ECB: Mitigating side effects - gauging the tiering premium
|An ECB tiering system is widely expected to be announced at the ECB September meeting. However, the exact design and ultimately the market impact are difficult to assess. In this document, we lay out our views on how a tiering system could be constructed.
Our preferred tiering proposal would result in a less than 1:1 effect on EONIA from the expected deposit rate cut. We argue that a 'tiering premium' may be a result of a political decision and may be worth around a quarter of the rate cut . We believe that the proposal would address what we consider to be the four key features of a tiering system. However, we acknowledge that point 4 ('worth the trouble') is debatable (see overleaf).
The preferred tiering proposal consists of the following
Static part: an exemption threshold set at a pre-specified historical (to announcement) date. We argue for an individual bank's threshold to be set at 25% of net deposits on 31 August 2019. We do not expect a calibration period.
Dynamic part: all further deposits remunerated at the lower rate. This would ensure that the deposit rate continues to be the most important and with a restart of QE and rise in excess liquidity EONIA would gradually decline.
We find the current ECB pricing of a 17bp rate cut in September to be almost a 'corner solution' of what we see the ECB can deliver. With a 'tiering premium' of around 5bp, it may even be be on the slightly aggressive side.
Finally, we highlight that the ECB has been very creative on previous occasions, so there is considerable uncertainty about the exact nature of the tiering system. There were discussions on a tiering system in 2016 and Q2 19 and the ECB concluded not to implement it due to its potential complexities.
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