Is the ECB meeting next week will change the rules of the game in the financial markets?

maybe, already have changed? (response may be at the end of entry)

hello,

Today, a clear revaluation of the english pound might at first glance, does not have much in common with the ECB meeting that awaits us in the next week, but on reflection is such compound makes sense. This is the beginning of changes which are associated with a radical solution that is introduced into the financial markets by the European Bank.

We are talking about a negative interest rate, because of the possibility of using the tools of monetary policy, which is will apply next Thursday the ECB is the most powerful and controversial. Consider first what it really means a negative interest rate?

But before we move on to the main topic, you must make some assumptions that are saying that the ECB will take a decision on the introduction of the European version of QE as a last resort. Once you have all the tools to be used.

Let's start with the fact that not so long ago, some economists believed that the interest rate can not be negative. After all, you can not pay someone for lend money from us! You can always put banknotes in the "proverbial sock" and achieve zero percent. What adjusted for inflation is already showing a negative rate.

However, the modern financial system is not functioning so.

Money is an electronic record that needs to be stored somewhere. For a bank, it may be a borrower, it may be another commercial bank, security or the central bank. Last, mentioned the possibility, as the guarantor of the financial system, is considered a very safe haven for electronic money. Currently, the ECB maintains a zero interest rate, which means that banks do not pay any interest on money kept at home. From next week may decide that it will charge a fee for their safekeeping.

Why should we care? Well, the banks certainly know how to count and know that paying for the ECB that it will invest the money there is not a good business.

What are their alternatives?

(1) They can lend to other banks, and in part so they do, but here, after the banking crisis, still the principle of limited trust.

(2) In addition, a large and reliable banks themselves may want to borrow your money.

(3) Banks can buy German treasury bills as the equivalent of cash. These instruments are now practically do not give interest and now the banks will compete with funds and large corporations which access to transactions with the ECB does not have.

Increased demand will make the yield of these securities will also be explicitly negative, acting poor alternative to lend to the ECB. To looking for a positive yield they need to move up on the yield curve, eg to buy 10-year Govt. bonds. This is because the yield of German 10-year Govt bonds is rapidly fell. You can also take greater credit risks, such as higher interest rates to buy Spanish bonds with lower rating. These are just accidentally lowest yields in history, showing how huge the demand is there. Naturally, the banks paying the ECB for safekeeping money will not give themselves generous offers interest rates on deposits. Therefore, investors also need to take greater risks in search of returns, such as increasing the allocation to equities at the expense of banking deposits.

What is common with all a losing a pound? In previous months, the euro and the pound were gaining against the dollar, because short-term interest rate was higher here than in the U.S.. Now investors already know that the euro is about to change. The Bank of England will not introduce negative interest rates, but today is the yield of British bonds fall most encouraging to sell the currency.

ECB deciding to introduce negative interest rate will explain the necessity of the fight against too low inflation. But the truth is that on the occasion of to change the game rules in the financial markets. 

I'm sorry, already has changed.

regards,

oscarjp