When the ECB announced its new plan to buy peripheral government debt in
Europe (for the purpose of reducing yields) there was some concern over
the fact that the purchases were going to be "sterilized."
In theory what this means is that if, say, the ECB goes out and buys 50 billion EUR worth of sovereign debt, then somewhere else it will remove 50 billion EUR from the system so as to avoid inflation (and placate the Germans).
Some people wondered: What assets will the ECB sell in order to finance these purchases.
But the market was clearly not worried about this sterilization news, as evidenced by the big market surge on Thursday and Friday, as investors realized that "sterilization" is mostly for show, with little real impact on the amount of money in the system.
In a note from last December, JPM's Greg Fuzesi explained how the ECB engaged in bond sterilization (this was in reference to the old SMP program, but the gist is the same.
In theory what this means is that if, say, the ECB goes out and buys 50 billion EUR worth of sovereign debt, then somewhere else it will remove 50 billion EUR from the system so as to avoid inflation (and placate the Germans).
Some people wondered: What assets will the ECB sell in order to finance these purchases.
But the market was clearly not worried about this sterilization news, as evidenced by the big market surge on Thursday and Friday, as investors realized that "sterilization" is mostly for show, with little real impact on the amount of money in the system.
In a note from last December, JPM's Greg Fuzesi explained how the ECB engaged in bond sterilization (this was in reference to the old SMP program, but the gist is the same.
When the ECB purchases peripheral
government bonds through its Securities Markets Programme (SMP), it pays
for these by creating new bank reserves (i.e., through the modern form
of printing money). In terms of its balance sheet, both assets and
liabilities increase. The purchased peripheral bonds are held as assets
in the SMP category and are matched on the liability side by a larger
amount of bank reserves. In the first instance, the new reserves are
added to the current accounts that commercial banks hold at the ECB. In
this form, the reserves are fully liquid as they count towards meeting
banks’ reserve requirements and they can be used to settle interbank
payments.
The way the ECB has chosen to sterilize
these reserves balances is to encourage banks to shift them from the
fully liquid current accounts into fixed term deposits, which are just
another form of reserves. The ECB could offer these at any maturity but
has chosen a short maturity of just one week (likely for operational
reasons). The deposits are auc- tioned through a tender procedure, which
requires banks put in bids, stating the amount they are willing to tie
down for the one week period and the interest rate at which they are
willing to do so. The maximum interest rate that the ECB is willing to
pay is the main policy interest rate, and it be- gins by picking the
cheapest bids until it has met its target level.
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