By Marius Zaharia
LONDON, Feb 4 (Reuters) - German Bund yields hit their lowest in six months on Tuesday on talk the European Central Bank was seeking support to stop sterilising its crisis-era bond purchases in money markets.
The ECB takes an amount equivalent to its holdings of euro zone government bonds as weekly deposits from banks to offset the buying and neutralise any threat it will fuel inflation.
The weekly operations are also aimed at quelling concerns the bond purchases were directly financing governments, something the ECB is not allowed to do.
A Bloomberg report, citing two euro-area central bank officials familiar with the debate, said ECB President Mario Draghi would only consider ending the sterilization if he is openly backed by the Bundesbank.
“There’s talk Draghi is looking for German support for ending sterilisation. For me, that’s effectively QE (quantitative easing),” a trader said, using market jargon for central bank asset purchases as a monetary policy easing tool.
German 10-year Bund yields, the euro zone benchmark, were last 1.4 basis points lower on the day at 1.54 percent, having earlier fallen to 1.534 percent, their lowest since late July 2013.
The ECB has failed to sterilise the entire amount in recent weeks, with traders saying banks preferred to hold on to the funds rather than handing them back to the ECB.
That was because excess liquidity - the amount of cash banks have beyond what they need for their day-by-day operations - hovered around two-year lows.
It was last at 170 billion euros, slightly higher than the low of 125 billion hit in January, but well below highs of over 800 billion hit in mid-2012 after the ECB injected more than 1 trillion euros in three-year crisis loans - LTROs - into the banking system.
The drop in excess liquidity led to increased volatility in overnight bank-to-bank borrowing rates in January as some banks, less reliant on ECB funds, had to be more active in money markets.
Draghi said an “unwarranted” rise in money market rates would prompt the ECB to ease monetary policy further.
If the ECB stopped sterilising, the excess liquidity in the banking system - the cash banks hold beyond what they need for their day-by-day operations - would rise by almost 180 billion euros.
It would keep money market rates anchored at low levels, preventing a tightening of market conditions that could hamper the euro zone economic recovery, analysts said.
“It would certainly help ... (to) calm down fears of a drop in excess liquidity,” DZ Bank strategist Christian Lenk said.
The ECB’s next sterilising operation is scheduled at 1200 GMT.