Improving economic data had not pointed to a 25 basis point reduction in both the main refinancing rate and the marginal lending rate. The eurozone economy emerged from recession in the summer and is now embarking on a moderate upwards trend. The pickup in the eurozone is on a broad regional footing and also encompasses countries such asSpainandPortugal.
The ECB justified its rate cut with the revision to its medium-term inflation outlook. It sees evidence of lower inflation over an extended period. We concede that at present – given underused capacity and weak labor markets – there is scant inflationary pressure in the eurozone. For the foreseeable future inflation is more likely to undershoot than overshoot the ECB’s stability target of close to 2%. But the drop in inflation in the eurozone is also a reflection of the return to competitiveness repeatedly called for. The discussion about deflation risks in the eurozone, triggered by the unexpectedly steep drop in inflation in October, is taking place against the backdrop of a remarkable structural adjustment in the eurozone and in our view offers no grounds to turn the interest-rate screw. What is more, the positive impact of low inflation on real household disposable income is being largely ignored.
According to the ECB President the euro exchange rate played no role in the decision. The euro is likely to tend downwards. However, against the backdrop of more dynamic growth in theUSand the delayed, but not ditched, tapering by the Fed, we see downward risks to the euro which could spawn inflationary trends. In the medium term the upward trend in the eurozone economy and unlimited supply of liquidity provide the breeding ground for rising inflation rates.
In such conditions, the maintenance of the easing bias is hard to understand, i.e, the ECB has left the door open for a cut to the zero bound with its unchanged forward guidance.
By contrast, we welcome the fact that, in view of fragmented banking markets, the ECB has extended its very generous supply of liquidity with full allocation until mid-2015. The availability of liquidity for banks with limited access to the money markets is far more important than lower interest rates.
The rate cut makes it less attractive to turn to the money market for funding – its role is increasingly being assumed by the central banks. A substantial reduction in the still bloated Target2 balances is therefore not on the horizon.