The European Central Bank (ECB) plans to maintain a “floor” under market interest rates, with the decision on the amount of liquidity increasingly being made by the banks themselves, Reuters reported on Thursday.
The ECB is reevaluating its approach to short-term interest rates due to higher inflation and the reduced need for cash from stimulus programmes.
The current system, which kept rates at or below zero and provided banks with excess cash, will change as interest rates rise and excess reserves become unnecessary.
The ECB will continue to set the lowest inter-bank lending rate but will not solely determine the banking system’s liquidity.
Instead, commercial banks will borrow the reserves they need from the ECB. In order to make borrowing more affordable for banks, the ECB plans to reduce the rate on its weekly cash auctions from the current 4.5 per cent to a rate closer to its 4.0 per cent deposit rate.
This new “demand-driven floor” framework is expected to be announced next month. The ECB’s bond portfolio size and composition are still under debate.
The ECB currently owns €4.7 trillion ($5.1 trillion) worth of bonds, ensuring the banking sector will have more reserves than needed until 2029, according to the ECB’s estimates.
