U.S. Markets open in 6 hrs 34 mins

ECB has room to move in deflation fight: Marc Chandler

Aaron Task
Editor in Chief
Daily Ticker

Europe is "clearly moving in the right direction - the glass is at least half-full." That, at least, is the view of European Central Bank President Mario Draghi, who issued those comments in Brussels this week ahead of the ECB's policy meeting on Thursday.

This week's ECB-speak would seem to be an upgrade from Draghi's statement on Feb. 27 when he said: “We will remain alert as to whether any indication on further downside risks to price stability emerge and we stand ready to act.”

The recent drama in Ukraine, as well as data showing eurozone inflation rose a higher-than-expected 0.8% in February, have further complicated economists' efforts to predict what the ECB will -- and won't  -- do at Thursday's meeting. About one-third of economists surveyed by Reuters expect the ECB to cut its key repo rate from its current 25 basis points, while Bloomberg's survey showed only 25% expecting a move.

But there is more the central bank can do, Marc Chandler, global head of currency strategy at Brown Brothers Harriman says in the accompanying video, including:

  • Cut its overnight lending rate, which is currently at 75 basis points.
  • Start charging banks for deposits held at the ECB (the rate is currently zero).

"By lowering the price of money" and instituting negative deposit rates, "the ECB hopes to encourage people to borrow as well as banks to lend," Chandler says, noting bank lending in the eurozone has fallen for 19 consecutive months.

The problem with that theory is "banks are in process of deleveraging," he says, citing another factor that has most observers much more concerned about deflation in Europe vs. inflation -- and concerns the ECB is behind the curve.

As Bloomberg reports: While the ECB cut its benchmark to a record low in November, it hasn't issued three-year loans to banks since 2012, has resisted quantitative easing and its balance sheet has shrunk almost 30% since a June 2012 high of 3.1 trillion euros ($4.26 trillion). By contrast, the Federal Reserve has held its key rate near zero since 2008 and a third round of asset purchases has swelled its balance sheet beyond a record $4 trillion.

Another factor likely to weigh on the ECB's decision Thursday is the recent strength in the euro, which dipped on Wednesday but remains near the top of its recent trading range vs. the dollar at $1.3739.

If the ECB "disappoints" and leaves rates unchanged, the euro could hit $1.40 in short order, Chandler says.

A stronger currency would make European exporters less competitive vs. U.S. and Asian competitors, threatening the eurozone's recent recovery and reviving the deflationary forces Draghi is trying to slay.

Aaron Task is the host of The Daily Ticker and Editor-in-Chief of Yahoo Finance. You can follow him on Twitter at @aarontask or email him at altask@yahoo.com.