Markets mull next ECB move as rate-cut effect fizzles out

Simon Morgan

File photo shows the Euro logo displayed in front of the European Central Bank (ECB) building in Frankfurt, Germany on September 5, 2013

The European Central Bank's surprise rate cut will have only a limited impact on anaemic economic recovery and further action will be needed to get Europe back on its feet, analysts said Friday.

The feel-good effect from the ECB's surprise decision a day earlier to clip a further quarter of a percentage point off already record low borrowing costs had already fizzled out by Friday.

Stock markets gave up their modest gains and Standard & Poor's downgrade of France sent the euro back rising against the dollar.

And ECB watchers -- who had been caught off guard by the central bank's move -- said the cut was primarily symbolic in nature and would not on its own be sufficient to kick start the eurozone's anaemic economic recovery.

"It was more a signal, a symbol than something which will have any great impact on the economy," said Marie Diron at EY Eurozone Forecast.

While the timing of the move came as a surprise, a cut per se had already been priced in to the markets, the expert said.

"So to have any impact, we need to see more. That could involve talking down the euro in some way," or a new long-term refinancing operation (LTRO), by which the ECB can pump more liquidity into the financial system, Diron argued.

The ECB already launched two massive LTROs at the end of 2011 and the beginning of 2012 to avert a potentially disastrous credit crunch.

And there is a concern that banks, even financially sound ones, may find themselves strapped for cash again soon as they beef up capital ratios ahead of an upcoming ECB audit.

Pumping liquidity into system

Prospects that the US Federal Reserve could also start "tapering" or phasing out its own anti-crisis measures could also see liquidity conditions tighten on this side of the Atlantic.

A new LTRO would be "one way of addressing a possible 'liquidity accident' and could help those banks that are ultimately healthy but need a bit of a buffer," said Diron.

ECB chief Mario Draghi insisted on Thursday that the strength of the euro -- it recently rose as high as $1.38 -- played no role in the decision to cut rates.

The ECB traditionally does not have any exchange rate target but closely monitors developments on the forex markets for their possible effects on inflation and growth.

A strong euro could choke off the tentative economic recovery.

The ECB would therefore have to find some way of talking down the euro, albeit indirectly, said Diron at EY Eurozone Forecast.

One possible way would be to be much clearer on its so-called "forward guidance" -- with which it essentially signals to markets where interest rates may be headed in the future.

So far, Draghi's forward guidance -- first issued in July -- has consisted solely of saying that he expects "the key ECB interest rates to remain at present or lower levels for an extended period of time."

But he has refused to be pinned down any further.

Analysts say the ECB could give clearer guidance by providing a possible timeframe or linking any moves to economic indicators.

With the key refi refinancing rate at an all-time low of 0.25 percent, the ECB does not have room to cut rates much further, without taking them into negative territory.

Draghi himself has repeatedly said the central bank is technically ready for such a move.

But both the ECB and analysts have warned of potential negative unforeseen consequences.

ECB watchers noted how pro-active the central bank has become under Draghi's leadership, compared with predecessors Jean-Claude Trichet and Wim Duisenberg.

"We had been impressed, when the ECB delivered a rate cut the day Draghi took over as president by how he developed a 'model based' view of the monetary stance, inspired more by the Fed's approach than by the ECB's tradition," said Deutsche Bank economist Gilles Moec.

"The very fact that Draghi demonstrated again a capacity to act fast and energetically strengthens our core conviction for Europe," said Berenberg Bank economist Holger Schmieding.

Draghi and German Chancellor Angela Merkel "will do whatever it takes to get the eurozone through the euro crisis," he said.

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