ECB's Current Move: Inflating Deflation by Deflating Rates. When is the Next Move?

In the morning we can expect the ECB to put some meat on the bones of its talk. Generally anticipated is the ECB will make a move. What appears rather mellow is the expected move to be made. Economists expect the ECB to start lite with a cut in the main refinancing rate to .15% to .10%. The ECB is also expected to ease the interest rate on deposits from banks at their facility. Economists expect this rate to go to .1%, and economists consider this to be a negative interest rate.

One can only consider this to be a negative interest rate when considering divergent inflation/deflation rates in the euro area. For instance, euro area HICP (harmonized index of consumer prices) was at .2% month over month for April of 2014 and .7% year over year. For May, this same data dropped to .5% year over year. A negative trend in inflation is occurring and certainly far from the ECB's goal of just under 2.0% inflation.

 

Such inflation, actually deflationary, numbers make an ECB deposit rate of .1% essentially a negative .1% in the short term and only .4% year over year. That is, to find the real interest rate, or yield, one subtracts the rate of inflation from the stated rate. Or, in deflation, one adds the rate of deflation to the stated rate to find the real interest rate.

 

Keep in mind, Germany demonstrated actual deflation in April with a Consumer Price Index (CPI) of -.2% and a year over year inflation rate of 1.3%. France was flat on its CPI at 0.0% with a year over year inflation rate of .7%. European Producer Price Index numbers are even worse. European Union flash GDP numbers generally disappointed with import number exceeding export numbers, certainly for Germany.

 

Add to deflationary pressure in Europe the slowing economies of China and Japan (let alone geopolitical risk in Eastern Europe), and one can see the reason for toughening exports out of Europe aside from a high euro. 

 

Simply generating negative interest rates in Europe doesn't kick start economies like Europe. But it might help restart Europe's shadow banking system by giving confidence to other financial intermediaries. ECB's potential action can help mitigate yesterday's term structure risk and essentially move maturity transformation to safer ground for past market transactions.....If only these past transaction had a present day liquid market. I'm referencing, of course, markets to move otherwise illiquid bank loans. 

 

Such wishful projections assume a market, outside of sovereign debt, through which participants can diversify otherwise illiquid assets based on price and maturity. Future looking market participants, however, might see chasing deflation, by deflating the currency, by reducing rates in the present economic/market climate, as growth potential. It's possible.