The European Central Bank (ECB) has sent a very strong signal to markets by saying it will keep rates low for an extended period of time, just weeks after its U.S. counterpart raised the possibility of scaling back its extraordinary monetary easing before the year-end, said economists.
The ECB surprised markets by stating clearly the future path of interest rate policy on Thursday putting the possibility of negative deposit rates back on the cards, according to experts.
"After 14 years of commitment anxiety, the ECB has today [Thursday] decided that providing forward guidance, in effect communicating that the current level of policy rates will for long be a ceiling, not a floor," economists at Deutsche Bank, wrote.
(Read More: Goldman Sachs Sees More Easing in Europe and UK )
"The message to the money market is strong: negative deposit rates, which had been seemingly downplayed last month, are firmly back on the table," they said.
Economists at Barclays agree there is a chance of further action by the ECB later this year, including a 25 basis point cut in its key interest rate to 0.25 percent, or a new round of long-term refinancing operations (LTROs). Via the LTRO programs, ECB lends money to banks at very low rates, which can then be used to buy higher yielding assets.
"More significant action including a negative deposit rate may be triggered by significant risks such as a hard landing in China," Barclays economists said in a note.
BoE Joins In
Just 90 minutes before the ECB's policy announcement, new Bank of England (BoE) governor Mark Carney also struck a dovish tone, saying increasing interest rates are "not warranted" as this could derail the country's fragile recovery.
"I think what we saw yesterday [Thursday] was extremely important from an ECB and BoE point of view. It was central bank independence day, fourth of July," said Rob Rennie, chief currency strategist at Westpac.
(Read More: How It Happened: Markets, ECB and BoE Decisions )
"They made a very strong statement that yields are rising as a result of Fed tapering; saying we've got to start pushing back. A rise in yields in Europe is unwelcome, a rise in the U.K. is unwelcome," he said.
Expectations for a winding down of the Federal Reserve's bond buying program has pushed yields in European government bonds higher in the past month, with the Spanish 10-year , for example, rising to 5.16 percent in late-June from 4 percent at the beginning of May.
The U.S. non-farm payrolls data for June due out later in the day, seen as a clue for the timing of the Fed tapering, is expected to show 165,000 jobs were added last month after 175,000 in May.
As a result of the ECB's dovish stance, Rennie said that he is recommending his clients sell the euro (Exchange:EUR1M=) against the U.S. dollar. The single currency fell to a five week low of $1.2284 late Thursday, before steadying to $1.2898 in the Asian trading session on Friday.
(Read More: Euro Slides as Draghi Commits to Low Rates )
He added that tensions in the financial markets stemming from the prospect of Fed tapering will be at the center of discussions at the upcoming G-20 meeting of finance ministers and central bank governors on July 19-20.
For, Steen Jakobsen, chief economist at Saxo Bank, the ECB and BoE's willingness to communicate with the market has made him less confident in their economic outlooks.
"Maybe it's just the skeptical part of me, but since first Fed, then ECB and BOE seems to be more willing to communicate with the market I have become less confident in both their forecast and projection because ultimately what they are telling is: We have tried everything - now we can only talk to you - dazzle you with our ability to make a song and a dance," Jakobsen said.
- By CNBC's Ansuya Harjani.
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