FRANKFURT, Dec 16 — The European Central Bank slowed the pace of its interest rate hikes Thursday, while warning there was still a long way to go.
Policymakers also gave more details on another front in the fight against surging prices — winding down the ECB’s huge balance sheet, swelled by years of anti-crisis measures.
Why is the ECB’s balance sheet so big?
The eurozone was dogged for years until recently by persistently low inflation.
From the 2008 financial crisis through the coronavirus pandemic, the ECB stepped in with exceptional measures to prop up the economy.
The policy of quantitative easing initiated in 2015 and the pandemic emergency purchase programme — or “PEPP” — involved massive purchases of government and private debt on the secondary market.
The aim of the two bond-buying programmes was to further suppress interest rates in order to pump up the economy and boost prices.
The Frankfurt-based central bank also unleashed several waves of massive and inexpensive loans to banks, known as TLTROs.
But all this has left the ECB with a bloated balance sheet, which currently stands at a colossal €8.5 trillion (RM39.9 trillion).
Why trim the balance sheet?
The longer the ECB continued to roll over the debt on its balance sheet by purchasing new assets, the longer it kept the expansionary monetary policy of the last decade going.
Increasingly, the sheer scale of the programme seemed out of keeping with the ECB’s aggressive moves to raise interest rates in the face of runaway inflation.
The ECB has therefore embarked on the task of winding down its balance sheet to completely turn the page on the era of ultra-loose monetary policy.
How is it doing this?
In a first step in October, the ECB announced it would tighten the conditions on the TLTRO loans, to incentivise earlier repayment.
Lenders had been previously been able to make an easy profit by parking their excess TLTRO cash at the ECB and pocketing the new, higher deposit rate — not a good look at a time when many consumers and companies are struggling.
At its meeting Thursday, policymakers took another step, explaining how they would start reducing the ECB’s five-trillion-euro bond portfolio after years of buying up corporate and government debt.
From March, it will gradually stop reinvesting the proceeds from maturing bonds bought under the quantitative easing programme since 2015.
It will decline on average at €15 billion per month until mid-2023, with the subsequent pace to be determined later.
Possible problems
The timing to start tightening is not ideal. It is not clear that other lenders will take the relay from the ECB with their capacity to take more and bigger risks limited by regulations.
A major challenge will be to limit the widening of “spreads” between the borrowing costs for financially stronger and more fragile countries in the eurozone.
It is this fear that motivated the ECB to launch the so-called Transmission Protection Instrument, which would allow the central bank to buy debt from countries whose borrowing costs rise much faster than those of stable benchmark Germany. — AFP
