Europe’s biggest bond buyer starts thinking about selling

The European Central Bank may be on the verge of answering a lingering question in the coming weeks that could have major repercussions for financial markets.

At its December meeting, the ECB is set to discuss and reveal more concrete details on how it will unwind 8.8 trillion euros ($9.21 trillion) from its balance sheet – in a process known as quantitative tightening.

For years, the central bank has been ultra-loose with its monetary policy, buying sovereign debt across Europe to keep borrowing costs low for governments and, subsequently, for individuals to stimulate growth.

However, with inflation at record highs and a number of rate hikes under its belt, markets are now awaiting details on how and when the ECB will sell these bonds.

“The biggest question in December is what will they do about QT,” Marchel Alexandrovich, European economist at Saltmarsh Economics, told CNBC by phone.

In October, ECB President Christine Lagarde said discussions on bond sales would take into account three main factors: the outlook for inflation, the measures taken so far and the timeframe for transmission – being given that it takes some time for a monetary decision to have an impact on the economy.

Speaking on Monday, Lagarde confirmed the schedule. “In December, we will also set out the key principles for reducing bond holdings in our portfolio of asset purchase programs,” she told EU lawmakers.

ECB officials have suggested the process will be “gradual” and “predictable” – meaning it is unlikely to depend on meetings.

At present, the central bank applies a meeting-by-meeting approach to interest rate decisions, arguing that there is a high degree of uncertainty that prevents it from guiding markets with more detail over the medium term. .

“The balance sheet should be normalized over time in a measured and predictable way,” Lagarde said on Monday.

As such, economists do not expect full details to be out in December.

“In December, the ECB will set out some general principles on how it intends to conduct QT but will not yet specify precise amounts and timelines for balance sheet settlement,” Franziska Palmas, senior Europe economist at Capital Economics, said by email. . .

She added that the upcoming changes to the balance sheet will likely only be applied to APP (Asset Purchase Program) holdings and not PEPP (Pandemic Emergency Purchase Program).

The APP started in mid-2014 to deal with still low levels of inflation. It was frozen between January and October 2019 and then lasted until July 2022. On the other hand, the PEPP was a more flexible bond purchase program introduced during the coronavirus pandemic.

As part of the broader stimulus actions, the ECB has reinvested the profits made from these asset purchases. Instead of starting to unwind its balance sheet by selling the actual bonds, some expect the ECB to stop these reinvestments.

“The ECB will only reduce APP holdings by ceasing to reinvest proceeds from maturing APP assets, not by actively selling them. The pace of QT could be particularly slow at first as the ECB reinvests still the majority of proceeds from maturing assets,” Palmas says.

Nomura economists also expect the ECB to slow such reinvestments as a first step in shrinking its balance sheet.

“We believe the ECB will only allow 1/3 of APP portfolio redemptions to be reversed, with the rest reinvested,” they said in a research note after the ECB’s last meeting. This can be seen from the second quarter of 2023, according to the same note.

Frederik Ducrozet, head of macro research at Pictet Wealth Management and an avid ECB watcher, said the bank “will likely introduce caps on monthly reinvestments under the APP program, until the ECB stops reinvesting the proceeds of maturing securities”. .”

He added that it would likely start in March.

Cumulative net purchases of public debt by the ECB in October 2022 amounted to €2,740 billion.