MNI POLICY: ECB Saves Look At Balance Sheet Cuts For Late '23

The European Central Bank is only likely to begin in-depth discussions over its balance sheet reduction after the conclusion of its operational framework review due by the end of the year, and while the matter is likely to come up at this week's Governing Council, any trade-off between higher rates and further reductions in bond reinvestments or active bond sales is improbable, MNI understands.

Policymakers still see reinvestments from the Pandemic Emergency Purchase Programme as the first line of defence against yield fragmentation across the eurozone, ahead of activation of the still-untried Transmission Protection Instrument (TPI). This should help keep the subject off the table for now, though opportunities for discussing an early end of reinvestments in 2024 could open up as inflation slows and the outlook for interest rates improves.

Nonetheless, even with policymakers split on whether the central bank needs to pause tightening or enact a further 25bp hike at the Sept 14 meeting, there are some within the eurosystem who believe the future reinvestment policy of PEPP should be on the agenda as the next step towards normalisation of monetary policy. (MNI SOURCES: Hawks Aim For ECB Hike Before Data Ties Hands)

However, such a discussion would only involve on an end to reinvestments, with no current appetite for active sales of government bonds or assets from the balance sheet, something which would consolidate capital losses on central bank balance sheets across the eurosystem.

There remains an outside chance that doves could this week put PEPP reinvestments on the table to strengthen their argument for a rate pause, though this is unlikely and any such call is likely to be isolated.

For the moment, the ECB’s balance sheet deliberations remain largely at a technical level within the review teams, as the review into the operational framework gets closer to reporting.

An ECB spokesperson declined to comment.