With borrowing costs already in negative territory and recent data showing a moderate improvement in the euro zone economy, the European Central Bank (ECB) have made subtle indications that they would be reluctant to push interest rates down and investors are toning down their bets on the possibility.
Mario Draghi, ECB chief, said last Monday that the central bank was aware of the growing costs their ultra-loose fiscal policies are having on the euro zone banking sector and said he would not like to keep the policy for much longer.
The euro zone overnight index average (Eonia) for just before the ECB’s next meeting in the first week of December was at minus 0.3532 percent in the middle of the week, nearly the same as the previous overnight mark, showing investors are no longer backing a 10 basis point cut by the end of 2016. It’s already ultra-low at 0.45 percent.
“We certainly weren’t expecting this situation back in June when the Brexit happened,” a senior spokesperson at CITIC Tokyo International commented in a note to investors. “The market was pricing in a whopping 85 percent likelihood of an ECB cut at that time. Everyone was worried that Britain’s outlook for inflation and expansion was in the balance.”
Since the UK’s vote to leave the European Union, several positive economic reports have surfaced and across the Atlantic U.S. figures have improved so much that a Federal Reserve interest rate hike is expected before the end of the year.
All indicators currently reveal that interest rates have bottomed out, an encouraging sign for the banks, which previously were being charged money just for keeping their funds in central bank vaults.
“The lower boundary for rates looks like it has been reached, which is why investors are pricing out of any further rate cuts in the foreseeable future,” says ABN AMRO chief analyst Kim Liu. “The probability of further easing by the ECB is extremely low now, but not out of the question.”
Further fiscal stimulus by the ECB is likely to come in the form of asset purchasing, and particularly an expansion of their 1.8 trillion euro bond purchasing program.
The detrimental effect of negative rates on banks has been underlined recently with the concerns over Europe’s largest lender, Deutsche Bank, who is facing a $15 billion fine from U.S. authorities for their part in the sub-prime mortgage affair in 2008 and is finding it difficult to pull in revenue in the current financial environment.
