to seem to be too soft in general. Cutting rates and taking a haircut aren’t likely in the same week.
  3. Second LTRO awaiting: February 29th is a special date, that might see an indirect European QE in the magnitude of 1 trillion euros. The first LTRO resulted in 489 billion euros lent to European banks, and certainly helped stabilize the fragile banking system. Draghi took pride in this move, and will likely await the second operation before making new policy decisions.
  4. Inflation Still High: Contrary to the days of Jean-Claude Trichet, the ECB doesn’t have a single needle in its compass of inflation anymore. Nevertheless, Draghi would not want to anger the northern inflation hawks with another rate cut, while headline CPI is at 2.7%, above the “2% or a bit lower”” target.
  5. Rate at Minimum: It’s important to remember that 1% is the lowest rate ever, including during the peak of financial crisis, and including when inflation was extremely low. Cutting it would likely require more justification.

In the current environment, a rate cut would likely be greeted with a stronger euro on an active ECB, while avoiding a cut might be received with disappointment and a stronger euro.

When a member of the euro-zone is close to a default, whether orderly or disorderly, we are not in normal times, but rather “interesting times”, as the Chinese say.

Press conference

Draghi proved his skills at press conferences. He remains calm, confident and unmoved by reporters’ questions. He will likely express confidence about the LTRO. This worked perfectly well last time, and there’s no reason that it will not work now.

Reporters will likely ask many questions regarding the ECB’s involvement in Greek debt. Draghi will probably be wise to dodge such questions and say that negotiations are still going on. The same goes for any political of half-political questions.

In the previous press conference, Draghi didn’t categorically reject an ECB haircut. There is little chance that he’ll say more this time.

Assuming that Draghi will not slip his tongue, the euro will likely stabilize, and the pair will return to swing by every bit of news from Athens.

Update: Serious progress has been made in Athens, and this helps the euro. The chances of a rate cut are even lower now. There’s only a 300 million euro gap between both sides, and Greece was given two weeks to sort it out.

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Yohay Elam – Founder, Writer and Editor I have been into forex trading for over 5 years, and I share the experience that I have and the knowledge that I’ve accumulated. After taking a short course about forex. Like many forex traders, I’ve earned a significant share of my knowledge the hard way. Macroeconomics, the impact of news on the ever-moving currency markets and trading psychology have always fascinated me. Before founding Forex Crunch, I’ve worked as a programmer in various hi-tech companies. I have a B. Sc. in Computer Science from Ben Gurion University. Given this background, forex software has a relatively bigger share in the posts.