Euro-area money-market rates are on course to drift higher in coming weeks as banks prepare for the start of the European Central Bank’s tiered deposit rate system. The question for lenders, traders and policy makers is how far and how fast.
Tiering was announced last month to mitigate the cost to banks of lower interest rates. It means lenders will be able to put hundreds of billions of euros of excess liquidity on deposit at the ECB at 0%, rather than paying to park cash at its minus 0.5% policy rate.
Traders are already pricing in the Euro Overnight Index Average rate rising about two basis points by October 30 due to the impact of tiering. Nikolaos Panigirtzoglou, a global market strategist at JPMorgan Chase & Co, estimates this overnight rate could rise by up to 10 basis points as banks shift as much as €100bn ($110bn) of funds in coming weeks.
“Eonia rates should rise given peripheral banks, such as those in Italy” can deposit their reserves at 0%, said Panigirtzoglou. “The risk is that this interbank flow could be delayed or happen more slowly over a longer period of time beyond October, dampening any upward pressure on Eonia rates.”
The prospect of a move higher in money-market rates is spurring debate among analysts over whether the ECB has inadvertently tightened policy. These rates are used as benchmarks for trillions of euros of debt across the region.
Central banks in the post-crisis era have used an array of new policy tools and tactics to bolster growth and also ensure the stability of the banking system, which at times has made controlling policy more difficult. The Federal Reserve was forced to start adding temporary liquidity to the banking system in September to rein in a key policy rate after a funding squeeze pushed it too high, and will take more permanent action this month to bolster reserve levels.
The ECB’s tiering policy means banks may have a preference to park money with it at 0% rather than in negative-yielding securities, which may also cause rates on short-dated instruments to moderately rise. Two-year government bond yields slid into negative territory and reached record lows in some nations this year, yet have climbed since the ECB announced tiering as part of stimulus measures.
A new euro-area overnight benchmark rate, known as ESTR, which the ECB started publishing on October 2, will also play an important part in the trajectory for Eonia. The ESTR rate fixed at -0.55% for October 11, and Eonia is now set daily at the ESTR rate plus 8.5 basis points.
ESTR is part of a global effort by regulators to move away from tainted benchmarks. The way ESTR is calculated, using a volume-weighted trimmed mean methodological, could limit any upwards pressure on Eonia as extreme rates may be filtered out. The ECB removes the top and bottom 25% of aggregated transactions.
The ECB has maintained that the interest rate in the overnight interbank market will still gravitate toward the rate on its deposit facility even with tiering in place. Within the new system, the central bank has flexibility to adjust the degree of reserves exempt from negative rates to better control money-market rates. Currently, reserves as much as six times the minimum amount a bank is required to hold will be exempt. Any reserves beyond that mark will be subject to the ECB’s deposit rate of minus 0.5%.
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