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Transmission of interest rate hikes depends on the level of central bank reserves held by banks
Since the second half of 2022, the Eurosystem increased key interest rates significantly to curb inflation. The deposit facility rate, i.e. the interest rate banks receive when they hold overnight deposits (reserves) with the central bank, is shown in Figure 1 (black line). When this rate became negative in 2014, banks had to pay interest on their reserves. When this rate turned positive in September 2022, banks once again earned interest income from their reserve holdings. Compared with previous tightening cycles, it is striking that banks are holding substantial reserves with the Eurosystem in the current cycle. In ... (full story)