In today's Eurointelligence Daily Briefing Wolfgang Münchau writes:

ECB is expected to decide on a pre-announced 25bp rise in repo rates to 1.25% today; Deposit rates are likely to be left at 0.25%, effectively neutralising the rise in repo.

Not to make a fine point of it, but an one-month (21-business-day) exponential moving average of EONIA was until today within 35bp (bp = "basis point" or 0.01%) below the repo rate or, equivalently, over 40bp above de deposit facility. It has been as low as 10bp above depo.

In addition, Euribor 1M is now within a few bp of the 1% former repo rate. In the time since June 2009 it has been as low as 15bp above depo and 60bp below repo for about a year.

See the charts labelled "EONIA and ECB Policy rates" in my diary the EONIA heartbeat. They're over a month out of date but the raising trend in EONIA and eonia volatility has persisted so they're good charts for illustrative purposes.

While I can't find fault with the ECB raising the repo rate while maintaining full-tender liquidity auctions, I don't think one can be quite so sanguine about the consequences of a rate rise, except in so far as the rise has already been priced in in the interest rates.

The reason is that insolvent banks need to be gradually pushed over the edge since governments won't recapitalize them of their own accord despite the sternly worded warning from Commissioner Almunia at the start of December 2010. It appears that the only politically palatable way to do this is to raise the repo rate.

However, Münchau was wrong in that the ECB did not just raise the repo rate while keeping depo at 25bp. They also raised de depo rate to 50bp. This, I think, is true insanity. But it is consistent with the ECB's view of things.

I say this because the depo rate is what the ECB pays for excess reserves held at the ECB. Raising this rate means that solvent banks having excess liquidity have a bigger incentive to park that excess liquidity at the ECB. If what you want to do is withdraw liquidity from the system, raising the depo rate makes sense. The ECB believes there is excess liquidity.

I believe there is no excess liquidity and the liquidity that there is needs to circulate. To that end, keeping the depo rate low keeps the incentives to circulate the liquidity. But if you believe in the quantity theory of money and believe there is excess liquidity and believe there are inflationary pressures, you won't want liquidity to circulate.

Economics is politics by other means