ECB drives rates below 0.05%: And now what?

The move of the ECB on June 5 was primarily aimed at restoring conditions of low and stable money market rates.

It was not difficult to predict (here) the direct consequences of the new official rates and, notably, of the prolongation of fixed rate, full allotment tender procedures, and of the decision to suspend the weekly fine-tuning operation sterilising the liquidity injected under the Securities Markets Programme.

Except for the end-of-June spike, money market rates appear more stable and lower.


Technically successul, this policy move is not likely to succeed in raising inflation, or ending Eurozone stagnation.

The logic of moving market rates close to zero builds on the hypothesis that the Eurozone is in liquidity trap.

The reality is that the Eurozone is in a savings trap. Escaping from a savings trap requires the end of austerity now.

Eurozone liquidity conditions: Still a bit tight in the midst of plenty?

Mario Draghi’s “historical measures” (as defined by Bloomberg) are best seen as ways to restore the interbank rate of interest (EONIA) that prevailed throughout 2013, when the interest rate that banks paid each other for lending and borrowing liquidity (aka “reserves”) had stabilized a few basis points above zero.

This rate is the main policy-driven rate that shapes all money market rates. A super-low and stable EONIA had been the outcome of two ECB measures in 2012: the VLTROs and the Deposit Facility rate cut to zero.

Then, in 2014, with Eurozone banks accelerating repayments of VLTRO, bank liquidity has inevitably fallen. This can only be a problem as long as the fragmentation of the banking system persists and some banks prefer to bear the costs of holding excess liquidity rather than lending to banks they don’t trust. In addition, large “autonomus factors” (such as tax payment deadlines in large countries like Italy) and Fed announcements of tapering (relevant to those banks with high dollar exposure) added more instability. In some cases, the rate has steeped up to its natural ceiling (i.e., the rate set by the ECB on marginal lending operations).

The result of the above factors was that EONIA became more volatile and moved north, contrary to the ECB’s monetary policy strategy.

Thus, on June 5, the ECB corrected its operational framework, moving the “corridor of interest rates” down, while adding more “excess liquidity” to the banking system.


The chart, courtesy of @MigeruBlogger (click to enlarge), nicely illustrates how the ECB has found it increasingly difficult to maintain the policy-driven rate near zero, and how the most recent measures seem to have improved ECB’s ability to control EONIA. However, banks may still face tight liquidity conditions in the market for reserves. Notice the interest rate peak at the end of June 2014, a sign that some degree of banking fragmentation is still a factor in the European banking system.

Bottom line: The ECB has been targeting EONIA with varying degree of success. The June 4 measures seem to have helped the ECB to more effectively steer EONIA towards a target somewhere in the range of 0-0.05%.

ECB: What are negative rates for?

As of 11 June 2014, the interest rate on the Eurosystem Deposit Facility is -0.10%. This negative rate applies to all banks’ holdings of euros in excess of the minimum reserve requirements, as well as to cash balances above a certain threshold that Eurozone governments hold in the Eurosystem (this is cash obtained through taxes or bonds issued and not yet spent), as well as to all deposits held by non-Eurosystem central banks.

What does it mean that the ECB sets a negative interest rate?

In the same way as an interest paid by the ECB to holders of euros is a net addition to holders’ income, an interest paid by the banks to the ECB for holding euros is equivalent to a tax on holders of euros.

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ECB: Where is the news? (so far)

Has the ECB lowered interest rates at historical low?

Not exactly. The rate goal of the ECB is the interbank rate (called EONIA). This has always been below 0,10% in 2013.  The problem was that as banks began early repaying their LTROs, EONIA went above 0,10% in 2014. Thus, today’s move is simply an attempt to pull EONIA down to below 0,10% and stabilize it there, if possible.

Is the negative rate on the Deposit Facility big news?

Given that the ECB will apply, as of June 11, a negative rate on ALL excess reserves (Deposit facility AND Reserve account), and given that the ECB is expanding excess reserves by ending SMP sterilization, my early considerations on the effects of negative rates apply.


The Old Lady (of Threadneedle Street) fails to get an ‘A’

In two recently released videos, the Bank of England (BoE) explains what fiat money is and what monetary policy means.

This is good progress in the understanding of monetary operations, especially in the light of conventional wisdom having inspired a number of erroneous interpretations during the banking and financial crisis.

However, more progress is desirable, notably with respect to the following statements written in boldface.  I will explain why, at the end of this post.
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