Banks Paid to Borrow From Each Other

Via massive QE purchases of bonds, ECB president Mario Draghi is flooding Europe with cash that European banks don't want and cannot use.

One curious result of unwarranted QE is a negative interbank lending rate: Banks Paid to Borrow as Three-Month Euribor Drops Below Zero.

Banks in the euro area can now get paid to look after each others' cash for three months as the European Central Bank's bond-buying program floods the region's money markets with excess liquidity.

The euro interbank offered rate, or Euribor, for that time period dropped to minus 0.001 percent on Tuesday, according to data from the European Money Markets Institute. That's the first negative reading since Bloomberg started collecting the data at the end of 1998. The index represents the average rate at which the region's banks say they see each other lending in euros for three months.

Money-market rates have declined after several moves by the ECB. In June it introduced a negative deposit rate, meaning that commercial lenders were required to pay a fee to park their excess cash overnight with the Frankfurt-based institution. The ECB lowered the rate to minus 0.2 percent in September. Then in March this year the central bank started buying government bonds under a 1.1 trillion euro ($1.2 trillion) quantitative-easing program aimed at boosting growth and staving off deflation.

"Excess liquidity keeps flowing into the system week by week because of the QE program," said Nikolaos Panigirtzoglou, a strategist at JPMorgan Chase & Co. in London. "Banks find themselves inundated with deposits but they don't want to pay the ECB for parking their money there. Instead they'd rather lend the cash in the interbank market."

"It's good news for borrowers, not so good news for lenders," O'Hagan, Paris-based head of European rates strategy at the French bank. "Mr. Draghi wants us to spend the cash, not keeping it in Euribor. The purpose of QE is to get us to take on some risk."

ECB Risks Freezing Repo Market

An ICMA official says ECB Risks Freezing Repo Market.

The European Central Bank (ECB) risks secured-lending or repo markets grinding to a halt unless it works more closely with national central banks (NCBs) to improve liquidity, a senior trade association official told Reuters.

Godfried de Vidts, the chair of the International Capital Market Association's European Repo Committee, said unless the ECB took action within the next few months, investors might start avoiding euro zone bonds.

"Investors could become reluctant to invest in euro zone debt," he said, noting that his committee had voiced its concerns to officials at the ECB. "We are scared about the market freezing," de Vidts said.

In recent weeks, one 10-year Bund became so scarce that market players paid up to 2.5 percent to lend cash in exchange for the German bond, dealers said.

De Vidts said the ECB's "securities lending" framework also relies too heavily on NCBs offering their own lending programs, and many of them have not yet put systems in place.

NCBs are responsible for 80 percent of purchases under QE, with the ECB directly buying the remaining 20 percent in the roughly 7-trillion-euro euro zone government bond market.

"We are driving without headlights in the dark," said de Vidts, proposing that the ECB centralizes the scheme in Frankfurt.

"You are getting this scenario - which is a nightmare for the repo market - of a re-nationalization of a market that had developed to become European."

Last week, ECB President Mario Draghi said the bank saw no evidence QE was creating a shortage of bonds, or that this might happen in the future.

Come Hell or Frozen Water, Program Will Continue

De Vidts believes excess liquidity might cause a freeze. On April 15, Mario Draghi made the claim "Stimulus is Working".

"European Central Bank President Mario Draghi said the bank's stimulus efforts are beginning to take hold in the European economy and batted away concerns in financial markets that the bank may have to end its more than €1 trillion ($1.1 trillion) asset purchase program early."

If it's working, why wouldn't Draghi welcome ending the program early? Of course if it blows up in his face with unintended consequences, he may be forced to end it early.

Either way, Draghi has put himself into a box that says he will continue his plan come hell or frozen water.

The market may have something to say about that, perhaps sooner rather than later.

Stunning Arrogance

The arrogance of central bankers in spite of the fact they recently brought the world to the edge of financial collapse is stunning. Now they have created equity and junk bond bubbles of massive proportion and don't even see it.

The program must continue. Why? Because we said so. All in the foolish belief they need to stop consumer prices from falling.

Even the BIS recognizes the foolishness of the idea that falling consumer prices are damaging. For discussion, please see Historical Perspective on CPI Deflations: How Damaging are They?