European Central Bank Cuts Interest Rates, Trading Implications

The European Central Bank (ECB) Thursday cut both deposit and lending rates as European economic indicators continue to sour. The bank announced that it had cut the benchmark deposit rate to 0 percent from 0.25 percent and the benchmark lending rate to 0.75 percent from 1.00 percent, the lowest on record. President Draghi said, “economic growth continues to remain weak with heightened uncertainty weighing on confidence.”

The EUR/USD plunged on the news, falling from 1.2503 to below 1.24 on the cuts. Further, the EUR/AUD pair fell almost 1.25 percent to 1.2033. The Aussie dollar is highly correlated to commodity prices, as Australia has a large mining sector. The rate cuts aimed at boosting global growth signal to investors a potential uptick in demand for commodities, boosting the Aussie dollar. Rate cuts are also assumed to be a negative for a currency, weakening the euro.

As anticipated, the ECB did not launch a new round of non-traditional policy such as another LTRO. Credit conditions in Europe, as seen by the TED Spread, have not widened as they did in the fourth quarter of 2011. Thus, the need for further liquidity-boosting measures was not necessarily needed. Rate cuts are targeted at boosting growth, which has been lacking in Europe.

The trading implications of the cut are severe. Even as the EUR/USD plunged on the rate cut, analysts still believe that further downside is in store. Greg Michalowski, analyst at Forexlive.com, highlighted that the lows of May will be targets for a new leg down. "Downside targets now become the lows from May - 1.2360, 1.2335, 1.2286. The midpoint of the EURUSD all time range comes in at 1.2130. Keep this level in mind as a key target."