When the Riksbank cut the repo rate to 0.00%, the corridor around the repo rate for fine-tuning operations was also changed, from +/-10bps around the repo rate to the same level as the repo rate. The decision to alter the corridor was a precautionary measure, due to uncertainty about whether a negative interest rate could lead to technical problems for the banks and the system.
For logical reasons, it was not deemed possible to gauge the lie of the land before the rate decision because of the risk of this sending an advance signal of the decision. However, in the standing facilities, the deposit rate remains negative (-0.75%). Yet, out of the present liquidity surplus of SEK 54 billion, the amounts deposited there are very low. Instead, the Riksbank receives the absolute majority of the surplus in the form of deposits through overnight fine-tuning and/or through its weekly issues of Riksbank certificates. The spread between these two alternatives used to be 10bps, to the advantage of the certificates, but is now zero since fine-tuning also occurs at the repo rate.
Fine-tuning used to be carried out in a range of +/-10bps around the repo rate, but because of the surplus in the system (i.e. on average, certificate issues have not been fully subscribed), the lower part of this range has held greatest significance. Hence, banks have had an incentive to adjust the surplus between themselves as long as a better level than the one offered by the Riksbank was achievable, e.g. by agreeing on a level of repo -5bps instead of repo -10bps. This has promoted activity on the interbank market. Now, without the interval and fine-tuning occurring at the same level as the repo rate, commercial incentives fade for the banks to balance liquidity between themselves, which risks reducing activity on the interbank market. It also means that the banks can, at no cost, have the Riksbank as counterparty instead of another bank.
Narrowing the corridor to zero shall thus affect the equilibrium price and hence, all else equal, lead to somewhat higher interbank rates. This is also the tendency seen in markets after the rate decision on 28 October. Short liquidity in SEK has become slightly more expensive, as reflected in rising 3m Stibor and that FRA vs. RIBA spreads have widened (Fig 1). The fact that liquidity in SEK has become more expensive is also reflected in the increase in EUR/SEK cross currency basis swaps (Fig 2) which, adjusted for EUR/USD effects, equals to the same amount that fixinig spreads have widened.
Given the surplus in the system, and assuming that the counterparty risk is valued at close to zero, this change ought to be worth a maximum of 10bps (i.e. the difference between -10bps and zero), which caps how much e.g. FRA vs. RIBA spreads can diverge due to this effect. However, lower activity can also affect liquidity on the interbank market and lead to increased volatility and greater negative effects in the transition around IMM dates, quarters and years than before. This is particularly the case in a situation in which behavior geared to greater interest in investing in certificates over these transitions persists.
So, to sum up, it seems fully reasonable that the change in method has led to slightly higher interbank rates, and they look set to persist until the pricing of fine-tuning returns to its previous state. The Riksbank always has the possibility of reverting to earlier fine-tuning methods, e.g. if it finds that there are no technical difficulties in having a negative interest rate in the system. Such a decision would likely lead to an immediate corresponding downward adjustment in Stibor and fixing spreads, but could also open up for speculations about a negative repo rate, should the economic outlook support such a bold move.
Nordea