Outcome of the ECB’s operational framework review
The Governing Council of the ECB has announced changes to the operational framework for implementing its monetary policy. The operational framework’s aim is to steer short-term money market rates closely in line with the Council’s monetary policy decisions. The purpose of the review was to ensure that it remains appropriate as the Eurosystem’s balance sheet normalises.
The deposit rate will remain the key policy rate in determining the monetary policy stance. So as now, the deposit rate will continue to provide a floor for money market rates. While the floor is not a cast-iron one (with overnight rates around 10bp below it), this is unlikely to change, as non-banks will remain excluded from the ECB’s deposit facility.
At the same time, the spread between the main refinancing rate and the deposit rate will be narrowed from 50bp now to 15bp by cutting the former by 35bp on 18 September. This should not be seen as a change in the monetary policy stance, but rather a technical change to incentivise bidding in the weekly operations to limit volatility in short-term money market rates. However, the reserve ratio for determining banks’ minimum reserve requirements remains unchanged at 1% and the remuneration of minimum reserves remains unchanged at 0%.
The way liquidity is provided will change. Whereas currently, more than sufficient liquidity is provided as a result of the ECB’s monetary policy, in particular the QE portfolios, in the future the Eurosystem will provide liquidity through a broad mix of instruments. This includes MROs, that will continue with full allotment and are seen as playing a central role in meeting banks’ liquidity needs, as well as 3-month LTROs.
The Governing Council also intends to introduce structural longer-term credit operations and a structural portfolio of securities, however only at a later stage once the Eurosystem balance sheet begins to grow durably again. This would be required to cover the banking sector’s structural liquidity needs arising from autonomous factors and minimum reserve requirements. These changes would likely start to materialise once excess liquidity declines to around optimum levels, which could be in a range of EUR 1-1.5 trillion. Given excess liquidity currently sits at around EUR 3.5 trillion, this moment is probably quite far away in the future.
The structural portfolio of securities is not to be confused with the securities the ECB currently holds for monetary policy purposes under the APP and PEPP. The latter portfolios will likely be fully wound down. This will take some time as it will be done gradually given the end of reinvestments under the APP and - by the end of this year - the PEPP. The Governing Council has not announced any modalities for the new structural portfolio of securities, however it is very likely that it will have a much shorter maturity profile than the APP and PEPP. This is because its purpose will simply be to provide liquidity, rather than to compress term premia.
Finally, the above changes are not fixed in stone. The Governing Council ‘will carefully monitor the evolution and distribution of excess liquidity, the formation of money market rates, the evolution of banks’ demand for reserves, and the functioning of money markets and broader financial markets’. It will review the key parameters of the framework in 2026 and ‘stands ready to adjust the design’.