The liquidity management of the Eurosystem during the period of financial turmoil

In the past few months, euro area money markets have been exposed to intense tensions. On 8 August, overnight interest rates rose to very high levels which required interventions of the Eurosystem in order to stabilise short-term money market interest rates around the target level, i.e. the minimum bid rate on the main refinancing operations. The article explains how the Eurosystem steers very short-term money market interest rates by adjusting its supply of liquidity on the money market. It is shown how the Eurosystem’s liquidity management stabilised short-term money market interest rates around the minimum bid rate on the main refinancing operations in the first half of 2007. Although short-term money market interest rates were more volatile during the period of financial turmoil, the Eurosystem nevertheless managed to safeguard the signalling function of the short-term money market interest rates by applying its operational framework in a flexible way. More specifically, the Eurosystem decided to allot more liquidity than the benchmark amount in the main refinancing operations early within the maintenance period. It was also decided to conduct fine-tuning operations on a more frequent basis in order to stabilise short-term rates. Finally, the Eurosystem also decided to increase the share of longer-term refinancing operations in the total amount of outstanding open market operations. Despite the relative success in stabilising very short-term money market interest rates, longer maturity unsecured interest rates – for instance the 3-month Euribor – increased significantly during the period of financial turmoil. These movements cannot be controlled directly by central banks as they are determined predominantly by private sector behaviour. However, when assessing the appropriate monetary policy stance, the Governing Council of the ECB takes these possibly changing financing conditions into account.