FRANKFURT (Reuters) - The European Central Bank failed to fully offset its past purchases of government bonds on Tuesday, missing its target for the third week running as spare cash in the banking system falls to critical levels.
The ECB has been taking an amount equal to its holdings of euro zone government bonds as weekly deposits from banks to neutralise any threat that the buying will fuel inflation. But many banks are repaying early loans they took from the ECB at the height of the euro zone crisis, and have set aside tens of billions of euros before an ECB health check of the sector, leaving them less cash to deposit at the central bank.
The ECB drew back 103.946 billion euros (85.46 billion pounds) on Tuesday in seven-day deposits, well below a target of 172.5 billion, equivalent to the size of its first and now terminated sovereign bond-buy plan, which remained unchanged last week. The drop in the amount of surplus cash in the system puts upward pressure on market interest rates. The ECB earlier this year debated ending its sterilisation operations to loosen lending conditions but opted to keep them going for now.
Further highlighting the tightening on money markets, banks took 172.621 billion euros in weekly loans from the ECB on Tuesday, the most since the last week of June 2012 and beating expectations in a Reuters poll of traders for 130 billion euros. The EONIA overnight rate hit 0.398 percent on Monday - its highest since 2011 with the exception of two liquidity-tight days at the end of last year and at the end of the first quarter of 2014.
The ECB, whose main refinancing rate stands at 0.25 percent, is watching EONIA moves carefully, having identified an "unwarranted" tightening of short-term money market rates as one of the scenarios that could prompt fresh policy action.
Banks are taking more money from the ECB to balance out a drop in excess liquidity
Excess liquidity fell to around 86 billion euros on Tuesday, according to Reuters calculations, a level last seen just before the ECB offered three-year crisis loans to banks in December 2011.
In the Reuters poll, 16 of 19 traders said pressure on money market rates would eventually ease as banks take more money in the weekly ECB operations. The other three said falling excess liquidity would push the EONIA rates higher.
(Reporting by Eva Taylor, Sakari Suoninen and Paul Carrel; Editing by Gareth Jones/Ruth Pitchford)