EU repo market activity – No sign of reversal of the downward trend

Euro Money Markets Weekly

•    Repo: According to the latest ICMA  repo survey, overall activity in the EU repo market declined  slightly in December 2015. However, we think it is premature  to consider this a sign of bottoming out after the last  five-year downward trend. Regulation and abundant liquidity  in a context of negative rates are likely to favour a  further gradual contraction.
•    ECB: Recent comments by ECB members  Constancio and Visco suggested that the ECB could introduce  a multi-tier reserve system to protect banks from further  cuts in the depo rates. In our view, a possible  scheme could comprise three tiers. The first would  correspond to the amount of required reserves (remunerated  at the refi rate); the second would include part of banks'  excess reserve up to an amount established by the ECB and  calculated as a multiple of the reserve requirement  (unremunerated or charged with a marginal negative rate);  the remaining amount of reserve would go into the third tier  and be charged at a very punitive rate. Such system would  allow further depo rate cuts, protect banks and create a  strong incentive for banks to lend the marginal amount of  liquidity to avoid the punitive Tier 3 rate.
•    Short rates: ECB officials’ latest  comments have supported current market expectations of  further depo rate cuts (cumulative 25bp cuts by year-end are  priced in the Eonia forward curve). Should the rhetoric keep  focusing on the introduction of a tiered reserve system, we  see room for a further rally at the front end and 1y1y Eonia  forward potentially moving below even -50bp from the current  level of -48bp.
•    Eonia: Eonia fixing moved in a very  narrow range of -24.2bp to -24.4bp last week, with volumes  creeping up to €14bn from €12.6bn at the beginning of the  week. Should the ECB adopt a multi-tier system, we believe  the lowest level of the deposit facility rate, which is the  penalty rate for liquidity in TIER 3, would become the  reference rate for Eonia and Euribor fixings, with the  former likely to keep fixing at depo rate +6bp and the  latter at depo +15bp.

Barclays
Interest Rates Research