MNI INTERVIEW: ECB To Move Cautiously On Reserve Remuneration

Concerns over potential collateral squeezes are likely to prevent the European Central Bank and other national central banks from replicating the Bundesbank’s Aug 4 decision to cut reserve remuneration on domestic government deposits to zero before early next year, the International Capital Markets Association senior director Andy Hill told MNI.

While the Bundesbank had indicated in April that a return to 0% for reserves currently earning 20 basis points below the ESTR benchmark would be appropriate and neutral for monetary policy, Hill said investors had clearly thought such a move was still months away.

But the Bundesbank felt “emboldened” by the ECB decision on July 27 to end remuneration on banks’ minimum required reserves, said Hill, who oversees ICMA’s work on repo and short-term interest rates.

“I think they have been itching to do this for a while. It’s a bit of a free lunch, even at ESTR less 20bp, it is still a free lunch,” he said in a phone interview.

Although the ECB sets the ceiling payable on reserves, Eurosystem national central banks still set the minimum payable rate.

Before the Bundesbank’s move, there had been EUR300 billion of remunerated domestic and non-euro government reserves, and now, with more than EUR250 of government reserves still earning interest elsewhere in the eurozone, the question is when the ECB and other central banks will follow suit.

“If that goes to zero what will that mean? And how much will find its way into the short end and chasing HQLA (high-quality liquid assets)?” said Hill. “And what does mean for collateral scarcity going into year end?”

CAUTION INTO YEAR-END

While predictions are difficult, he expects a cautious approach.

“I think the ECB is very sensitive, particularly to year-end,” he said. “We don’t sail through year-end like the U.S. or UK, we survive year end in Europe. I could easily be wrong, but I would maybe expect them to hold off until year-end, until January maybe.”

Hill said market volatility in the wake of the Bundesbank’s move was just part of the inevitable ongoing process of normalising monetary policy. The reduction of reserves on the one hand and putting collateral back into the market via quantitative tightening make likely future episodes of volatility less likely. (See MNI INTERVIEW: ECB QT To Squeeze Bank Liquidity Levels- EBA)

(Additional reporting by Les Commons in London)