EUR: The Quiet Before The Storm; How To Play It? - Credit Agricole

The EUR came under sharp selling pressure on the back of media reports about the ECB considering a two-tier deposit rate cut. In essence, the ECB will want to distinguish between retail and wholesale banks in the Eurozone. The policy makers are reluctant to penalize the retail banks that fund themselves mainly via domestic deposits too aggressively given that this could increase the risk of deposit flight. As a result, they could end up penalizing wholesale banks more aggressively given that the threat of deposit flight is less pronounced there.

All that could imply that deeper depo rate cuts could be announced for certain banks in the Eurozone next week. One way to do that is to use thresholds levels for excess deposits beyond which the ECB will apply more onerous penalty. These thresholds will be a function of the bank’s required reserves, which in turn depend on the size of their retail deposit funding.

If the ECB were to adopt the above measures this need not be seen as a significant drag on the EUR especially if it penalizes less the banks with the larger retail deposit bases. Indeed, the flight from EUR was partly driven by foreign depositors fleeing because of concerns that the retail banks will start charging negative deposit rates. If these banks are ‘spared’ by the ECB, however, this could slow down the EUR-outflow not accelerate it. We further expect that more aggressive deposit rate cuts could encourage bank lending as well as investor demand for Eurozone stocks. These could prove long-term growth and EUR positive.

In terms of views and as stressed above we see additional room of the EUR correcting higher. This is especially true as there is limited room of even further rising ECB easing expectations. We expect levels closer to 1.08 to prove another opportunity to sell the currency.

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