Exclusive: Symmetrical Distribution of Key ECB Rates Optimal, But No Urgency Seen
20 May 2022
By David Barwick – FRANKFURT (Econostream) – Theory prescribes no precise corridor width between the key interest rates of the European Central Bank, in the view of an ECB insider who felt that a desire to calibrate that spread was less likely to drive the magnitude of any rate moves in the earlier phase of policy normalisation.
Once interest rates return to somewhat more normal levels, however, achieving a symmetrical distribution in which the rate on the main refinancing operations (MROs) is equidistant from each of the ECB’s other two key rates would be an appropriate objective, he suggested.
The spread between the deposit facility rate (DFR) and the rate on the MROs now stands at 50 bps, while that between the MRO rate and the rate on the marginal lending facility (MLF) is at an asymmetrical 25 bps.
In general, this person said, the appropriate spread should be small enough so as not to encourage excessive volatility of the overnight rate, while not so small as to cramp normal market functioning.
‘Under current circumstances, however, the whole meaning of the corridor is a bit blurred, because the main refinancing rate is not effective’, this person observed. ‘At least as long as we have the huge liquidity surplus that we now have and that is going to be there for a while, the key is with the deposit rate, not so much with the main refinancing rate.’
Were monetary policy more normal, then a symmetrical distribution of the key rates would be ‘the easiest way and most effective way to impact, for example, expectations on short-term rates, because there is no evidence that the liquidity shock distribution is asymmetric’, he said.
‘So, if the liquidity shock distribution is symmetric, then having a symmetric corridor gives you equal probabilities of maintaining the deposit facility or the marginal lending facility, and theoretically the independent market rates should be at the midpoint, without any excess of liquidity’, he said.
At some point, the key rates would have to move by different amounts to achieve this, but there was no hurry about this until ‘we are back under normal, balanced liquidity conditions’, he said. ‘But now, with excess liquidity in the thousands of billions, what matters is only the deposit facility rate.’
Even well after the ECB starts to hike rates, a great deal of excess liquidity would still persist, he said, ‘unless we see extreme quantitative tightening, which we won’t.’
It could thus be some time before the ECB needs to worry about the corridor or the symmetry of the distribution of its key rates, he said.
This does not exclude the possibility that the ECB could choose to calibrate the spread relatively early on, however: as Econostream reported on April 21, another ECB insider envisaged a return to a more normal corridor sooner rather than later.