Exclusive: ECB Insiders Reasonably Relaxed About Current Pace of Quantitative Tightening

28 June 2023

Exclusive: ECB Insiders Reasonably Relaxed About Current Pace of Quantitative Tightening
- ECB insiders express unwillingness to court financial instability needlessly
- ECB insiders suggest that passive run-off of balance sheet could be sufficient for now
- ECB insiders indicate readiness to leave PEPP forward guidance in its current form
- ECB insiders focused on interest rates rather than other instruments in toolkit

By David Barwick and Xavier D’Arcy – FRANKFURT (Econostream) – Reducing the size of the European Central Bank’s bond holdings is a worthy goal on which the ECB is making welcome progress, but there is no current or near-term need to significantly accelerate the effort beyond what has already been announced, in the view of three Eurosystem insiders who spoke to Econostream recently.

The views of all three rather hawkish policymakers coincided with each other to a high degree, and also with the opinions expressed by Latvijas Banka Governor Mārtiņš Kazāks in an unrelated on-the-record interview with Econostream published earlier Wednesday. Kazāks was similarly disinclined to step up QT and instead more interested in relying on the ECB’s primary tool of interest rates.

One relatively prominent hawk told Econostream that he expected no near-term change in balance sheet policies and reasoned that in terms of the monetary policy stance, there was no need for such changes, given the preferability of achieving the desired impact via further standard policy tightening.

Moreover, this person argued, national central banks across the euro area were already facing losses that could be exacerbated by an even faster rate of divestiture. Yet another reason to tread cautiously, he said, noting the rough sledding experienced by the Bank of England, were financial stability concerns in an environment already fraught with risks.

The financial stability argument, he said, also applied specifically to a change in policy regarding the pandemic emergency purchase programme (PEPP). The PEPP is currently subject to the guidance that principal payments from maturing securities are to be reinvested until at least the end of 2024, and that as redemptions come due, they will be flexibly reinvested ‘with a view to countering risks to the monetary policy transmission mechanism’.

Person one said that he would be opposed to modifying the guidance on PEPP reinvestments and attributed the orderly behaviour of euro area sovereign spreads to the ECB’s potential reliance on such reinvestments in the event of market turbulence. Changing PEPP policy would put financial stability at risk, he said.

Person two, somewhat less hawkish but no dove, said he was ‘not sure’ whether there was really any need for the ECB to engage in actual sales of assets, arguing that the maturity of the portfolio was such that passive reduction of the balance sheet via ‘the maturing operations could be fast enough’ by itself. This would be all the more so once PEPP reinvestment eventually came to an end, he said.

Financial stability concerns would ‘certainly’ have to be ‘taken into account’ by the ECB if it were to entertain a significant change in QT, person two said. ‘The interest rate is the primary tool now for steering prices, and why should we do something with secondary tools if it were to create big problems?’, he asked rhetorically.

The ECB would do well enough with complete passive QT regarding the asset purchase programme (APP), ‘and on PEPP we live with the forward guidance that has been given before’, he said.

Person two made clear that he was ‘not in a hurry’ to change the PEPP guidance. ‘I think we need to have a good reason to deviate from the past forward guidance on this one, and currently the interest rates are doing the trick’, he said.

This person agreed with Econostream that QT would thus not be a way to take pressure off the Governing Council to hike again in September, if it were to feel the need to consider increasing interest rates yet again.

The last person Econostream spoke to, also relatively hawkish, emphasised the importance of the TLTROs in the ECB’s downsizing efforts and reiterated the concerns of his peers with respect to financial stability, saying quite openly that this was a worry.

The ECB has had, since almost a year ago, the transmission protection instrument (TPI) to ensure the effectiveness of monetary policy transmission across all euro area countries, he was reminded. Of course, he agreed, ‘but that doesn’t mean we want to have to put it to the test.’