ECB rate cut expectations temper curve flattening

Nick Kounis, head of financial markets research at ABN AMRO, suggests that financial markets have started to price in a significant possibility of ECB rate cuts, with the chances of a relatively early move rising since the re-escalation of the US-China trade conflict.

Key Quotes

“We calculated that financial markets are pricing in around 25% chance of a 10bp deposit rate cut by the end of this year, and a close to 40% chance of a 10bp reduction within a year from now.”

“We agree with the notion that the chances that the ECB implements another round of stimulus have risen and are now significant. Although a recession in the eurozone economy as whole over the next few quarters does not seem very likely, continued sluggish economic growth for a longer period is plausible.”

“Together with depressed inflation expectations, this could see underlying inflationary pressures remaining weak. So there is a clear case for additional monetary stimulus. However, we doubt it will take the form of rate cuts. Although ECB officials have rightly played down the impact of negative rates on bank profits recently, they have also expressed concerns that the adverse effects could rise over time.”

“We think on balance, fresh stimulus is likely to come in the form of another round of quantitative easing.”

“Although raising the limit would likely be an uncomfortable situation for the ECB, it would be willing to do this in our view given the lack of other alternatives. If the ECB were to go for QE-II rather than rate cuts, yield curves would likely flatten even more aggressively reflecting further term premium compression, while swap spreads would likely widen further.”

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