Liquidity conditions and monetary policy operations from 2 August to 31 October 2023

Prepared by Denis Lungu and Kristian Tötterman

Published as part of the ECB Economic Bulletin, Issue 8/2023.

This box describes liquidity conditions and the Eurosystem’s monetary policy operations during the fifth and sixth reserve maintenance periods of 2023. Together, these two maintenance periods ran from 2 August to 31 October 2023 (the “review period”).

The Governing Council raised the ECB’s three policy rates by 25 basis points at each of its meetings on 27 July and 14 September 2023. These increases took effect in the fifth and sixth reserve maintenance periods of 2023 respectively. At its meeting on 27 July, the Governing Council also decided to reduce the remuneration of minimum reserves that banks are required to hold with their Eurosystem national central bank to 0%. This reduction came into force at the beginning of the sixth maintenance period.

Excess liquidity in the euro area banking system continued to decline during the review period. This decrease was due mainly to the maturing of the fifth operation under the third series of targeted longer-term refinancing operations (TLTRO III) and early repayments by banks of other TLTRO funds on 27 September 2023. To some extent, it was also the result of the fall in asset purchase programme (APP) holdings since the Eurosystem’s discontinuation of the reinvestments under the programme from 1 July. However, the reduction in liquidity provision was partly offset by the continued decline in net autonomous factors that had started with the end of the negative interest rate environment in July 2022, owing primarily to a drop in government deposits.

Liquidity needs

The average daily liquidity needs of the banking system, defined as the sum of net autonomous factors and reserve requirements, decreased by €101.3 billion to €1,735.0 billion in the review period. Compared with the third and fourth maintenance periods of 2023, this was due entirely to a €101.3 billion fall in net autonomous factors to €1,570.0 billion (see the section of Table A entitled “Other liquidity-based information”), driven by a decline in liquidity-absorbing autonomous factors and an increase in liquidity-providing autonomous factors. Minimum reserve requirements remained unchanged at €165 billion.

Liquidity-absorbing autonomous factors decreased by €83.0 billion to €2,720.6 billion in the review period, owing primarily to a decline in government deposits and other autonomous factors. Government deposits (see the section of Table A entitled “Liabilities”) fell on average by €32.8 billion over the review period to €222.6 billion, with most of the decline taking place in the fifth maintenance period. This decline reflects the continued normalisation in the overall volume of cash buffers held by national treasuries and, within those buffers, an adjustment in their cash management strategies owing to the changes in the remuneration of government deposits with the Eurosystem that made it more financially attractive to place funds in the market.

More specifically, the ECB lowered the ceiling for the remuneration of government deposits held with the Eurosystem to the euro short-term rate (€STR) minus 20 basis points as of 1 May 2023. Under the ceiling concept, Eurosystem national central banks may decide to deviate from the ceiling and remunerate government deposits at a rate lower than the ceiling. For instance, the Deutsche Bundesbank set a 0% interest rate for the remuneration of domestic government deposits as of 1 October 2023. However, the downward effect of this change on the affected government deposits was offset by upward, seasonal-related changes in other government deposits. The normalisation of repo market conditions and higher repo rates relative to the €STR have also made market investment a more attractive option than deposits with the Eurosystem. The average value of banknotes in circulation decreased by €5.5 billion over the review period, down to €1,559.8 billion, reflecting a continuation of the reduction in banknote holdings observed since the ECB’s policy rates were lifted out of negative territory. Other autonomous factors also declined by €44.7 billion on average. The decline reflects several changes in other sundry assets and in the revaluation account.

Liquidity-providing autonomous factors rose by €18 billion, to stand at €1,150.8 billion. Net assets denominated in euro increased by €28.5 billion in the review period. This increase was largely the result of a continued fall in liabilities to non-euro area residents denominated in euro. This in turn reflects an adjustment in the cash management strategies of customers of the Eurosystem reserve management services (ERMS), since the remuneration of deposits held under the ERMS framework was also adjusted as of 1 May 2023. Net foreign assets decreased by €10.5 billion, partially offsetting the above-mentioned decline in other autonomous factors.

Table A provides an overview of the Eurosystem’s liquidity conditions, including the changes in autonomous factors discussed above.^[1]

Liquidity provided through monetary policy instruments

The average amount of liquidity provided through monetary policy instruments decreased by €406.7 billion to €5,359.5 billion during the review period (Chart A). The reduction in liquidity was driven primarily by a decline in credit operations.

The average amount of liquidity provided through credit operations fell by €329.3 billion to €568.2 billion during the review period. This decrease largely reflects the decline in outstanding TLTRO III amounts owing to i) the maturing of the fifth operation under TLTRO III (€66.7 billion) and early repayments of other TLTRO funds (€34.2 billion) on 27 September, and ii) the maturing of the fourth operation under TLTRO III (€476.8 billion) and early repayments of other TLTRO funds (€29.5 billion) on 28 June, which were still affecting the average level of credit operations in the previous review period. Increasing on average by €0.5 billion and €4.3 billion respectively, the main refinancing operations and three-month longer-term refinancing operations offset only a small part of the liquidity drained by TLTRO III repayments. The limited increases in these operations reflect banks’ comfortable liquidity positions and the availability of alternative funding sources.

The average amount of liquidity provided via holdings of outright portfolios decreased by €77.3 billion during the review period. This decrease was due to the discontinuation of reinvestments of the principal payments from maturing securities under the APP from 1 July 2023. Under the pandemic emergency purchase programme, the principal payments from maturing securities have been fully reinvested since net purchases were discontinued at the end of March 2022.^[2]

Chart A

Changes in liquidity provided through open market operations and excess liquidity

(EUR billions)

Excess liquidity

Average excess liquidity decreased by €305.3 billion, to reach €3,624.5 billion (Chart A). Excess liquidity is the sum of the reserves banks hold in excess of the reserve requirements and the recourse to the deposit facility net of the recourse to the marginal lending facility. It reflects the difference between the total liquidity provided to the banking system and the liquidity needs of banks to cover minimum reserves. Since peaking at €4,748 billion in November 2022, average excess liquidity has decreased steadily, owing mainly to maturing operations and early repayments under TLTRO III. The discontinuation of reinvestments under the APP from 1 July 2023 has also been contributing to the decline.

Interest rate developments

The €STR increased by 47.8 basis points, from 3.404% on 1 August, the last day of the previous review period, to 3.882% on 31 October, the last day of the current review period, reflecting the increases in the ECB’s policy rates.^[3] The pass-through of the policy rate increases that took effect in August and September 2023 to unsecured overnight money market rates was immediate and complete. The end-of-quarter and end-of-month effects on the €STR were slightly more pronounced in September and October. This can be attributed to attempts by banks to optimise their minimum reserve base with a view to reducing their reserve requirements for the seventh and eighth reserve maintenance periods of 2023 respectively. The €STR traded at 12 and 11.8 basis points below the deposit facility rate at the end of September and October respectively, which was slightly higher than the average spread of 10.8 basis points for the quarter-ends and month-ends in 2023.

The euro area repo rate, as measured by the RepoFunds Rate Euro index, increased by 49.6 basis points, from 3.438% on 1 August to 3.934% on 31 October. Similarly to the unsecured money market, the pass-through of the ECB’s policy rate hikes to the secured money market was immediate and complete. The functioning of the repo market remained orderly owing to several factors, including higher net issuance since the beginning of the year and the release of mobilised collateral on the back of the maturing TLTROs, as well as the decline in the outstanding APP holdings.