September 27, 2007
ECB fights crisis only half-heartedly
Roughly six weeks ago when the turbulences in the financial markets came to the attention of the general public and the ECB pumped the money market with special overnight tender of roughly € 100 bn, we highly praised the ECB’s reaction. Looking at the ECB now for its latest management of the tensions in the money market, it unfortunately deserves much less praise.
Not only run tensions still high in the EMU money market which becomes obvious by the fact that the three-months EURIBOR interest rate now stands at almost 4.80 percent (see the figure taken from the Bundesbank’s website), roughly 80 basis points above the main refinancing rate officially stated by the ECB. The ECB has also done a much poorer job in managing the money market than the Bank of England or the US Fed.
In the US, the Fed had intervened in the federal funds market to an extent that the effective interest rate fell below the target rate even before the official rate cut (see graph) from 5.25 to 4.75 percent on September 18 while the BoE managed to bring LIBOR rates back down significantly closer to its overnight target rate.
It is not that the ECB could not have acted more boldly. Both the long-term and the short-term tender this week ended with average refinancing rates far above the minimum bid rate of 4.0 percent: In the weekly tender, banks had to pay an average of 4.29 percent, for the three-months tender, they were charged an weighted average of 4.63 percent. In the weekly tender, banks which bid below 4.20 percent were not alloted any liquidity. In the three-months-tender, the marginal rate reached 4.5 percent. If the ECB were serious about tensions in the money market, it would have alloted more liquidity to a lower interest rate.
The fact that the ECB does not really act that boldly raises the suspicion that it is not really serious about fighting the tensions in the money market. Parts of the governing council still want to increase interest rates and seem to be content to have the interest rate increase through the back door. After all, for the banking sector as well as the economy, it is not the stated minimum bid rate for weekly tenders (which is the key interest rate decided on by the governing council) that matters, but the effective interest rate the banks have to pay. This rate is now already significantly higher than the 4.0 percent officially stated, thus already acting as a brake on economic activity.