Successful auctions by peripheral eurozone borrowers over the last two weeks is concrete evidence, if needed, that the ECB’s deposit rate cut to 0% in July has worked. Italy and Spain’s yields dropped sharply at short term auctions last week, while investors that had shunned Ireland’s euro commercial paper since the beginning of its bail-out programme are making enquiries about the credit again.
Having seen the benefit of cutting the rate to zero, the ECB should not be afraid to go further. Another cut in the deposit rate at the ECB meeting on Thursday would cause short term levels to plunge further and force more investors — already crying out for yield — to look down the credit curve for pick-up.
Those worried about going into the unchartered territory of negative rates should look at the Danish example. There has been no negative effects in the Nordic country’s money markets since that its own central bank cut the deposit rate to minus 0.2% in July.
Money market participants are also better prepared for a cut this time. A mild panic ensued at the last ECB deposit rate cut, with money market participants complaining that they had been taken by surprise. Given recent statements by ECB officials that a negative rate is a possibility, the industry should be ready.
If it is to introduce negative rates, the ECB needs to make investors feel comfortable about holding peripheral eurozone debt. That requires the unveiling of a coherent bond buying programme either at Thursday’s ECB meeting or after Germany’s Constitutional Court ruling on the legality of the European Stability Mechanism on September 12.
Central bank interest rates are not going to solve the problems of the eurozone in the long term. But a negative deposit rate, combined with a new bond purchasing programme, will push short term yields down to acceptable rates and buy troubled sovereigns some much needed time.
The ECB must seize this opportunity.