(Bloomberg) — The Bundesbank’s decision to stop paying interest on German government deposits, while jolting markets, marks a return to how it dealt with such holdings in the past.
(Bloomberg) — The Bundesbank’s decision to stop paying interest on German government deposits, while jolting markets, marks a return to how it dealt with such holdings in the past.
The arrangement was always a stopgap measure: the European Central Bank allowed its national counterparts to temporarily pay interest on such state cash a year ago to ensure a smoother transition back to the old system.
While the Bundesbank didn’t explain its reasoning when announcing late Friday that it would halt interest payments from October, it had already flagged its preference for doing so back in April.
The ECB only sets ceilings for how government deposits are remunerated, leaving the rest to national central banks to decide themselves.
The move saw demand for short-term German debt jump on expectations that the government holdings — about €54 billion ($59 billion) at end-July — will eventually be redirected to such securities.
It will also restore some semblance of normality after years of quantitative easing and negative rates. That recently left the Bundesbank and its peers across the region saddled with large interest payments on holdings from governments and other depositors.
The decision “has come as a surprise to us and the market judging by the reaction,” said Rabobank analysts including Richard McGuire. There is “the possibility that other euro-zone national central banks will follow the lead of the Bundesbank.”
Under current rules, set in February, euro-area central banks can pay interest up to the equivalent of the euro short-term rate, €STR, minus 20 basis points on government deposits.
The Eurosystem has historically refrained from remunerating such holdings, encouraging its clients to place them in the market instead. As a result, balances at central banks — the Bundesbank included — were negligible.
When the ECB cut its deposit rate below zero in 2014, it capped interest on government deposits at that rate. Large-scale asset purchases were already in the pipeline — they’d eventually start in 2015 — and it was clear that overnight market rates would follow official rates into negative territory.
That’s significant because European law prohibits the ECB from financing governments, so it’s also not allowed to remunerate their deposits at rates exceeding comparable market ones.
A regime shift was necessary last year when the deposit rate turned positive in September for the first time since 2012. Policymakers judged that they’d need time to return to their historic zero-rate policy — to make sure large government deposits built up during QE wouldn’t suddenly depart, potentially worsening a scarcity of collateral in financial markets and lowering interest rates there.
Friday’s step was a “significant surprise and could worsen collateral scarcity fears,” said Rohan Khanna, a strategist at Barclays.
General government deposits have fallen significantly over the past month, and the Bundesbank said as early as April that it advocates a return to the earlier zero-rate policy for government deposits. It argued that doing so gives “due account” to the fact that such deposits don’t fulfill an autonomous monetary-policy function, and that account management is just one of the services it offers for public-sector players.
–With assistance from Greg Ritchie.
(Updates with background starting in third paragraph.)
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