MNI SOURCES: New ECB Framework To Maintain Continuity

Options for the European Central Bank’s new Operational Framework Review are likely to be presented to the Governing Council by as soon as the Feb 22 non-monetary policy meeting, and while sources close to technical discussions told MNI that there appears to be broad agreement on maintaining a modified version of the existing framework, they stressed no final decision has been made.

Talks have been ongoing for months in committees, and a final decision has already been pushed back from the turn of the year, with President Christine Lagarde signalling a final outcome by around the end of the first quarter.

It is not impossible the publication date could be pushed back again, several sources said, though Eurosystem officials saw broad agreement on a “system characterised by ample liquidity and maintaining continuity with the existing framework,” albeit with some adjustments in execution.

The framework review comes after years of unconventional monetary policy have transformed the scale of excess liquidity and the market for banks reserves. It will determine whether the ECB shifts its current de facto floor system of interest rates, in which the overnight deposit rate is the main instrument for influencing short-term money market rates, to a corridor system between a floor set by a tiered deposit rate for banks’ reserves and a ceiling marked by the rate on fixed allotment repo operations.

NO MAJORITY FOR LARGE LIQUIDITY INJECTIONS

Under the existing floor-system the ECB maintains excess liquidity at levels high enough to keep short-end rates pinned to the deposit rate. Chief Economist Philip Lane in early 2023 suggested that the ECB could contribute liquidity via a structural bond portfolio. One source however told MNI there is no majority for a “large supply-driven system that will inject large amounts of excess liquidity through structural operations.”

An alternative approach was suggested by Executive Board Member Isabel Schnabel in a speech around the same time, in which she argued in favour of a corridor system which would allow banks to determine the level of liquidity they want to hold.

One source said the outcome could be "a demand-driven system where the marginal unit of refinancing comes through weekly operations, with fixed rate full allotment”. “The issue
still to be discussed is how wide shall the corridor be, and should an operational framework also have implications for the collateral framework?”

A major point of contention in the review, which should have no implications for the ECB’s monetary policy stance, will be the eventual size of its balance sheet. (See MNI SOURCES: ECB Cut Expectations Range From 50-100BP In 2024)

Bank of Finland Chief Economist Tuomas Valimaki has said the balance sheet’s optimal size is likely to be “no larger than it has to be for effective monetary policy implementation.” Another central bank official noted that the size of the balance sheet will be “compromise- and events-driven.”

An ECB spokesperson declined to comment.