Julian Callow at Barclays Capital provides us with the following chart. Note the sharp moves on the day of the ECB liquidity operation last week:
As he notes:
Unsurprisingly, the vast excess of term liquidity generated by last Wednesday’s one year refinancing has resulted in a massive surge in overnight deposits banks are making back with the ECB: the ECB just noted that €236.2bn was deposited last Friday, up from €143.4bn deposited on Thursday, €7.4bn last Wednesday, and just €286mn on Tuesday, prior to the operation . Last Wednesday we estimated the excess liquidity resulting from the one year refinancing (which allotted €442.2bn) as around €270bn, and Friday’s use of the deposit facility would be consistent with that.
What that means is that Europe’s banks are hoarding much of last week’s injection of ECB 12-month money. This has led banks to shy away significantly from lending to each other via the euro area effective overnight index average (EONIA). Accordingly, the rate continues to set record lows amid a collapse in Eonia volumes. What’s more, Callow expects volumes only to decline further.
Key to the whole thing though is the following observation from Callow:
Overall, as we suspected, the ECB’s stance - as revealed by developments during Wed-Fri last week - is to let the market address the excess liquidity itself, rather than by actively draining. It is very likely that at Wednesday’s regular weekly repo there will be a very large “negative” bid as the market adjusts to the excess surplus (use of the deposit facility is costly since banks will have borrowed at 1.0% and re-deposited at 0.25%: they can simply rein in the excess liquidity by borrowing less at weekly and quarterly refinancings).
Hence it continues to be the case that, in this environment of unlimited allotments, the ECB is tolerating volatility in EONIA. In “normal” conditions it has sought to keep EONIA averaging a constant spread of 6-8bp above the minimum bid rate in its weekly operations (the “main policy rate”). But with the provision of unlimited liquidity, particularly if for one year in such gigantic size, it is not practical for the ECB’s operations directorate to be actively compensating for that with day to day fine tuning operations.
Which means in effect, RIP Eonia, alongside Libor. Or if you don’t trust us, here’s Callow’s conclusion on the matter:
…the ECB would apparently let the market settle the liquidity excess itself, even if that means that EONIA has been very volatile since the unlimited allotments commenced in mid-October last year. If anything, the volatility has increased during the past two months, despite the market effectively shifting to anticipate no more ECB rate cuts. In turn, the EONIA volatility is damaging to the money markets, since EONIA is one of the cornerstone of pricing of all maturities (and it influences strongly Euribor, which in turn is the key reference rate fior banks in setting lending and deposit rates to households and businesses).
It seems that, rather than pursue a more simple and transparent policy, as with other central banks, of focusing on the short term rate (and thereby lowering this), the Governing Council, by shifting its focus to the one year rate via the unlimited one year refinancing, has left the market decide of the amount of liquidity in the system. And thus, it is in effect letting the market decide about very short end rates.
Related links:
Crushing rates the ECB way - FT Alphaville
Libor is useless - FT Alphaville
