Daily Management Review

ECB Would Drain Cash To Counteract The New Yield-Cap Programme: Reports


ECB Would Drain Cash To Counteract The New Yield-Cap Programme: Reports
According to reports quoting sources, the European Central Bank will likely drain liquidity from the banking system to offset any bond purchases made to control borrowing costs for indebted eurozone nations.
Bond yields in Italy and other debt-laden countries have risen since the European Central Bank announced intentions to cease buying debt and hike interest rates for the first time in more than a decade next month to combat runaway inflation.
Because of the market instability, the ECB has accelerated work on a new bond-buying scheme to reduce yields. This puts it in the uncomfortable position of boosting borrowing costs for the entire eurozone while capping them for certain of its weaker countries.
To avoid this seeming contradiction, the ECB is considering matching the new bond-purchase plan with auctions in which banks can park cash with the ECB for a higher interest rate than the standard deposit rate, according to persons with direct knowledge of the situation.
This would allow the ECB to'sterilize' the new scheme's bond purchases, similar to its weekly "liquidity-absorbing" operations a decade ago. These gave banks interest rates up to the ECB's refinancing operation, which was then 0.25 per cent.
Unlike a decade ago, the ECB has created 4.48 trillion euros ($4.74 trillion) of surplus reserves in the banking sector through a slew of stimulus measures over the last decade, giving it plenty of leeway.
The proposed option would also be more convenient than selling bonds from nations with lower borrowing costs, such as Germany, which would almost certainly result in losses for the local central bank.
Ignazio Visco, governor of the Bank of Italy, hinted at such a step earlier this month when he stated the ECB did not need to sell bonds to sterilise its purchases and could instead work with interest rates. The new strategy, aimed at combating financial fragmentation among eurozone countries, will be announced on July 21 during the ECB's Governing Council meeting.
Details are still being worked out, but beneficiary countries should expect loose strings attached, such as a commitment to follow the European Commission's economic recommendations.
This week, ECB policymakers are meeting in Sintra, Portugal, for their annual forum.