By Hans Bentzien
FRANKFURT (Dow Jones) — The European Central Bank (ECB) has three main reasons for getting rid of the bonds it has bought over the past eight years, according to ECB Director Isabel Schnabel. In a speech for the money market contact group, Schnabel only listed a more rigid monetary policy as the last reason for the “quantitative tightening (QT). The ECB director gave the following reasons:
1. Regaining monetary policy space
According to Schnabel, the ECB wants to regain “valuable monetary policy space” in an environment where it does not need as much excess liquidity as it currently has to steer short-term market interest rates. “This means that the current size of our balance sheet is larger than is needed to effectively implement our monetary policy stance,” Schnabel said. How much liquidity the ECB actually wants to reduce depends on the choice of monetary policy regime, which should be decided by the end of the year.
2. Reduce the negative side effects of high bond holdings
The ECB director points to price distortions that could endanger financial stability, an increase in wealth inequality and allegations of financial or fiscal dominance, which undermine the credibility of the monetary policy could damage. In addition, the central bank exposes itself to increased credit and duration risks and, last but not least, impairs the effectiveness of its monetary policy by making government bonds scarcer, which therefore enjoy a scarcity premium and put the brakes on interest rates.
According to Schnabel, around half of the repo transactions backed by German Bunds traded at times 40 basis points below the general collateral rate.
3. Monetary tightening
According to Schnabel, the ECB’s very large bond holdings continue to have a very accommodative effect, which could run counter to the achievement of the inflation target. In doing so, they believe QT will reverse some of the effects of quantitative easing (QE). Risk premiums would probably rise again. The ECB director expects a further interest rate-raising effect from the fact that investors will no longer be willing to hold riskier securities to the same extent.
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(END) Dow Jones Newswires
March 02, 2023 09:07 ET (14:07 GMT)