UPDATE 1-U.S. Fed mulls reverse repos to cut liquidity -FOMC minutes
Aug 21 (Reuters) - The U.S. Federal Reserve is considering a new tool to help drain cash from the banking system and keep short-term interest rates on target when it shifts away from its current monetary policy, minutes of the Fed's latest policy meeting showed on Wednesday.
Fed policymakers were briefed during their July 30-31 meeting on the potential for creating a fixed-rate facility for overnight reverse repurchase agreements, or reverse repos.
"They are setting the stage for an eventual policy tightening by sometime in 2015," said Mary Beth Fisher, head of U.S. interest rates strategy at SG Corporate & Investment Banking in New York.
The Fed adopted a near-zero interest rate policy in December 2008. It has kept its target on the federal rate or the overnight borrowing cost on excess reserves between banks in a range from zero to 0.25 percent.
This reverse repo program, if adopted, would complement payment of interest on excess reserves and other tools to help achieve the Fed's interest rate targets, according the Fed's minutes.
"In general, meeting participants indicated that they thought such a facility could prove helpful," the minutes said.
While they expressed interest, there was no indication as to when the policy makers might decide to go ahead with a reverse repo facility.
In an overnight reverse repo transaction, the Fed would sell a Treasury bond to a U.S. primary dealer or a large money market fund and buy it back the next day for a slightly higher price. The transaction temporarily takes cash out of the banking system, while the dealer or fund earns interest on the deal.
The Fed has plenty of assets to reduce money supply after three rounds of massive bond purchases, or quantitative easing. These moves have more than tripled the size of the Fed's balance sheet to $3.6 trillion, with $2 trillion in Treasuries securities.
The central bank has been holding small-scale tests with primary dealers and money market funds since 2009 to determine its readiness to conduct reverse repos.
While the concept of a reverse repo facility supports the notion that the Fed is preparing for an eventual rise in interest rates, SG's Fisher said it is not a signal from the Fed about tightening policy while it considers reducing its $85 billion monthly bond purchases later this year.
"It is not a message" about pending changes in Fed policy, she said of the reverse repo facility mentioned in the minutes.