Eurozone money markets at the short-end have remained tight and volatile despite excess liquidity back above €150bn after a brief period around €130bn. The inability of money markets to normalise suggests a high risk that the ECB ease policy further at its Feb meeting by cutting the refi rate a further 10/15bp.
Last week’s ECB money market operations saw excess liquidity back above €150bn as banks demanded more liquidity via the MRO and supplied less liquidity via the fixed deposit operation. The ECB operations today saw very little net addition to excess liquidity with the 3y LTRO repayment of €3.7bn to dominate.
After today’s ECB operations we see excess liquidity on Wednesday lower by €3.48bn largely as a result of the €3.7bn repayment of 3y LTRO loans that was announced on Friday. The MRO and fixed term deposit operations led to a small increase in liquidity addition as the lower allocation at the MRO (€0.65bn) was offset by an SMP that was left slightly more unsterilized (€0.86bn).
This liquidity will not have much of an impact on overall liquidity conditions at a time when the money market curve is still far from being normal, especially at the front-end. The ECB has told us that it would act on any “unwarranted” tightening of money markets and we stick with the view that the ECB will ease policy as early as its February meeting. We now see the potential for a 10/15bps reduction in the refi rate at its Feb meeting.
The risk is clearly that this action will be delayed until its March meeting but risk/reward continues to favour playing for a surprise cut in rates. We remind ourselves of the surprise the ECB delivered in Nov 2013 when it cut rates despite the consensus that it would wait until updated projections were available in December.