JPMorgan expects ECB to cut deposit rate to -0.7% this year

JPMorgan expects the European Central Bank to ease monetary policy further by cutting the negative deposit rate to -0.7% in 2016.

JPM now expects the central bank’s March package to include a larger deposit rate cut of 20 basis points, taking it to -0.5%, with another package after that, possibly as early as June. The second package is expected to take the deposit rate down to -0.7% and extend quantitative easing until the end of 2017.

The US bank said that up until now, its expectations had been that the ECB would announce another policy package in March, with a 10 basis points cut of the deposit rate to -0.4%, an increase in the monthly pace of QE purchases by €10bn, a three-month extension of the QE programme to mid-2017 and two additional TLTROs in the second half of this year.

It was not anticipating any further easing beyond that, but expected the central bank to remain accommodative for a long time, with the first hike only towards the end of 2019.

However, JPM changed this call on Tuesday, with economist Greg Fuzesi attributing the move mainly to inflation rather than a change in the growth outlook.

“First, we continue to think that inflation will rise towards the ECB’s target more slowly than its staff expects. Second, the ECB will be more sensitive to this in an environment of persistent downside risk. Hence, our new call is mainly about risk management, as we are not making any changes to our macro forecasts,” he said.

Fuzesi added that while GDP growth was sluggish in the second half of last year, the underlying pace was likely firmer.

“And, while the January business surveys raise some concern about the underlying pace, we are not currently convinced that there has been a real change in underlying economic conditions.”

However, from the perspective of the ECB, uncertainty about the global economy has increased even further and recent financial market developments “are surely uncomfortable”, Fuzesi said.

As a result, when the ECB staff publishes its new inflation forecast for 2018 early next month, which he reckons could be at 1.8%, “the Governing Council is likely to remain nervous about the outlook and respond quickly to gradual disappointments on inflation”.