Global bank reserves are monitored here as an indicator of central bank policy rather than because they have a significant direct implication for the economy. Reserves can sometimes signal policy shifts that are not associated with a change in official interest rates. This may be useful for anticipating market developments given the importance of policy for investor “risk appetite”.

As previously discussed, aggregate reserves held at the Fed, ECB and Bank of Japan fell to a 12-month low in early March as a repayment of LTRO borrowing by Eurozone banks offset US and Japanese QE. The ECB’s willingness to allow this liquidity drain was a signal of a neutral or even restrictive policy bias and was reflected in a firming of short-term market interest rates (e.g. the three-month EONIA swap). The fall in G3 reserves suggested that the ECB’s “stealth tightening” was more significant than continued US / Japanese easing. The shift away from aggregate accommodation may have contributed to risk assets losing momentum recently.

The G3 total, however, has rebounded strongly over the last month as the Eurozone LTRO repayment has slowed, US QE has continued and Japanese reserves have reconnected with their (now-steeper) expected path – see chart. Aggregate reserves are currently only 4% below the February 2012 high and are certain to move significantly above it over the remainder of the year – the illustrative projection* in the chart shows them climbing 22% by end-2013.

The projection may be conservative if the ECB, as widely expected, responds to recent soft economic news and a fall in inflation by launching further easing. A cut in the headline refinancing rate would not, in itself, expand reserves. The ECB could introduce a new facility allowing banks to borrow at a lower rate (0.25%?) against SME loans, echoing the Bank of England’s funding for lending scheme. Take-up, however, could be modest and drawn-out, judging from UK experience, implying no big impact on reserves.

Global growth may be peaking but significant weakness may be necessary to trigger a bearish market scenario, given ongoing liquidity support. The forecasting indicators monitored here, while moving lower, have yet to signal such weakness.

*The projection assumes that the Fed lowers securities purchases from $85 billion to $40 billion per month during the second half while the BoJ implements its recently-announced QE plan and Eurozone LTRO repayments taper to zero by mid-2013.