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By Richard Leong
NEW YORK, April 30 (Reuters) - The continued rise of a key U.S. interest rate that the Federal Reserve targets is fanning speculation the U.S. central bank will make another tweak to a monetary policy tool this week to prevent the rate from climbing further.
It has also stoked talk the Fed would launch a program, referred to as a standing repo facility, to pump more cash into the banking system.
The effective, or average, federal funds rate rose to 2.45% on Monday from 2.44% on Friday, New York Federal Reserve data released on Tuesday showed.
The fed funds rate is the overnight borrowing cost for U.S. banks to borrow excess reserves and is the basis for other short-term bank borrowing costs.
This rate’s premium over the interest rate the U.S. central bank pays on the excess reserves that banks leave with it (IOER) reached a record 5 basis points on Monday.
Some analysts expect that Fed policymakers may reduce the IOER by 5 basis points to 2.35% at their two-day meeting that will begin later Tuesday.
“Even though this is meant to be a technical adjustment, the Fed will be aware that such a cut in the present environment would have some symbolic significance,” Citi analysts wrote in a research note released on Tuesday.
The Fed made technical adjustments to the IOER twice last year in a bid to encourage banks to lend their reserves rather than leave them at the Fed.
There have been concerns that the fed funds rate might break above the top end of the Fed’s target range, currently at 2.50%. If this were to occur, it may disrupt money markets and shake investor confidence in the Fed’s ability to control short-term interest rates.
The spike in the fed funds rate in recent days likely stems from less cash in the banking system due to annual tax payments to the federal government, Citi analysts said.
If the Fed does not reduce the IOER this week, it may offer guidance on the introduction of a standing repo facility to curb money market volatility during bank reporting periods when demand for reserves jumps, analysts said.
“The medium-term solution, which we believe is coming over the next few months, is another standing repo facility, which is likely to reduce volatility in money market rates around month, quarter and year-end and narrow the spread between short-term Treasuries and OIS, all else equal,” Standard Chartered Bank economist Sonia Meskin wrote in a note on Tuesday.
Reporting by Richard Leong; Editing by Bernadette Baum