what does this mean from ft.com

[brut]

Money market rates have been distorted as banks parked money overnight, with overnight funds rates far below the Bank of England’s 5.0 per cent rate. However, as of Thursday, money borrowed for three months on an unsecured basis was trading at a crisis high of about 1.5 percentage points above the three-month forward overnight rate, known as SONIA.The Bank said it would continue to drain reserves from the short term money markets to help keep those rates in line with its Bank Rate

what do they mean by drain reserves from the short term money markets ?

 

[Rhody Trader]

Central banks add and withdraw (drain) reserves as part of their market operations to keep their target rates in line. Basically that means they are controling the supply of reserves (money banks are required to have on deposit against the loans they make) to offset the demand situation. If the market rate is below the target that means there are too many reserves on offer, so the BOE will drain reserves by selling short-term debt.

 

[brut]

hi, thanks for your reply. sorry but I'm still confused:

when you say add and withdraw reserves, do you mean their own reserves, or those of other banks? ie are they trying to drain the reserves of other banks, or their own reserves?

how does selling short term debt achieve drain the reserves of other banks. who is to say that banks will purcchase their debt?

further to this, how does draining reserves drag down short term interest rates?

thanks

 

[Rhody Trader]

when you say add and withdraw reserves, do you mean their own reserves, or those of other banks? ie are they trying to drain the reserves of other banks, or their own reserves?

It means draining reserves from the banks - bringing money into the BOE.

how does selling short term debt achieve drain the reserves of other banks. who is to say that banks will purcchase their debt?

When the BOE (or any central bank) sells securities the banks pay for them with money (reserves), thus the reserves are taken out of the banking system and cannot be used to support lending. Aside from staying in the good graces of the central bank, the other banks will buy the securities to earn a better return than they would have been able to otherwise.

further to this, how does draining reserves drag down short term interest rates?

Simply supply/demand. If there's more money out there avaiable to be loaned, interest rates will go lower.

 

[brut]

thats great, thanks mate

 

[brut]

sorry, but will draining reserves not push interests higher, adding to their problem of high short term interest rates?

 

[Rhody Trader]

sorry, but will draining reserves not push interests higher, adding to their problem of high short term interest rates?

Yes. That's the idea. Remember the very first line of your original post:

Money market rates have been distorted as banks parked money overnight, with overnight funds rates far below the Bank of England’s 5.0 per cent rate.

The BOE is targeting the overnight rate. If it's too low that means there are too many reserves on offer by the banks, so the central bank is going to drain.