Divyang Shah
IFR Senior Strategist
Critics of the ECB’s latest rate cut have focused on the impact it will have on savers. Much of the analysis against the ECB rate cut fails to focus on low inflation and how the cut was justified by the ECB’s inflation mandate.
The potential for the ECB to continue to surprise on the policy front suggests taking a look at OTM calls on Euribor.
What is interesting is the way in which ECB chief economist Praet takes the mandate based explanation a step further today and reminds savers: “Prolonged stagnation in incomes and negative inflation can only bring destruction of income and saving. As Japan teaches, permanent stagnation brings decades of zero or even negative returns for savers.”
The trigger for action was not that inflation surprised, but that the ECB saw the prospect of inflation persistently staying below 1%. The ECB feels that the rate cut is buying some insurance against low inflation. The ECB is taking its mandate seriously and over the coming months the outlook on inflation will determine whether the ECB needs to deliver further easing.
The scope for further ECB policy surprises is higher than markets currently believe, as the ECB is looking to deliver on its inflation mandate.
Taking an upside punt via calls seems attractive from a risk reward perspective. Dec14 Euribor options with a 99.875 strike, which expire Dec 15 2014 have a theoretical value of 4 ticks.