Home » ECB towards the great rate reset for euro banks. The other move coming

ECB towards the great rate reset for euro banks. The other move coming

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ECB towards the great rate reset for euro banks.  The other move coming

Christine Lagarde’s ECB is already putting the brakes on the monstrous liquidity that it has guaranteed to euro area banks for years.

Not just with the endgame of the TLTRO-III plan with which the European Central Bank continued to provide Eurozone credit institutions with financing at practically rock-bottom rates.

In addition to this other bazooka baked in favor of the banks, the European Central Bank led by Christine Lagarde is in fact also reflecting on how to calibrate market rates, including the same ones interbank rates.

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ECB working on market rates. Towards maintenance of the ‘floor’

In the last few hours, the Reuters news agency has addressed the liquidity issue for banks by exclusively publishing some rumours, in the article “Exclusive: ECB to keep floor under market rates but with eye on demand”.

From the rumors, it emerged the Eurotower’s intention to continue to confirm a “floor” at market interest rateswhile ensuring that banks have a greater say in deciding how much liquidity they want to draw on.

What does all this mean?

Meanwhile, a premise: the ECB is already studying how it should orient short-term interest rates in a new era, the one that began about two years ago, in which inflation is higher and in which the massive injection of liquidity pumped into the banking system over the last few years, through various stimulus plans launched, is not only no longer necessary but also creates significant side effects.

In short, if previously the euro area banking system was constantly flooded with new liquidity, in a macroeconomic context in which fear, rather than inflation, it was deflation for about ten years, things could be very different in the future.

In fact, although the disinflationary process is underway, the outlook remains that of an economy destined to still be grappling with the inflation problem.

The mechanism that the ECB has thus continued for approximately 10 years it is therefore no longer in step with the times.

Euro interbank rates in the years of fear of deflation

The reference is to those interventions that the Eurotower launched in favor of euro area banks, keeping rates at zero or at an even lower level and diverting, in fact, a higher amount of liquidity to the financial system than necessary, through the disbursement of loans, precisely, and with the purchases of bonds .

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With those purchases, which began with the quantitative easing launched by former ECB president Mario Draghi, the ECB flooded in fact, the Eurozone financial system is characterized by liquidity.

All this, with a very specific objective: raise inflation, which was too low at the time.

As a result, that same mechanism meant that banks did not have to knock on the ECB’s door and that the overnight rate that applies to the loans that banks provide to each other was tied to the rate that the central bank paid on deposits. A rate that was precisely equal to zero, if not less.

With the ECB having repeatedly raised rates in the last two years, to try to bring inflation back into line, things have changed, however, quite clearly.

Not there is enough, if not too much, inflation according to its wishes ECB President Christine Lagarde.


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Interest rates are well above zero and those massive amounts of excess reserves by banks they are no longer considered necessary.

Not only that: those same quantities they are causing great losses to the detriment of the ECB itself and some central banks in the euro area. Just look at the record budget loss suffered by the central bank’s balance sheet.

Consequentially, the Eurotower needs to reset the mechanism it has relied on for a long time.

Something is already moving.

The ECB meeting to evaluate what to do. Announcement soon

Reuters reports that the ECB met last week to try to understand how to act.

FRANKFURT AM MAIN, GERMANY – MAY 04: Christine Lagarde, President of the European Central Bank, leaves a press conference following a meeting of the ECB advisory board on May 04, 2023 in Frankfurt, Germany. Europe continues to struggle with high inflation, which is mostly a result of consequences stemming from Russia’s ongoing war in Ukraine. (Photo by Thomas Lohnes/Getty Images)

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From the rumors reported by four sources, it emerged that, within the institute, an agreement was reached on the need for the ECB to confirm the “floor” for interest rates, that is, it is always the central bank that sets the interest rate lower than those applied on the loans that banks grant each other (interbank rates).

The ECB, however, would be ready to announce an important news: once it has drained the excess reserves present in the euro area financial system – something that will in any case take years – Frankfurt could decide to allow the same commercial banks in the euro area to help you determine those interbank rates.


Those rates would be determined by the loan requests that the banks would forward to the Central Bankand, therefore, in a similar way to that mechanism which is currently launched by the Bank of England, the central bank of England.

The sources also reported that the central bank could lower the reference rate it applies on its weekly cash auctions, currently equal to 4.5%, to bring it closer to the current level of the deposit rate which, after the repeated monetary tightening of recent years, is equal to 4%.

In this way, Eurotower would launch what Reuters called a “narrow corridor”narrow corridor, which would reduce the stigma for the most liquidity-strapped banks.

An announcement about this new mechanism – which would be called demand-driven floor or floor conditioned by demand – could arrive within a few days, according to sources interviewed by Reuters, on the occasion of the next non-monetary policy meeting of the European Central Bank, scheduled for March 13th.

The big announcements that the ECB has made in recent months, presenting some innovations for the banks of the euro area, have not been entirely positive. Among these, the decision to set the remuneration of compulsory reserves deposited by banks at zero, thus commented by the president of ABI, the Italian banking association, Antonio Patuelli:

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“This decision today by the ECB will now cost the banks, just as the ECB’s decision last autumn to make it significantly expensive the residual liquidity granted by the ECB to the banks through the TLTRO long-term financing plans”.


Euro banks risk a new ECB slap on mandatory reserves

ECB: bad surprise from Lagarde for compulsory bank reserves

BTP ‘at the mercy’ of the ECB. And finally TLTRO haunts Italian banks

ECB, Lagarde: ‘we have modified the conditions of the TLTRO bank loan program in an anti-inflation move’

Interbank rates: rumor about the ESTR rate

Meanwhile, we learn that from the ECB meeting discussed exclusively by Reuters, it also emerged that the central bank would tolerate some fluctuations in the Euro Short-Term Rate (ESTR), the benchmark rate of the interbank interest rate market, around its own deposit rate.

For now, another rumor, no change should be required from banks on the level of minimum reserves they must hold, which remains equal to 1% of the deposits of the respective customers.

This status quo should be confirmedalthough Reuters does not rule out the arrival of proposals for changes from some ECB officials.

Finally, the sources made it known that the ECB is still discussing what should be the size of the bond portfolio in the hands of the central bank, grew dramatically with QE and is now destined to fade with the plan QT-Quantitative Tightening which the Eurotower has been carrying out for a while.

The other question is whether this portfolio should be made up primarily dto short-term bonds or also include securities with longer maturities.

Having said that, being still in possession of bonds of a value that is around 4.7 trillion euros, for now we can be calm about the fact that, also according to what the German representative of the Executive Committee of the ECB had already said in one of her speeches Isabel Schnabel, the banking sector will continue to have more reserves than it needs at least until 2029. The fact is that the European Central Bank’s liquidity-draining plan, however, continues.

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