Abhishek Singhania, Research Analyst at Deutsche Bank, suggests that in theory the ECB should be doing “credit” easing rather than pure “monetary” easing given the tightening in financial conditions and in particular the deterioration in funding conditions for banks. Key Quotes • “Direct credit easing options are unlikely at the March meeting given that macro-economic data has not weakened sufficiently and credit flow has bounced back in January after having weakened in December. • The path of least resistance would involve the ECB fine tuning its existing policy measures which include rate cuts and expanding the QE programme. This leads us to maintain our long position in 10Y BTPs rather than recommending more risk-on trades such as outright paid position in core rates or steepeners at the long-end of the EUR curve. • There has been recognition on part of the policy makers that further rate cuts into negative territory and flattening of yield curves is likely to weaken bank profitability given the inability of banks to pass on negative rates to retail depositors. • The direct impact of negative rates on banks could be mitigated by (1) reducing the refi rate along with the negative deposit facility rate or (2) implementing a two-tiered depo system. • The impact of a two-tiered deposit facility system can be particularly complex depending upon the details of the system. If the ECB introduces a two-tiered deposit system but is reluctant to cut the deposit facility rate by a significant amount at the March meeting it could result in a moderate disappointment in the short-term. However, over the medium-term market rates would slowly converge to the deposit facility rate as the effective excess reserves in the system increases with on-going QE. • The ECB could announce a modest increase in the pace of QE by ~EUR 10bn. The ECB is also expected to announce some technical changes which should reduce concerns about the availability of bonds and offset flattening pressure on core curves. • The EUR curve has bull flattened aggressively since the start of the year as in Q1 2015. However, unlike Q1 2015, QE expectations are no longer the primary driving force behind the move. Instead, concerns about the effectiveness of monetary policy including negative rates and heightened risk aversion globally seem to be having a greater impact.” For more information, read our latest forex news.