Neil Williams (pictured), Chief Economist, Hermes Fund Managers, comments on the European Central Bank’s (ECB) decision to cut interest rates…

Today’s ECB moves are a step in the right direction, but look too little, too late to snuff out deflation-risk and kick-start growth. The 10bp shavings off the refinancing and deposit rates are puny, and look more cosmetic than real. Any drop in the euro on the back of them would be welcome, but possibly short lived. The ECB hopes that the new, negative deposit rate (-0.1%) will deter banks from parking cash at the ECB, instead passing it on to consumers and firms. But, this may be a red herring, given still subdued credit demand, pressure for the banks to pass stress tests, and the fact that the bulk of reserves still gets the positive (0.15%) refinancing rate. These rates may have to be cut again.
 
The ECB’s ‘ground work’ on private asset purchases may help, but are not the ‘bazooka’ of unlimited sovereign QE it could have fired today. This preferably should be on a GDP-weighted basis to overcome the Bundesbank’s scepticism. But, it’s clearly leaving its powder dry. Snr Draghi’s hesitancy to use all his bullets today reflects how empty his policy tool box is. With demand subdued and the likelihood at some stage of rising bond yields, the ECB will have to capitulate on QE.
 
The biggest test will be when global yields start to climb, probably in 2015. Given two-thirds of euro-zone activity is long, not short-rate, driven, this will sap demand. Otherwise, the zone’s misery may be compounded by a stronger euro, doing nothing to allay fears that Japan is ‘leading the way’ in terms of deflation risk.”


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