February 4, 2014 / 3:55 PM / 5 years ago

ECB sterilisation suspension only one of several policy options

FRANKFURT, Feb 4 (Reuters) - The European Central Bank has discussed the possibility of suspending operations to soak up money it spent on sovereign bonds but this is just one policy option and is unlikely to be decided this week, people familiar with the issue say.

Ending the so-called “sterilisation” operations would inject about 175 billion euros ($237 billion) of liquidity into the financial system, which would help ease strains in euro zone money markets.

An “unwarranted” tightening of short-term money markets was one scenario President Mario Draghi set out after the ECB’s January meeting that could trigger policy action. The other was a deterioration in the medium-term inflation outlook.

The ECB holds a policy meeting on Thursday.

But new ECB economic forecasts due for the March policy meeting will give the Governing Council fresh grounds to review its policy stance and could be the occasion for a review of the liquidity stance too, said one person familiar with the issue.

Liquidity is the key issue for determining whether to suspend the sterilisation of the now-terminated Securities Markets Programme (SMP) to allow liquidity levels to rise.

In weekly transactions, the ECB takes deposits from banks to offset its spending on the SMP bonds, to ensure that the debt purchases will not trigger inflation.

If the central bank were to suspend the operations, this would lift the amount of so-called excess liquidity - money banks have beyond what they need for their day-to-day operations - in the financial system.

“I do not see any risk but also not much benefit in this,” said Berenberg bank’s Christian Schulz, a former ECB economist.

“Stopping sterilisation would increase excess liquidity and thus drive down EONIA again. But at 15bp, its level is hardly a major issue,” he added.


EONIA overnight lending rates spiked above the ECB’s key rate - currently at 0.25 percent - last month after a drop in excess liquidity as banks repaid early big chunks of crisis loans they took from the ECB two years earlier.

Overnight rates have since fallen and traded at 0.14 percent on Monday as the tensions eased. But excess liquidity is set to fall back again this week to the levels that sparked volatility in bank-to-bank lending rates last month.

The ECB absorbed the full amount of its SMP programme on Tuesday, withdrawing 175.5 billion euros from the market - around 24 billion euros more than last week. It also allotted some 20 billion euros less in its weekly refinancing operation.

This means the amount of excess liquidity will fall to some 140 billion euros from 186 billion euros once the operations are settled on Wednesday - a level that saw EONIA rates spike above the ECB’s key rate last month.

One argument against suspending the sterilisation operations would be to avoid raising questions about ECB policy ahead of a ruling by the German Constitutional Court on the central bank’s new bond-buying programme.

The court is considering whether the ECB’s plans to buy “unlimited” amounts of bonds from stricken euro zone states, announced in 2012 at the height of the euro zone crisis, is really a vehicle for funding member states through the back door. That could violate German law.

Purchases made under the yet-to-be-used bond plan are meant to be sterilised. Suspending the SMP sterilisation might raise questions about ECB policy ahead of the court ruling.

“It could provoke the German Constitutional Court, which may feel that the ECB is changing the rules of the SMP ex post” said JP Morgan economist Greg Fuzesi.

Berenberg’s Schulz played down this concern: “The court should not be concerned by this,” he said. “The SMP stock will decline over time, so the action would be limited in time and amount.”

$1 = 0.7397 euros Editing by Jeremy Gaunt

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