FRANKFURT Jan 7 The amount of excess cash in
the euro zone financial system is likely to nearly halve this
week as banks take up less European Central Bank funds, pushing
up money market rates and putting pressure on the ECB to take
action to stop that rise.
Higher money market rates effectively tighten monetary
conditions, which the ECB loosened only in November by cutting
its refinancing rate to a record low of 0.25 percent.
The ECB meets on Thursday, and while it is widely expected
to take no action this time, it will be keeping a close eye on
the money market as well as on weak inflation.
While lenders relying less on central bank cash generally
indicates that money market tensions have eased, the resulting
drop in liquidity also pushes up market rates, which if
prolonged could hamper the economic recovery.
"There are worries that liquidity will wilt away, and this
means that the ECB could have to take action," Nordea analyst
Jan von Gerich said.
On Tuesday, banks took 112.5 billion euros ($153.5 billion)
in the ECB's main weekly refinancing operation - 56 billion
euros less than the week before, when they were stocking up for
the tense end-of-the-year period.
The ECB also successfully drained funds to offset government
bonds bought under its now-ended bond-buying programme, after
three consecutive failures. Banks will deposit 179 billion euros
at the ECB for a week - 74 billion euros more than in the
previous operation on Dec. 30.
This all means that on Wednesday, when these transactions
are settled, euro zone money markets will be down by 130 billion
euros, which could mean excess liquidity - the amount of money
in the market beyond what banks need for their day-to-day
operations - falls to about 150 billion euros from the current
"While one week does not fundamentally change the tone, this
confirms the direction of earlier last year," von Gerich said.
In a Reuters poll last month, 25 of 40 respondents said the
ECB would increase liquidity through a third long-term loan,
probably early in 2014.
"The ECB will see no need to act (this month), but will
think of options, such as a targeted long-term liquidity
operation," von Gerich said. "It won't take much in the way of
bad news for the ECB to act."
Euro zone inflation fell in December after a small increase
the previous month, adding to the challenge the ECB faces in
avoiding deflation while supporting the bloc's recovery.
ECB President Mario Draghi has said that if the central bank
did inject more cash, it would have to ensure that any
additional long-term money is not just used to buy government
debt, as it was when the ECB poured in more than 1 trillion
euros in two operations in late 2011 and early 2012.
Other options for the ECB include cutting interest rates,
taking its deposit rate into negative territory or no longer
offsetting its bond purchases, which would add 179 billion euros
to the market immediately, or cutting its reserve requirements.
In November and December, when excess liquidity also fell to
around 150 billion euros, short-term market interest rates rose.
That trend could resume, especially when voluntary paybacks of
three-year central bank loans resume next week.
The ECB's twin three-year cash operations in late 2011 and
early 2012 helped push up excess liquidity to more than 800
Those loans will expire in about a year's time, but banks
have used the early repayment option and returned almost half
the money to the ECB already.
($1 = 0.7330 euros)
(Reporting by Sakari Suoninen; Editing by Hugh Lawson)