HSBC believes that ECB will cut rates and extend QE

Thursday, Nov 26 2015

In a report on the European Central Bank (ECB), the HSBC bank has dissected the bank’s agenda, with an inflation rise one of the biggest priorities. HSBC believe that the markets doubt the willingness of the ECB to tackle the inflation problem, of reaching the desired 2% threshold. Also, the euro area is unresponsive to economic slack, and therefore recovery.

As inflation falls, it becomes embroiled in various formal and informal rules in pricing contracts, that are linked to future prices for inflation today, HSBC said. Even if economic recovery begins to accelerate at pace, inflation could still remain lower than 1%, if inflation expectations are dislodged.

The best means to hike inflation HSBC believe, is to push the exchange rate down, resulting in import prices being increased. In their report, HSBC opined that the cutting of the bank deposit rate would be an effective tool, in pushing the euro down.

Additionally, a negative deposit rate could have the effect of funnelling excess reserves, from the balance sheets of core euro area countries to more peripheral ones. Although HSBC warned that negative interest rates can be counter productive, as you would not want to cause a run on the euro. Despite that view, HSBC are expecting a reduction in the deposit rate of about 10 basis points at this stage, with a further ten point cut next year.

Quantitative Easing (QE) is expected to be expanded to act as a counter force to the downward pressures on the euro. The size of the asset programme may face constraints, due to the comparably small size of the German bond market, and that there is a collective action clause over new euro zone issuance.

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