ECB executive board member Schnabel outlined her thinking on the future of the ECB balance sheet. The topic has received more attention since global money markets have shown increased signs of tightness (we have written about it here). In EUR money markets, euro short-term rate (ESTR) fixings for unsecured overnight borrowing have reached their highest levels relative to the deposit facility rate since 2021.
Overall, the latest developments remain within the realm of the gradual upward pressure already present for the past couple of years. And perhaps more importantly, the secured funding rates, which are banks’ preferred markets to redistribute liquidity within the system, have not shown an accelerated drift higher. Since summer, for instance, the GC pooling overnight rate has largely come in a band of +/-1bp around the deposit facility rate outside month-ends.
But as Schnabel outlined, at some point these repo rates are likely to start rising also here as the roll-off from the monetary policy portfolio reduces reserves in the system. Part of the plan in transitioning to the new operational framework is that this will steer banks to the ECB liquidity-providing operations. This, in turn, will see very little take-up. Keep in mind that the ECB provides liquidity at 15bp above the deposit rate, which is still an expensive option for now.
When will banks start to turn to the ECB for liquidity? Timing depends on the level of reserves banks want to hold, which is difficult to measure. Based on scenarios around future banks’ desired liquidity coverage ratios and the share of reserves of banks’ highly liquid assets to back these, ECB staff estimates imply that we could reach that point even as early as mid-2026, while a middle scenario puts it more toward the end of 2027.
That appears to give EUR markets a bit more time to prepare, but it indicates that there is still an upside stemming from the transition, which can also have implications for something like Bund spreads over OIS which also show a close link to repo funding markets. Relief from a structural ECB bond portfolio could be even more distant, as Schnabel indicated, as it is likely only at the bottom of the list of the structural operations to be introduced stepwise, and further out the curve as the portfolio could be focused on shorter dated paper. As is, the current bond portfolio still depresses 10y bond yield by 60bp by the ECB’s estimates.