ECB View: Fall in Euribor and jump in balance sheet could trigger tiering change – The Governing Council’s monetary policy meeting this week will be watched for the tone of its commentary on the economic outlook as well as any policy changes. We think the ECB will strike a more positive note on current economic developments, while continuing to express caution about the outlook further out. Some of the hard data have hinted that the Q2 contraction might be somewhat less sharp than the central bank previously expected, while the Q3 rebound could be bigger. However, the ECB’s Chief Economist noted in a speech (see here) last month that while ‘the unlocking of the economy is likely to be associated with a substantial improvement in a variety of near-term growth indicators…the scale of the initial rebound in these weeks will not necessarily be a good guide to the speed and robustness of the recovery’.
As far as policy changes go, we do not expect major changes at this meeting so soon after June’s significant step up in asset purchases. However, the ECB may well decide to increase the multiplier for the calculation of the allowance of excess reserves that banks can hold free of charge. A increase in the tiering system ratio could reduce the burden of direct costs to banks from negative interest rates.
In October 2019, the ECB introduced an initial tiering multiplier, which was set at six. Now, we judge that the ECB is likely to gradually increase it, with a first step to seven. An increase in the tiering ratio by 1 (from six to seven), would lead roughly to a EUR 700mn cost reduction for eurozone banks. The largest benefactor would be the German banking sector, which would see a benefit of roughly EUR 200mn. Of course, this is a benefit, but is clearly modest compared to total eurozone bank earnings. In its communication, the Governing Council has communicated that the multiplier could be changed over time and that it will be set at ‘a level that ensures that euro short-term money market rates are not unduly influenced. The multiplier may also be adjusted in line with changing levels of excess liquidity’.
Two developments in the interbank market suggest that this might be the right time to begin a gradual adjustment higher. The interbank market is an important consideration for the ECB, as an increase in the tiering ratio could act to push up interbank rates in an environment of insufficient excess liquidity, which would be unhelpful when it is trying to lower the costs of loans in the general economy. However, the 3m Euribor rate has come down significantly and is back down to levels close to its normal relationship with the deposit rate. This followed a spike relating to disfunctions in money markets, which now appear to be easing. A less dysfunctional money market could help ease an increase in tiering. Second, the amount of excess liquidity has risen sharply due to the ECB’s asset purchases and the large net TLTRO take up. Therefore the ECB may judge that it can afford to further alleviate the direct cost to banks from its negative interest rate policy and balance sheet expansion without putting upward pressure on interbank rates.