Montoro drops rates, next change must be creative

Very few people bet that Mario Draghi was going to lower interest rates yesterday, but he did it. The decision to push rates down to an historic low of 0.25% came as a big surprise. Markets reacted with significant gains early but turned when on the other side of the Atlantic news broke that US jobs reports and the GDP forecast were both better than expected, which could inspire the Fed to reduce its monthly stimulus buying.

But market behavior was secondary news yesterday. The focus was on what Mario Draghi was deciding to do with interest rates and his comments about the choice. The answer? Inflation. October price behavior shows a downward trend that could have a negative effect on recovery in the euro zone if it continues, especially in peripheral countries like Spain.

No inflation would eat up corporate profits, increase sovereign debt and could steer Europe toward a lost decade similar to what happened to Japan. Draghi also lowered interest rates in order to weaken the euro, because if it gains strength then commercial exports will suffer. Because foreign trade is the only business keeping countries like Spain afloat, increasing the value of the euro will seriously threaten our competitive edge.

How long will the effects of the rate drop last? That is the key question. Draghi only has one bullet left in the chamber. Drop rates any farther and we will have 0% interest rates. If unemployment keeps pushing salaries down and undermining consumer spending and citizens and companies cannot get credit, then the ECB could be forced to utilize non-conventional tools to fix the economy, similar to what the US Federal Reserve and the Bank of Japan have done in the past.