ECB may bring down rates further, says Citi

A third round of monetary stimulus was introduced by the Bank of England on Thursday. The European central bank announced that it would restart its printing presses and buy 50 billion pounds of asset purchases with newly created money to help the economy out of recession.

However, the markets were not too enthusiastic about the ECB moves. Jurgen Michels, Managing Director, Lead Euro Area Economist and ECB Specialist at Citi said that the ECB offered some positive surprises by bringing down the deposit rate to zero. He believes, this could also pave the way for taking the rates further down, even moving into negative territory at some stage.

There are several questions regarding issues in the euro area which need to be answered and the ECB is probably waiting to see more stress in terms of funding to the banking sector before infusing additional liquidity measures, Michels tells CNBC-TV18.

Below is the edited transcript of the interview on CNBC-TV18. Also watch the accompanying video.

Q: What did you make of what the European Central Bank (ECB) had to say yesterday? They went ahead with a deposit rate cut as well but the market got disappointed a bit more because there was no mention of long term refinancing operation (LTRO) or even mention of any bond buying in the Securities Markets Programme (SMP). Do you think that is what let the markets down?

A: First of all, it's a positive surprise that they brought down the deposit rate to zero. That was more than we expected. We thought there would be a kind of a threshold not going below this level but, with this thing it's now likely that they will even go as we have seen with the Danish central bank yesterday, to bring rates to negative territory at some stage.

But in the end, market was disappointed. I do not think that the market expected the ECB to come up with anything in respect of reactivating the securities market programme because that was away from their initial policy tool package for a while. But there was some hope and we thought that they could come up with some more indications regarding further LTRO or an easing of the collateral requirements.

This is indeed a negative surprise there but, it does not mean that the ECB does not come up with these measures in the future. We have now important talks with Brussels coming up again including questions about the recapitalization of Spanish banks and also with respect to the progress towards direct banks to European Stability Mechanism (ESM) funding.

All those questions are there and the ECB wants to see more programmes in that respect before going ahead with additional liquidity measures. They probably also have to see more stress in funding terms of the banking sector before gauging on more measures in that respect.

Q: What will be the next set of events or data or stimuli that markets will watch out for?

A: I think next Monday is important. We have the euro group meeting although, we do not expect too much. The Italian Prime Minister was very upbeat about the outcome of this in respect of getting more details on the packages and we don't think that is coming through. On July 20, we have another meeting of Euro Group again. We have to watch out what comes out there.

In addition to this we have to look at all the data on the economic sentiment reading, the PMIs this month will be important. At the end of July we may get the new bank lending survey form the ECB. What will give them more insight in credit conditions and the possible need of further liquidity measures to support the banking system.

3Q: Will there be any bond auctions or political events that could once again mean brinkmanship?

A: There are of course auctions coming through all the time. We don't think there is an immediate risk of some of those auctions failing. On the political side, we have 17 governments involved here and we have seen that for a while some statements in some countries can come up.

Of course, we have the decision of the German Constitutional Court regarding Germany's participation at European Stability Mechanism (ESM) outstanding those the hearing on July 10. We may not get final verdict that day, so uncertainty in that respect will loom. Otherwise, hard to say which specific events come through. We have lots of talks going on and it may be some comments from some politicians of some countries which are likely to create further stress in the market.

Q: The measures which were taken or not taken yesterday had significant impact in the currency market and also in the bond markets. We saw euro below 1.24 dollar index almost at 83 and the Spanish and Italian yields rising swiftly about 30 bps a piece. What do you think led to this reaction and the other point is do you see any kind of risk off in the near-term. There has been risk on mode for the last two-three weeks at least; do you see that unwinding in this month?

A: Regarding the reaction on the currency front, I think the zero rate was a clear signal to the exchange markets or currency markets that the ECB is willing to bring down rates further. So that is a reaction to looking at relative interest rate, particularly to US.

On the other hand, the renewed increase in bond yields in Spain is a clear disappointment on what we have discussed earlier in respect of no additional support measures from the ECB for the periphery countries coming through.

Q: I want to know about the risk off. We have been in risk on mode for the last three-four weeks, do you see that unwinding in the near-term. Are there any negative catalysts in your mind that could lead to that kind of environment?

A: As I said earlier, we have seen a bit of a positive reaction to the EU summit and indeed they were in-principle highlighting that they go in the right direction. But, there are lots of details which have to be put together and in that respect we may see disappointment to come through. Therefore, we may get a bit more risk coming up again.

Q: The whole Libor issue is largely unimportant for market. It would only be important with respect to maybe individual banks in penalties you think?

A: I do not have a specific view on that because I look more on euro area development. I think it has some implications of the political and also the board which is on the Bank of England. But that's an ongoing process and we have to see what they come up with.