The peculiarities of the ECB’s sterilisation plan

May 18, 2010

Sterilisation picture is not totally clear

Sterilisation picture is not totally clear

The ECB’s plans to sterilise its controversial government bond buying are designed to be a clear demonstration to its (mainly German) doubters that the move will not result in painfully high inflation.
The announcement was impressively quick, coming exactly a week after a screeching change of direction which saw the ECB abandon its deep-grained resistance to buying government debt.
The bank’s top men were even quicker out of the blocks.
Sensing that the euro zone’s population would be questioning the move, having been told throughout the crisis by people like ECB chief economist Juergen Stark, that buying government bonds would be a thoroughly bad idea, they launched a full on media assault in the hope of scoring some early verbal intervention points.
In a blistering series of attacks Stark and ECB President Jean-Claude Trichet hit the toughest target, Germany. Trichet then moved onto France as Nout Wellink, the bank’s longest serving policymaker, worked on another pocket of resistance — the Netherlands.
When the formal sterilisation plan came it was beautifully simple. Banks park an equivalent amount of cash at the ECB every week as has been spent on buying Greek and other euro zone bonds.
There is peculiarity however. Part of the deal is that banks will be able to use the deposits as a credit to borrow more money from the ECB. Bank of America’s Jeffrey Rosenberg puts it nicely.
“The ECB could end up effectively sterilising its own sterilisation,”
At the same time it also continues to shovel unlimited amounts of cash into the system, in a bid to keep down real interest rates and stop banks going bust.
“It is completely impossible to sterilise these flows while you are supplying the banking system with unlimited liquidity,” agrees Klaus Baader at Societe Generale.
The ECB clearly still has some propaganda work to do.

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