ECB Insight: Insiders Uniformly Without Appetite to Fiddle With QT; See Rate Cuts as Entirely Independent

18 February 2025

By David Barwick and Marta Vilar – FRANKFURT (Econostream) – The shrinking of the European Central Bank’s balance sheet at the same time as interest rates are being progressively lowered is not seen by the ECB Governing Council as posing any problem or being contradictory, according to a number of insiders who spoke to Econostream recently.

Asked whether the desire to provide more monetary accommodation would at some point imply the potential for a slower approach to reducing the balance sheet or whether QT should instead be left alone regardless of the level of borrowing costs, one insider answered unequivocally: ‘The latter.’

‘We have been very clear on this since the very beginning’, he said. ‘We want this quantitative tightening in the rundown of the balance sheet. We are doing it smoothly; we don't want to use it as a tool.’

Tweaking anything about QT would unnecessarily focus market attention on it, which would be undesirable, he said. The process was by intention ‘relatively boring, mechanistic, automatic’ and indeed ‘out of the scope of the market’, he said.

Another insider asserted that ‘we have not seen the slightest impact of a reduced balance sheet’ in the sense of distortions or a tightening that would meaningfully counteract the ECB’s more traditional monetary policy moves.

‘Nominally we have a tightening, but it is a very slow process, we are proceeding as we indicated we would and all market participants are fully informed and can easily see what’s happening’, he said. ‘So at the moment I see no tightening impact as a result of this, and in general no issues.’

The current absence of any issues could however change over time, with some institutions and countries likely to feel it first, but this remained a distant problem for now, he said.

A third insider echoed the sentiment that the ECB was far from needing to concern itself actively with the balance sheet, saying that this would only be the case once still ample excess liquidity had been substantially reduced.

‘The level of interest rates is not a condition for us to start thinking about what to do with the balance sheet’, he said. ‘The normalisation is a process for the time being that is working behind the interest rates, because there is still excess liquidity in the system.’

A fourth insider said he did not see why either QT or lower interest rates should imply a situation the potential for which wasn’t taken into account at the time of last year’s operational framework review.

As to the criticism of some observers that there was a potentially unsustainable contradiction between easing the main monetary policy instrument and tightening the balance sheet, this person responded by noting that some people had made a similar argument back when the ECB was hiking interest rates and purchasing assets.

‘If it’s a predetermined path, like QT is now, then it shouldn’t compromise our monetary policy stance in any way’, he said. For this to be otherwise, sovereign debt markets would need to be so fragile or so critical to the monetary policy stance that it would imply great problems for public debt issuance, he said.

After all, euro area countries were financing deficits in amounts distinctly larger than the sums by which the ECB’s balance sheet was being reduced, he reasoned.

The ECB’s balance sheet size could affect the precise value of the neutral rate, but the volume of global debt also influenced the neutral rate, he said.

‘Of course, the level of assets on our balance sheet will still impact the longer end of the yield curve’, he said. ‘But it’s something that we will take into account.’

The ECB was unlikely to accelerate the process of balance sheet reduction, he said. ‘The Governing Council decided that there is a hold-to-maturity portfolio, so if we didn’t treat it as such, we should have some monetary policy justification for that, and I don’t see it’, he said.

A fifth insider also said that for him, QT was ‘not in any conflict with interest rate cuts’ and this would not change even with borrowing costs at lower levels, provided the ECB maintained the current gradual, ‘natural’ pace of balance sheet reduction.

‘Because we are not doing anything active on that front, we are just running down the portfolio, neither buying nor actively selling’, he said.

It was important that the process continue, as the ECB had to create policy space, he added.