The ECB is currently at a crossroads. The consensus stands at a 50/50 rate cut, however, estimates increased from 10 basis points to 20 basis points.
The question here is whether Lagarde’s call on EU leaders and the latest emergency cut from the BoE make a difference regarding tomorrow’s decision.
Christine Lagarde’s Faces First Critical Test
Just about four months into her presidency, and given the fact that downside risk from the trade wars has deteriorated, one would expect Lagarde to announce that things have brightened up for the European economy.
On one end, this is correct, but no one is focusing on economic indicators right now.
The bitter reality is that she has a huge task at hand; join the other central banks with a 50% cut, or take a softer approach to cut.
Well, the markets expect the ECB president to take aggressive measures and cut interest rates. But how deep the cut will be is what will determine the euro’s fate.
Unlike the Fed, the situation with the ECB is quite different. To begin with, interest rates are at a record low of -0.5% and there is little room left to the negative side. However, rates in the EU have been sitting at record lows for a long time, which suggests that yield differentials might only stretch marginally with a very small cut from the ECB.
Will this help the euro bounce swiftly from a smaller than expected cut? Perhaps yes.
Lagarde might look into the implications of the coronavirus with a different eye overnight, as it has a direct negative effect on the EU GDP and employment. With the latest lockdown in Italy, the 4th biggest economy of the Union, she is probably going to be more dovish than neutral.
Italy is the hardest-hit country in the EU. At the time of writing, the death toll stands at 631, with over 10,000 cases having been reported and the whole country (60 million people) under quarantine.
We should take a moment to think about how the government is making efforts to tackle this pandemic at such a large scale. Was there an emergency fund ever in place for such a large scale calamity?
Lagarde will have to address what measures the ECB is willing to take to add liquidity not only to support Italy but other countries likely to follow soon.
Expectations Tilt to The Downside
While a rate cut just doesn’t miraculously fight off a virus, it is a small step to boost businesses and sentiment following a hit such as a coronavirus.
Amidst growing concern mainly due to the outbreak, the need to cut now might lead to a modest rate cut of 20 basis points, leaving some room for further cuts in the next ECB meeting.
This is likely to come along with increasing QE.
It would certainly be a surprise if the ECB decides not to go ahead with the rate cuts.