Exclusive-ECB to keep floor under market rates but with eye on demand -sources

investing.com:

By Francesco Canepa and Frank Siebelt

FRANKFURT (Reuters) — The European Central Bank will continue putting a «floor» under market interest rates in the years to come, but banks will play a greater role in deciding how much liquidity they want, four sources told Reuters.

The ECB is reviewing how it steers short-term interest rates in a new era in which inflation is higher and the massive amount of cash pumped into the banking system via stimulus programmes over the last decade is no longer needed and even creates some unwanted side-effects.

For much of the past 10 years the mechanism was simple: The ECB kept rates at zero or lower and flooded banks with more cash than they needed via bond purchases and loans, to encourage them to lend and revive inflation that was then too low.

This removed the need for banks to borrow from the ECB and pinned the overnight rate that banks charge each other to the one the ECB pays on deposits.

This framework needs changing now that interest rates are far above zero and massive amounts of excess reserves are unnecessary — and are even causing huge losses to the ECB and some of the 20 central banks around the euro zone.

Policymakers meeting in Frankfurt last week agreed that the ECB would stick to a «floor» system, where the central bank effectively sets the lowest rate at which banks would lend to each other, the sources said on condition of anonymity because the deliberations are confidential.

But there is an important twist: The ECB will not single-handedly decide how much liquidity it provides to the banking system once it has finished draining excess reserves some years from now, the sources added.

Instead, policymakers agreed commercial banks would help determine that by borrowing the