Mario Draghi Walks the Walk - Ahead of Wall Street

By Zacks | June 05, 2014 AAA

Thursday, June 5, 2014

The markets will breathe a sigh of relief that the European Central Bank (ECB) has finally come through with the long-promised easing measures. Stocks in the U.S. appear on track to respond positively to the ECB move, though a sustained upward move will become clear following the press event.

ECB President Mario Draghi had effectively promised the markets last month that the central bank would be doing something major on the policy front at this meeting. As such, expectations were high, though not many were looking for a Fed-type QE program. The rate cut announcement was largely expected and is likely nothing more than symbolic at this stage.

The ECB’s other announcement today – cutting the bank deposit rate into negative territory – is likely the major one, though this announcement was largely expected as well. This has been done in the past by the central banks in Denmark and Sweden, but never before by any of the major global central banks.

What a negative deposit rate means is that the ECB will be charging banks for keeping reserves at the central bank. The goal of this unusual experiment is to incentivize banks to lend out money to consumers and businesses and not hoard it. Increased bank lending, the ECB hopes, will spur growth and reverse the negative trend in the region’s inflation picture that has been threatening to morph into outright deflation.

Importantly, the ECB justifiably expects this decision to lower the common currency’s exchange value, whose strength has been a big contributor to the disinflationary trends in the region. Despite the largely expected nature of the announcement, the market’s immediate reaction this morning is along the ECB’s desired direction. But the magnitude and sustainability of any loss in the Euro’s value will depend on how long the ECB plans to keep this policy in place.

Today’s announcement proves once again that the Mario Draghi ECB has been able and willing to take actions to stabilize the Euro-zone’s outlook. Many had started suspecting that Draghi was more talk and less action. But today’s actions disproves that impression.

Sheraz Mian

Director of Research

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