Euro bank cuts interest rate and expands stimulus

Bonds and emerging-market equities were also hit on Thursday in the aftermath of the ECB’s decision, which saw president Mario Draghi announce a rate cut and bond-buying boost that fell short of what some investors had envisaged.

The ECB now sees inflation at 1 per cent next year, below its September forecast of 1.1 per cent, and expects inflation of 1.6 per cent in 2017, again slightly lower than its previous 1.7 per cent projection. That may keep the dollar on the rise as investors seeking higher yields put money in dollar-based assets.

The British pound rose 1.2 percent to $1.5144 GBP=D4 while the Swiss franc gained 2.4 percent to 0.9933 franc on the dollar CHF= on Thursday.

Draghi said there are risks that inflation might remain lower than expected.

The ECB also said it would add local and regional euro area bonds to the pool of assets it buys each month. “The suspicion is that Mr Draghi overplayed his hand and ran into stiff German-led opposition based on doubts about the economic case for further easing, and objections to an income transfer from core to peripheral banks implied by a larger cut in the deposit rate”, Simon Ward of Henderson Global Investors said.

And while critics say that cutting rates breaks the bank’s forward guidance, the ECB argued that Switzerland and Denmark moving rates deeper into negative territory actually lowered the floor rates, so it is not the ECB breaking its word but instead “lower bound” moving lower.

However, Asian stock markets were all in the red, with Tokyo losing 1.9 percent by lunch, Hong Kong and Shanghai down more than one percent and Sydney 1.8 percent lower.

The main move by the ECB was to cut the interest rate on deposits from commercial banks from -0.2 to -0.3 per cent.

“This is less of a rate cut than markets and we had expected, probably showing that the hawks at the European Central Bank had more leverage than expected”, said Carsten Brzeski, an economist at ING.

The huge foreign exchange market move actually tightens monetary conditions, effectively countering the ECB’s easing by lowering imported inflation through a higher exchange rate. “By trying to avoid exacerbating currency wars with more QE, the European Central Bank has merely become a victim rather than a victor”.

The stock value of PVH Corp fell more than 11% to $83.02 per share despite reporting better-than-expected earnings for the third quarter.

“The RBNZ will be the key event for the week, given it’s now priced 50/50, which currency market makers will expect some volatility on, so all eyes on the New Zealand dollar next week”, said Sam Tuck, senior FX strategist at ANZ Bank New Zealand. Against the yen, the common currency rallied 2.5 percent overnight before pulling back slightly to 133.80.

Even if oil prices account for part of the problem, core figures, which strip out energy prices, are running at half of the target, an indication that once the one-off effect of the crude price fall passes through, inflation will not rebound, they argue.

“That makes us much more cautious in terms of raising rates”, she said. French 10-year yields rose 0.17 percentage points to 0.96 percent, also a substantial move. Anything above 50 indicates expansion. This sets the stage for an interest rate increase into a growth-slowing environment and a possible recession on the horizon in the U.S. The stock market did not take that news very kindly on Thursday.