January 28, 2014, 12:44 PM ET
ECB Bond Sterilization Fails Again
By Christopher Lawton
The European Central Bank failed for the second time this year to fully drain the market of the more than €170 billion in government bonds it still holds under its previous bond-buying program.
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Excess liquidity in the interbank market has been so tight lately that the ECB hasn’t been able to entice banks to let go of the necessary funds. On Tuesday, the ECB drained €151.2 billion from the market, some €26.3 billion shy of its target.
The ECB bought over €200 billion in Greek, Portuguese, Irish, Spanish and Italian government bonds under its now-defunct Securities Market Program from 2010 to 2012. It has offered banks interest-bearing deposits on a weekly basis to drain an amount equal to the bonds it still has on its books.
The failed sterilization puts the ECB is an awkward position.
On the one hand, the tight liquidity in the banking system has caused some volatility in money markets. The ECB is determined to keep these rates down to nurture the banks and the euro-zone economy back to health. The excess cash from the failed operation can still be traded between banks, which helps keep the interest rates at which they lend to each other down.
The Euro Overnight Interest Average, or Eonia, fell to 0.188% as of Monday’s fixing, from 0.359% a week earlier.
On the other hand, sterilizing the purchases to keep the money supply stable helps the ECB show that it takes great pains to play within the lines of its mandate, which forbids it from financing governments. The issue is particularly relevant as the German Constitutional Court is still weighing the legality of its current and arguably more successful bond-buying program (which has yet to be used): Outright Monetary Transactions.
For now that means the SMP sterilizations are here to stay despite the recent problems, ECB watchers say.
One reason why the weekly drains may have failed is that core euro-zone banks are holding onto cash, says Christian Schulz, economist with Berenberg Bank. With banks in Southern Europe steadily repaying the €1 trillion in long-term loans they borrowed from the ECB in late 2011 and early 2012, core euro-zone banks have to pay more to borrow from them, Mr. Schulz adds.
Since this affects mostly the euro-zone core and not the stressed periphery, “it is not a great concern for the ECB,” he says.
Greg Fuzesi, an economist at J.P. Morgan, argues that with banks currently repaying their long-term loans to the ECB, excess liquidity is going to fall and there is going to be some volatility in Eonia rates. Even without the sterilization of the SMP, the levels of excess liquidity will still fall over time.
“At some point you need to accept that this is going to happen as part of the normalization process,” he says.
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