ECB Reverses Course and Widens Rate Corridor

• ECB has re-widened the rate corridor to 200bp effective on 21 January, reversing its 9 October decision. The move is an attempt to discourage the use of ECB's deposit facility, revive bank lending, and help normalize money markets.
• The move is likely to lead to lower eonia rates and perhaps slightly lower euribor rates. But the effects are likely to be quite small. The widening of the rate corridor also puts pressure on the already hardpressed banking sector.
• We do not expect this initiative to revive bank lending, and are somewhat puzzled by ECB's obsession with the amount on deposit, i.e. ECB would get much better results from proceeding with plans for a clearing house for interbank loans.

Fiddling while Rome burns

Rate corridor re-widened to 200bp

Yesterday the ECB announced that it will re-widen the corridor of standing facilities to 200bp effective from 21 January next year. This reverses ECB's decision from 9 October last year when it reduced the corridor to 100bp.

This means that the marginal lending rate will be 3.5% and the deposit rate 1.5% from 21 January (minus whatever ECB cuts on16 January). The ECB kept the weekly fixed rate tender procedure with the full allotment unchanged. So, unlimited liquidity is still in place.

Marginal lending is much less than earlier in the crisis, and the ECB's decision is mainly aimed at reducing the amount in the deposit facility.

Massive amounts are deposited at the ECB facility, which is clearly bothering it. ECB's aim is to encourage banks to increase lending in the economy and improve the functionality of money markets. The big question is whether it works.

The o/n eonia fixing is approximately 25bp lower than the refi rate at the moment. In more normal times eonia on average is slightly above the leading interest rate.

The lowering of the deposit rate will probably lower the o/n Eonia fixing somewhat, and hence pull longer eonia rates lower in the process. This may also have a slightly positive effect on euribor rates, as a wider spread makes euribor slightly more interesting.

However, there are also effects pulling in the opposite direction. Namely, banks are being punished for using both the lending facility and most importantly the deposit facility, adding to the banking sector's problems.

This could lead to less liquidity being drawn in the ECB and hence less being placed on deposit. This would not have any positive effect despite lowering the amount on deposit.

This does not solve much

We are very aware of the money market problems and the importance of improving the credit dynamics in Euroland. But this initiative is not a big piece in the solution, i.e. in our view ECB would get much better results from going forward with plans for a clearing house for interbank loans.

Should the widening of the rate corridor not significantly lower the amounts deposited at the ECB, further penalties could be in the pipeline.

We believe the ECB will cut the refi rate by 50bp effective on 21 January as well. This will take the refi rate to 2%, the marginal lending rate to 3% and the deposit rate to 1%.

Danske Bank
http://www.danskebank.com/danskeresearch

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