European Central Bank President Mario Draghi would only consider ending the sterilization of crisis-era bond purchases if he’s openly backed by the Bundesbank, according to two euro-area central bank officials familiar with the debate.
Ending the liquidity drain would add almost 180 billion euros ($243 billion) to the euro-area financial system at a time when officials are trying to curb volatility in money markets and official interest rates are close to zero.
Draghi said he would contemplate asking ECB policy makers to halt the absorption of liquidity from the now-terminated Securities Markets Program if the Bundesbank helps sell the move to the German public, the people said, asking not to be identified because the deliberations are private. Sterilizing bond purchases typically neutralizes their impact on money supply, curbing inflation risks.
Enlisting the Bundesbank to convince the German public of a change in the terms of the SMP may be Draghi’s defense strategy against the kind of backlash his predecessor Jean-Claude Trichet experienced when he announced the program in 2010. Then-Bundesbank President Axel Weber criticized the measure on the same day, saying it posed “significant” risks.
A spokesman for the ECB declined to comment yesterday. The Bundesbank supports ending the liquidity absorption and has deliberated on the measure in the ECB’s monetary-policy and market-operations committees, a central-bank official told Bloomberg on Jan. 31.
Ending the liquidity drain, which started with the bond purchases during the financial crisis, would more than double excess liquidity in the system. That could help to curb volatility in market interest rates and reduce banks’ incentive to keep cash at the ECB rather than lend it on. Draghi has said the Frankfurt-based institution is ready to act if money-market rates are unwarranted or the outlook for inflation worsens.
The central bank has failed for the past two weeks to sterilize SMP purchases in a sign that lenders may be reluctant to park cash at the central bank amid tighter funding conditions. Excess liquidity, money not immediately needed by banks to meet their obligations, fell to 168 billion euros on Jan. 31 from 813 billion euros two years ago.
Overnight interbank borrowing costs surged above the ECB’s benchmark interest rate last month, rising as high as 0.36 percent on Jan. 20. The rate stood at 0.14 percent yesterday. Inflation in the currency bloc unexpectedly slowed to 0.7 percent in January, compared with the ECB’s target of just under 2 percent.
The ECB’s Governing Council next meets to set monetary policy on Feb. 6. Policy makers kept the main rate at a record low of 0.25 percent in January after a surprise cut in November. [Bloomberg]