ECB shrinking its balance sheet

The European Central Bank has agreed to start discussions in early October on shrinking its balance sheet, increasing the pressure on the already stretched budgets of southern European governments. The proposed shift, which causes a central bank’s balance sheet to shrink and is known as quantitative tightening, may come into force in the first quarter of 2023, the insiders said. A change would bring the ECB into line with other major central banks, such as the US Federal Reserve and Bank of England. Both the UK and US central banks have already started to shrink their bond portfolios as part of their efforts to tackle soaring inflation by pushing up financing costs, leading to accusations that policymakers in Frankfurt remain behind the curve.

The discussion on shrinking the ECB’s balance sheet is due to start at the governing council’s meeting in Cyprus on October 5, when it will not be making monetary policy decisions. Any announcement on the issue is unlikely until later in the year, with the first opportunity coming at the October 27 monetary policy meeting in Frankfurt. If the ECB reduces the amount of bonds it buys under reinvestments, it is likely to increase long-term borrowing costs for eurozone governments, which have already shot up close to eight-year highs in recent weeks. Italy’s 10-year bond yield briefly rose above 4 per cent on Friday morning, more than five times higher than a year ago.

«The current inflation number is so out of whack with our target that we have to react,» said one person involved in this week’s discussions.

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