EUR Money Markets: Gradual Upward Pressure from Declining Liquidity
Unlike the Fed or the Bank of England, the European Central Bank (ECB) appears to have more time before excess reserves reach levels that trigger significant changes in bank behavior.
Recourse to ECB facilities remains relatively low, and short-term interest rates face only gradual upward pressure.
ECB's Monetary Policy Status
The ECB has reiterated that it considers its monetary policy to be in a “good place,” maintaining the deposit facility rate at 2% since the June meeting.
However, risks remain from trade uncertainties, political developments in France and Germany, and varying perspectives on inflation risks.
The market currently assigns about a 25% probability to another 25 basis point cut within the next 12 months.
Outlook on Excess Reserves and Policy Rates
ECB policy rates are expected to stay steady in the foreseeable future, though the market anticipates a gradual decline in excess reserves held by banks.
This decline results from the ongoing roll-off of bonds from the ECB’s securities portfolios.
- The level of excess reserves—those above the minimum reserve requirement—has fallen from around €2.9 trillion at the start of the year to €2.5 trillion.
- Excess reserves peaked at €4.75 trillion in 2022 following ECB interventions during the pandemic.
Summary
The ECB is managing liquidity carefully, with excess reserves declining steadily but still at levels allowing gradual adjustments in money market rates without abrupt shifts in banking behavior.
Author's Summary
The ECB faces measured liquidity decline and cautious rate pressures, maintaining steady policy as uncertainties and inflation risks influence market expectations.