While encouraging a decline in longer-term interest rates on one hand and expecting a rise in long-term interest rates in the longer run on the other hand seems contradictory at first glance, in fact it is nothing of the kind.
In addition, uncollateralized interbank trading, particularly of term instruments, has been declining, leading to an increase in funding costs for European financial institutions, mainly for longer-term and U.S. dollar-denominated funds.
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Specifically, the ECB has expanded the range of eligible collateral that banks can submit in order to acquire funds from the central bank, and has been providing banks with unlimited amount of longer funds up to the value of eligible collateral at a fixed interest rate.
These operations allow financial institutions to borrow unlimited amounts of longer-term funds from the Bank at an interest rate as low as 0.1 percent, equivalent to the target rate for the uncollateralized overnight call rate, against the value of corporate debt such as CP, corporate bonds, and loans on deeds, pledged to the standing pool of eligible collateral.
To encourage a further decline in longer-term interest rates in the money market, the Bank introduced in December 2009 a new funds-supplying operation, through which funds with a maturity of three months are provided at an extremely low interest rate of 0.1 percent, and the total amount of loans to be provided through this operation was set at approximately 10 trillion yen.
Furthermore, the extension of the average remaining maturity from slightly less than three years to about seven years(i.e., allowing for a range of about six to eight years) necessitates the purchases of JGBs with longer maturity, including 20- and 30-year bonds. Such JGBs with super-long maturities are likely to be held to maturity by institutional investors and their market is not so active.
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