Divyang Shah, Senior IFR Strategist
With the ECB hesitant to cut the deposit rate to below zero, we think it likely that only the refi rate will be cut next year and the corridor narrowed.
Neither Knot nor Coene are talking about a negative deposit rate, but instead mention how the interest rate corridor would impact on money markets.
Knot (Belgium CB head) is in favour of maintaining the corridor, warning that if the refi and deposit rates were not cut in tandem this would “stifle or even reverse” the nascent revival in the interbank market. Governing council member Coene, on the other hand, thinks that narrowing the corridor would limit volatility on EONIA. The comments were made in interviews with MNSI and highlight that the ECB remains undecided on what to do with the deposit rate.
The deposit rate has acted as a floor for money market rates with o/n EONIA still below 10bp despite the forward-curve pricing in an environment of lower excess liquidity. A negative deposit rate would hurt the interbank market as banks would be reluctant to conduct transactions at negative rates. A cut in the refi rate by itself, on the other hand, would have the advantage of supporting the ECB’s forward guidance, and flattening the EONIA forward curve.
If and when the Fed is ready to taper QE, the ECB is likely to look at a further refi rate cut as an option in order to flatten the EONIA curve and prevent it from steepening in line with the US money market curve. This would allow the other policy option of a VLTRO (very long-term refi operation) to be deployed, should excess liquidity decline too fast, or signs of stress appear ahead of the AQR/stress tests.
