By Hans Bentzien
FRANKFURT (Dow Jones) — The European Central Bank (ECB) will want to reduce its government bond holdings at a similar pace to the US Federal Reserve and the Bank of England, according to Rabobank analyst Bas van Geffen. According to the analyst, the pace of EUR 30 billion per month, converted to ECB conditions, cannot be achieved with the passive method favored by the ECB of simply not replacing maturing paper. His suggestion: The ECB should support the reduction of excess liquidity in the banking system by also issuing its own securities. It could offer them for sale in months when maturities are below the target amount.
Van Geffen makes the following assumptions:
1. Government bond holdings must be reduced
The ECB intends to at least reduce the government bond holdings acquired under the APP program in order to reduce liquidity in the banking system and thus reduce inflationary pressure. It also has to remember that it would have to be ready to buy bonds even in the event of future recessions. However, if it is still sitting on old stocks, there is a risk that ownership limits will be breached. After all, the banks also lack the government bonds as collateral.
2. Target for excess liquidity EUR 2 trillion
Van Geffen posits that global central bank reserve needs are much higher today than they used to be, for a variety of reasons. With regard to the euro area, there is also the “fragmentation” of the banking market, which triggers an additional need for liquidity. With a monthly inventory reduction of 30 billion euros, the ECB can come up with an excess liquidity of 2 trillion euros. Whether it will be further reduced from then on is another question.
3. No active sale of government bonds
The above goal can actually only be achieved with an active sale of government bonds. However, Van Geffen believes that the ECB does not want to actively sell government bonds because this would push up the spreads of highly indebted countries, which in turn could trigger purchases under the Transaction Protection Instrument.
4. Absorb liquidity differently
The analyst sees two other ways in which the ECB can extract liquidity from the banking system: First, by taking time deposits, which would then bear interest higher than the deposit facility. But that would not solve the problem of collateral shortages. Second, the issuance of securities that could be traded and used as collateral. In months in which the volume of maturities is higher than 30 billion euros, the ECB could buy back paper.
According to ECB Vice President Luis de Guindos, the Governing Council will discuss the “timing and modalities” of quantitative tightening (QT) in December.