What explains the spread between the euro overnight rate and the ECB's policy rate?

In this paper we employ a time series econometric framework to explore the structural determinants of the spread between the euro overnight rate and the ECB's policy rate (EONIA spread) aiming to explain the widening of the EONIA spread in the period from mid-2004 to mid-2006. We mainly estimate a model of the EONIA spread from March 2004 until August 2006. The analysis identifies possible driving forces underlying the evolution of the spread over time and aims to quantify the impact of specific factors on the observed upward shift. We show that the increase in the EONIA spread can for the largest part be explained by the current liquidity deficit. Moreover, tight liquidity conditions as well as an increase in banks' uncertainty about the liquidity conditions lead to a significant upward pressure on the spread. ECB's liquidity policy only has a significant impact on the reduction of the spread if a loose policy is conducted during the last week of an MRO. Interestingly, interest rate expectations have not been found to have an important influence.