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ECB Interest Rate Decision

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July meeting review

ECB Quick Analysis: Summer ends in September, EUR/USD falls

Yohay Elam
FXStreet

European Central Bank President Mario Draghi left everybody guessing. Markets wanted to pin down the date of the first rate hike by the Frankfurt-based institution, but they did not receive any clear-cut comments. As the eventual rate rise is quite far into the future, it makes sense not to commit to anything specific so far in advance. Uncertainties about the economy, inflation, trade relations and political turmoil caused the veteran banker not to disclose any detail. He did not pre-commit.

The ECB reaffirmed its way out

BBVA Bancomer Team
BBVA Bancomer

As widely expected, at today’s monetary policy meeting there were no changes in the ECB’s monetary policy stance, as the central bank left key interest rates unchanged and reiterated that it expects the key ECB interest rates to remain “at their present levels at least through the summer of 2019, and in any case for as long as necessary.”

ECB Governing Council monetary policy statement July 26

By FXStreet Team |

At today’s meeting the Governing Council of the ECB decided that the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00%, 0.25% and -0.40% respectively.

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Big Picture

what is the ECB?

The European Central Bank is the central bank empowered to manage monetary policy for the Eurozone. With its beginnings in Germany 1998, the ECB is empowered to maintain price stability in the euro area, so that the euro’s purchasing power is not eroded by inflation. As an entity independent of individual EU countries and EU institutions, the ECB aims to ensure that the year-on-year increase in consumer prices is less than, but close to 2% over the medium term. Another of its tasks is the one of controlling the money supply. This involves, for example, setting interest rates throughout the euro area. The European Central Bank’s work is organized via the following decision-making bodies: the Executive Board, the Governing Council and the General Council. Mario Draghi, member of the Executive Board, is also the President of this organism. His speeches, statements and declarations are an important source of volatility, especially for the Euro and the currencies traded against the European currency. 

who is ECB's President?

Mario Draghi was born in 1947 in Rome, Italy. Graduated of the Massachusetts Institute of Technology, he became President of the European Central Bank in 2011. Draghi gives press conferences in the back of how he observes the current European economy. His comments may determine positive or negative trends for the Euro in the short-term. Usually, a hawkish outlook is seen as positive/bullish for the EUR, while a dovish one is seen as negative/bearish. 

Mario Draghi

Draghi on his Profile and Wikipedia

How to Trade the ECB Rate Decision

Prior to the Rate Decision:

  • Many traders buy the rumors and square their positions shortly after the decision is made. For instance, if the market believes that the European Central Bank will hike the rate; traders buy the Euro and close the position shortly after the announcement. On the other hand, if the expectation is a rate decrease, traders will short the Euro and square the position after the announcement.

After the Rate Decision:

  • If the market’s expectations differ from the actual rate decision there can be some excellent trading opportunities.
  • If the market is expecting a rate hike, but the European Central Bank ends up cutting the interest rate, a short 1-2 hour trade selling the Euro may prove successful.
  • If the market expects a rate cut, but the ECB comes in with an increase in the rate, a trader may want to place a short long position on the Euro for 1-2 hours.

hike, low or mantain interest rates

The decision always has an effect on the Euro.

When the interest rate is increased the European Central Bank is literally selling government securities to large financial firms. In turn, the financial organizations are paying in Euros for these securities. This effectively decreases the amount of currency circulating in the economy. A decreasing supply leads to higher demand, and therefore causes the value of the Euro to appreciate.

When the interest rates are decreased, the European Central Bank floods the market with Euros. This is done by the purchasing government securities from financial organizations. In return for the securities, these banks and financial deals are paid in Euros, therefore increasing the supply of Euros in the economy. As supply increases, the value of the Euros depreciates.

the world interest rates table

The World Interest Rates Table reflects the current interest rates of the main countries around the world, set by their respective Central Banks. Rates typically reflect the health of individual economies, as in a perfect scenario, Central Banks tend to rise rates when the economy is growing and therefore instigate inflation.

some concepts you need to know

In practical terms, QE means that central banks create money out of nothing to buy securities, such as government bonds. This new money swells the size of bank reserves by the quantity of assets purchased and that’s why this programme is called Quantitative Easings. The money supply is intended to flood financial institutions with capital in an effort to stimulate lending and increase liquidity.

Much of the governments’ debt is held by banks in the Eurozone and the ECB wants them to give more credits. If the European Central Bank buys government bonds, their prices rise and profitability drop even more. This is a liquidity-providing operation that weakens the value of the euro. This depreciation makes European exports cheaper and competitive, and ultimately, helps in recovering. In addition, as a result of the stimulus to internal and external consumption, the ECB combats the risk of deflation, a widespread and prolonged drop in prices, as well as the high unemployment.

The long term refinancing operation (LTRO) is a cheap loan scheme for European banks that was announced by the European Central Bank towards the end of 2011 in a bid to help ease the eurozone crisis.

Round one was carried out on 21 December, when banks took €489 billion from the European Central Bank. The loans are due to be repaid within three years at a rate of 1%, and a second round will be launched on 28 February, with the results of how much money was requested due on 29 February.

As the eurozone crisis has escalated, banks have become less stable and have less money to lend. The objective of the LTRO is to boost cash flow in the market and avoid a severe credit crunch or collapse of the banking system. 

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