How does the Riksbank control interest rates?

How does the Riksbank control interest rates?

The deposit rate and the lending rate form the so-called interest-rate corridor, which is an important component of the system the Riksbank uses to control the shortest of all interest rates, the so-called overnight rate.

What is the interest-rate corridor?

The banks can deposit money overnight with the Riksbank at the deposit rate. The lending rate is the interest rate that the banks must pay when, against collateral, they borrow money overnight from the Riksbank. In this way the deposit rate forms the floor and the lending rate the ceiling for how low or how high the overnight rate can be.

 

The design of the interest-rate corridor makes it more profitable for the banks to borrow from each other than to turn to the Riksbank. This is because they get a higher interest rate, or pay less, when they borrow from each other.

 

At the monetary policy meeting in July 2010, it was decided that the deposit and lending rates would once again be 0.75 percentage points lower and higher, respectively, than the repo rate. 

 

In practice, the deposit and lending rates have very little impact on what the overnight rate will be, partly because the interest-rate corridor makes it profitable for the banks to borrow from each other and partly because the Riksbank is prepared to carry out so-called fine-tuning transactions every day. As a result, the overnight rate is kept inside a band that is narrower than the interest-rate corridor and contributes to clearer monetary policy signalling.

How is the overnight rate controlled?

Once a week, the Riksbank issues Riksbank certificates at an interest rate that is the same as the repo rate. In addition, the Riksbank is prepared to carry out daily fine-tuning transactions with the banks if there is an imbalance in the banking system's liquidity in relation to the Riksbank at the end of the day. In these fine-tuning transactions, the Riksbank either draws in surplus liquidity from the banks, that is the banks deposit money with the Riksbank, normally at the repo rate minus 0.10 percentage points, or, in the event of a shortage of liquidity, the banks borrow money from the Riksbank, against collateral, normally at the repo rate plus 0.10 percentage points. As the fine-tuning transactions are conducted at the repo rate plus/minus 0.10 percentage points, this means in practice that there is a much narrower band around the repo rate than the interest-rate corridor. Consequently, the overnight rate is kept stable and close to the repo rate. 

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