FRANKFURT – European Central Bank policymakers are approaching a “broad consensus” on a new way of steering short-term interest rates and, indirectly, the eurozone economy, people familiar with the discussion told POLITICO.
According to central bank officials, the ECB will maintain a so-called “floor system” where “ample” central bank liquidity will ensure that the rate on its deposit facility — which absorbs excess cash — remains the key point of reference for the financial system.
The move implicitly acknowledges that the unsecured interbank money market is unlikely ever to emerge from the coma it fell into during the Global Financial Crisis. It also acknowledges that the GFC, and the new regulation that followed on it, have permanently raised the overall level of liquidity needed by the system.
“Banks will depend on the central bank for liquidity to a large extent,” one official said.
To the extent that liquidity will be provided by lending, rather than by bond purchases, the ECB will continue to meet in full all of banks’ demand for money at a fixed interest rate in its short-term liquidity operations. And to ensure that any bank can use those facilities, it will maintain its enlarged pool of collateral against which banks can borrow. That will include credit claims, another official said.
Officials were granted anonymity to speak freely as discussions are private and ongoing.
A ‘structural’ bond portfolio
Longer-term liquidity will be provided via a mix of central bank loans and a “structural bond portfolio,” officials said. Policymakers have not yet discussed how large this portfolio should be or what proportion of overall long-term liquidity it should provide. One official suggested that the ECB may not decide this in advance.
Chances are that policy hawks will push for a limited portfolio. Super-hawk Klaas Knot, the Dutch central bank governor, told Boersen-Zeitung last year that the portfolio “should be as small as possible”, given that the EU Treaty bans the ECB from financing governments.
Such considerations may also play into the decision on the composition of the portfolio. The central bank has not yet decided what maturity of sovereign bonds it will hold, although some are keen to avoid very long-term debt, so as to limit the bank’s footprint in the sovereign debt market. Policymakers will also need to decide what other issuers it may consider, and whether or not to incorporate an element of incentivizing credit that aids the green transition.
Demand or supply
Officials are still being coy about one key variable, the expected size of the future ‘steady state’ balance sheet. Some policymakers hope that, as excess liquidity leaves the system, commercial banks can gently turn today’s supply-driven system into a demand-driven one, where banks’ demand at central bank auctions becomes more important, giving a greater role back to market signals.
One of the options under discussion to achieve this is the introduction of a small corridor between rates on the ECB’s weekly lending operations and the deposit rate. The thinking is that this would incentivize banks not to borrow more from the central bank than they need, helping to cap the overall size of the balance sheet.
This corridor is just one option under discussion. Given the current level of excess liquidity in the eurozone, a demand-driven system is still, at the very least, many years away.
Minimum reserve requirements
The unveiling of the new operational framework is unlikely to be accompanied by a decision to boost minimum reserve requirements, the officials said. The ECB cut reserve requirements to 1 percent from 2 percent in December 2011 to boost bank lending and liquidity. Several policymakers, including Luxembourg’s Gaston Reinesch, said minimum reserve requirements should be reviewed in the context of the operational framework review.
Even though some would still like to boost reserve requirements, the overwhelming majority feel that adjusting them at this stage would risk sending mixed signals about the direction of policy, something they want to avoid.
A spokesperson for the ECB declined to comment.
Additional reporting by Carlo Boffa and Ben Munster.
