As markets repriced the future path of short-term interest rates and uncertainty increased, the two-year Bund-overnight index swap (OIS) spread fell to record lows, while segments of the euro area repo market  came under significant strain. At times, around half of the repo volume backed by German collateral was trading more than 40 basis points below the general collateral rate (Slide 5). Such asset scarcity can delay, or even impair, the transmission of monetary policy. A persistent negative Bund-OIS spread, for example, implies that sovereign yields in the euro area’s largest economy remain more accommodative than intended by our policy stance. Similarly, it took more than a week for the policy decisions taken in September and October of last year to be fully reflected in many segments of the repo market (Slide 6, left-hand side). The dispersion across repo market rates was particularly large in the week after the September Governing Council meeting when the DFR turned positive (Slide 6, right-hand side). At that point, uncertainty about the remuneration of some of the Eurosystem’s non-monetary policy deposits exacerbated investors’ concerns about collateral scarcity. [10] The Eurosystem responded by temporarily removing the 0% interest rate ceiling for government deposits and announcing a further adjustment as of 1 May 2023, providing incentives for a gradual and orderly reduction of such deposits in order to minimise the risk of adverse effects on market functioning and ensuring the smooth transmission of monetary policy.
(2020), “Crossing the Credit Channel: Credit Spreads and Firm Heterogeneity”, IMF Working Paper, No 267. 29. See also Vayanos, D. and Vila, J-L. (2009), “A Preferred-Habitat Model of the Term Structure of Interest Rates”, Econometrica, Vol. 89, No 1, pp. 77-112; Adrian, T. and Shin, H. (2014), “Procyclical Leverage and Value-at-Risk,” Review of Financial Studies, Vol. 27, No 2; and Gertler, M. and Karadi, P. (2011), “A Model of Unconventional Monetary Policy,” Journal of Monetary Economics, Vol. 58, No 1, pp. 17-34. 30. See also ECB (2022), “Financial Stability Review”, November. 31. See, e.g. Albertazzi, U. et al., op. cit. ; and Krishnamurthy and Vissing-Jorgensen, A. (2011, op. cit.). There is also evidence that the share of sovereign bonds on a bank’s balance sheet can explain changes in the bank’s stock price after QE announcements, leading to a “stealth recapitalisation” that is akin to a capital injection for leverage-constrained institutions. See Andrade, S. C. et al. (2016, op.cit. ); Lamers, M. et al. (2019), “The Tradeoff between Monetary Policy and Bank Stability”, International Journal of Central Banking, Vol. 15, No 2; and Brunnermeier, M. and Sannikov, Y. (2013), “The I-Theory of Money”, Meeting Papers, No 620, Society for Economic Dynamics. Copyright 2023, European Central Bank