Joe Expert

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European Central Bank expected to stimulate euro zone

03 Jun 2014

The Governing Council of the European Central Bank (ECB) will meet this Thursday to discuss subdued euro zone inflation. Inflation in the EU has fallen to just 0.5%, failing to surpass the 1% mark over the course of the past 8 months. Governed by Mario Draghi, the 24-man council is widely expected to implement negative deposit rates in an unprecedented move to stimulate the economy.

In effect, this means that banks will no longer be able to park excess funds with the ECB free of charge; they will now have to pay for that privilege. The intuition is that banks will be forced to lend, thus driving activity in the euro zone. In addition to negative deposit rates, it is also forecast that the ECB will cut its main interest rate from 0.25% to approximately 0.15%. Again, the move is intended to increase economic activity. Lending to banks at an improved rate enables the ECB to increase the availability of credit across the euro zone. Draghi’s main concern at present is likely that the price of commodities may fall in the coming months, leading to a deflationary effect. This would force the ECB into quantitative easing measures, the extent of which would depend on the degree of deflationary effect. The success of Thursday’s proposals will ultimately determine whether such QE measures become necessary. The euro was down 0.22% against the US dollar late Tuesday evening at $1.36258. Mathieu L'Hoir, strategist at AXA Investment Managers, reckons Draghi has no option but to react “If Draghi doesn't do it you can be absolutely sure the euro will move above the $1.40 mark and will rise well beyond it”. A rising euro means that imports become cheaper, thus driving deflationary pressures.  If the ECB implements measures as expected, it’s possible that the euro will fall against the US dollar. Janet Yellen’s continued tapering of Federal Reserve stimulants will likely keep the dollar strong. To find the tightest fixed spreads on FX visit our currencies page.

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