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Christine Lagarde has said the European Central Bank is likely to discuss speeding up the shrinkage of its balance sheet by ending the last of its bond purchases earlier than planned.
The ECB president’s comments at a hearing in the European parliament on Monday are the clearest sign to date that the bank is preparing to further tighten monetary policy — beyond its earlier interest rate rises — by reducing the amount of bonds it plans to buy next year.
Several of the more hawkish members of the ECB have been calling for these reinvestments to end, saying the extra monetary stimulus is inconsistent with efforts to tame inflation by raising rates. They also point out that the pandemic crisis that initially justified the purchases has clearly ended.
The ECB stopped much of its bond-buying last year. But it is still reinvesting the proceeds of maturing securities in the €1.7tn portfolio it started buying in response to the pandemic and has set out plans to continue doing so until at least the end of next year.
“This is a matter which will come probably for discussion and consideration within the governing council in the not too distant future and we will re-examine possibly this proposal,” Lagarde told MEPs.
However, the reinvestments in the pandemic emergency purchase portfolio (PEPP) are useful for the ECB because it has the flexibility to skew them towards the debt of any particular country suffering a widening of its borrowing costs compared to others.
Some of the more dovish policymakers have argued against abandoning this “first line of defence” against financial fragmentation at a time when investors are becoming increasingly nervous about stagnant growth and high debt levels in many European countries, such as Italy.
The ECB’s overall bond holdings represent about 30 per cent of all eligible debt in the eurozone. It has already ended reinvestments in its €3tn asset purchase programme — a separate pool of assets it started buying in 2015. Lagarde said this so-called quantitative tightening had led to its balance sheet shrinking by €23bn a month on average this year.
Francesco Maria Di Bella, a fixed-income analyst at Italian bank UniCredit, estimated the ECB would buy bonds worth €180bn next year as part of its planned PEPP reinvestments.
While falling government deficits in many countries are expected to reduce the supply of bonds being sold next year, the “net supply that has to be absorbed by markets is set to rise due to the ECB’s quantitative tightening”, he said in a note to clients. “The picture could become more challenging if the ECB decides to start to run off of its PEPP portfolio.”
Most analysts expect the ECB to stagger the reduction of its PEPP reinvestments rather than halting them abruptly, to avoid spooking investors.
Jens Eisenschmidt, chief European economist at Morgan Stanley, has forecast the ECB will cut PEPP reinvestments by half for six months in April before ending them completely in October. He calculated this would shrink the central bank’s bond portfolio by €87bn by the end of next year and €258bn by the end of 2025.
The total balance sheet of the ECB and the national central banks that make up the Eurosystem has shrunk from almost €9tn to €7tn since last year, largely due to the repayment of cheap loans extended to banks in the pandemic.
However, at more than 60 per cent of eurozone gross domestic product, the ECB has a bigger relative balance sheet than either the US Federal Reserve or the Bank of England, both of which have already completely stopped bond purchases.