Last Thursday, the ECB lowered the key interest rate down to 0.00%, and also raised the penalty rate for depositing money at the ECB from 0.3 to 0.4%. It is a very brave step from Mario Draghi but the question remains; is it a good one? Many analysts expected that the ECB will act expansively, e.g. will lower the key interest rate and raise the monthly volume of the bond purchasing program, but not drastically. Lowering the key interest rate to 0.00% should flood the markets with money, which the ECB is hoping for so that their decision will lead to a higher inflation rate. Their aim is an inflationary rate of about 2% per year, so let’s now have a look what it means for us.
The higher penalty rate for depositing money will lead to more pressure on the banks. They could depressurize this through raising the amount and volume of loans, but this could lead to greater risk for the banks by having more clients with a lower credit rating, while not be able to increase the price (interest rate) on the loan side of things. Another alternative would be to deposit actual cash in a vault, but this leads to a negative return along with higher costs for insurance. Some other alternatives have been spoken of, but these are also connected with low returns or higher risk. So, over the long term, it seems we have to allow for higher costs within the pricing of retail banking services. The influence of higher bank fees will potentially be quite small for us retail customers but let us not forget about a possibly more damaging result: the expectations of our pensions and long-term investments.
With the constantly low key interest rate in place, we might have to lower our expectations for pensions because of the small profit margin in relatively safe financial instruments for banks and financial institutions. So not only are the bank’s profits expected to be lower also our retirement pension. Unfortunately, this topic is not discussed very often because it lies in the future, and will only be dealt with reactively when it actually occurs. However, with these lower expectations, we have to make sure to have enough capital in place for when we reach retirement. Let us have a look into the forex market if we have any chance to earn some money in the short-term because of the ECB decision.
In the most popular forex market. The EURUSD crashed down at first while Draghi spoke but after a short period of time it changed direction and rallied up for about 350 pips. This has been a huge range for just one day in the EURUSD. But what do we have to expect? The obvious assumption would be that EURUSD will trade lower because of the expansive strategy of the ECB, but this is not guaranteed to happen. There are many different opinions out there which will potentially lead to a very interesting and exploding move when one side will lose confidence in their conviction. As technical traders, we just have to wait and watch the markets until we see momentum, and then use our trading strategy to jump on-board and hopefully we will ride a few hundred or maybe even a few thousand pips over a few months. Regardless of the direction, EURUSD will be very interesting to watch after this brave decision from Mario Draghi, which doesn’t leave very much wiggle room on the expansive side of monetary policy.