Tuesday, April 21, 2015

ECB: Negative Rates Strikes Again!

On the occasion of 3 month euribor turning negative for the first time in history, here is a quick look at the policy rate corridor in Euro Area

What you see before the 2008 crisis is the original intention. The eonia and euribor tracking each other and the policy rate (refi rate) closely. The deposit rate and and the marginal lending facilities are uncollateralize lending and borrowing rates for bank with ECB. So naturally they straddle the other market and policy rates.

Then something changed after the crisis. Immediately after, and more emphatically in later half of 2012, the market rates (euribor and eonia) decoupled from the policy rate (refi). Finally ECB caught up in 2013. But eonia still trades below zero consistently. And today 3m euribor fixes below zero for the first time. Germany is negative till 8 year. 10y bunds on its way to trade below zero. Investors are ready to lend money to Germany for a meager 50bps for 30 year!

And we have quite a few months of QE left for ECB! A few more possibly if the inflation remains stubbornly moribund beyond 2016. Draghi categorically mentioned no further cut in depo. ECB under Draghi has been less prone to make statements in advance, or as Mr Draghi says, "pre-commit", without solid reason. So we can, for the moment, assume depo stays at negative 20bps.

The success of ECB QE is ultimately measured in inflation and inflation expectation. On this measure so far it has been moderate (see here). It remains to be seen if the bonds shortage issue come up in near future how ECB is going to handle that, without further cutting depo rate. 

Meanwhile we can assume they will not, and paying eonia on that assumption is the natural trade.

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