ECB To Offset Bond Purchases With Cash From The Banking System

ECB To Offset Bond Purchases With Cash From The Banking System

June 29, 2022 0 By Jeanine Sanchez

According to Reuters, multiple inside sources say the European central bank (ECB) won’t mind offsetting bond purchases for indebted euro zone states with cash from the banking system. Thus, it can limit borrowing costs.

Recently, ECB announced that it would no longer buy debt and increased interest rates. It was the first time the ECB would raise rates in nearly ten years. However, the news caused a rise in the bond yields for Italy and other debt-laden nations. The ECB is hastening efforts to buy new bond schemes to reduce yields.

The efforts had to be speedy as the downturn in the financial markets continued to worsen. That explains why the ECB raised borrowing costs for the whole eurozone. However, the same move has limited the purchasing power of some of its members.

The ECB’s New Scheme

The ECB’s solution to this apparent inconsistency is to pair new bond purchase schemes with auctions. Banks can keep their cash with the ECB through these auctions to enjoy better interest rates than the standard rate on deposits. This new scheme enables the ECB to stabilize bond purchases.

The move is similar to its weekly liquidity absorbing mechanism, which it did ten years ago. Thus, banks can get an additional 0.25% interest up offered through the ECB refinancing operation. A top representative of the ECB chose not to comment on the matter.

Compared to ten years ago, the ECB’s banking system now has an excess reserve of 4.48 trillion euros ($4.74 trillion). The ECB has built this reserve over the last ten years through various stimulus packages. Hence, there is room for the ECB to make various maneuvers.

Reducing Inflation And Helping Debt-Laden Nations

The ECB also deems this proposed solution as a better option for selling bonds from nations with lower borrowing costs like Germany. The latter option would likely result in losses for the local apex banks.

The governor of Italy’s apex bank, Ignazio Visco, agreed with ECB’s proposal based on his comments early in the month. He said the ECB should work with interest rates than sell bonds to neutralize its purchases.

The ECB hopes this scheme will solve the financial imbalance among eurozone nations. Europe’s apex bank will unveil its new scheme at its next governing council meeting scheduled for next month. While the details are not yet finalized, the terms won’t be too strict for the beneficiary nations.

One of the simple terms might be compliance with the economic suggestions from the European Commission. Later this week, ECB decision-makers will meet for their annual gathering in Sintra, Portugal.

According to ECB president Christine Lagarde, the ECB still plans to raise rates. Lagarde also said, “the current uncertainty in global financial markets makes it impossible to predict the speed of interest rate normalization.