The discussion on budget tightening has begun. And the first operational details will arrive as early as December. The European Central Bank (ECB), as President Christine Lagarde explained during the October meeting, will provide general indications on Quantitative tightening (Qt, or quantitative tightening). There is certainty that it will start in 2023, probably between the first and second quarters. On speed and breadth the tug of war between the northern front and the others, such as Italy, France and Spain, which are asking for more gradual normalization. Christine Lagarde confirmed today her willingness to provide specifics of the new process. The markets await clear answers.
A year ago Lagarde, in the meeting of December 16, explained that he had begun the process for the return to monetary normality. A path already then considered “long”, a word repeated several times during 2022. Inflation, although already high towards the end of the year, then exploded – in terms of persistence and magnitude – following the Russian invasion of Ukraine. Now, after a rise of 50 basis points in July and two by three quarters of a point in September and October, we are heading towards a further increase in the cost of money in December. Fifty basis points are requested by the countries most concerned about the consequences on economic growth, seventy-five points by the countries most intransigent in countering the flare-up in prices. Germany, the Netherlands, Austria and the Baltics will ask for more orthodoxy. But it is not certain that they will get it, given that Lagarde always wants to obtain a fundamental collegiality in monetary policy decisions. However, there was an opening: «In December we will illustrate the key principles for reducing the holdings of bonds in the portfolio.
In parallel, our tools to preserve the orderly transmission of monetary policy will remain in place, in particular flexible reinvestments under the Pandemic Emergency Purchase Program (PEPP, ed) and the new transmission protection instrument” (Transmission protection instrument, or Tpi, the anti-spread shield, ed.)». Thus the president of the ECB, Christine Lagarde, in her speech at the European Banking Congress.
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The compromise behind it all is the Qt announcement in December. The signs were all there. The vice president of the ECB, Luis de Guindos, explained in an interview with Politico that Frankfurt “will start the reduction of the balance sheet and of the bonds held certainly in 2023”. To do this, he pointed out, “a great deal of prudence” will be needed. The plane on which policymakers move is inclined. But there is the possibility of a ruse. “From my point of view we could start by not reinvesting maturing securities in the portfolio,” said De Guindos. In other words, the passive Qt. The reduction of bond portfolios purchased through the Asset purchase program (App) and the Pandemic emergency purchase program (Pepp) must, however, take place with precise gradualness. “It will be decisions made meeting by meeting,” said Board member Isabel Schnabel. Meeting by meeting, then.
The picture is also complicated by financial stability, which has steadily deteriorated over the last two quarters. To such an extent as to induce the European systemic risk board (Esrb) to issue the first “general warning” in its history at the end of September. De Guindos also recalled this when speaking at the Euro Finance Week in Frankfurt. Therefore, the downsizing process will have to be fine-tuned by the Eurotower. And from the approximately 2,000 billion euros of the post Lehman Brothers, it has gone to the current 8,800 billion. A lot, too much. And this is why, according to Lagarde, a reflection on the ECB’s portfolio of securities is needed soon. Words also shared by Klaas Knot, number one of De Nederlandsche Bank (DNB), the central bank of the Netherlands. According to which Frankfurt could slow down the pace of interest rate hikes but, the crucial note, “it must start quantitative tightening as soon as possible”. For Knot, “as monetary policy tightens, it will become more likely that the pace of rate hikes will slow down.” According to Knot “the neutral level could be reached as early as next month, within a generally accepted range between 1.5 and 2%”. Once this threshold is reached, Knot stressed, the ECB should “go into restrictive territory” to compress demand, but also begin to reduce the purchase programs implemented in recent decades.
“There is no doubt that a signal will have to be given, and a clear signal, regarding the Qt at the December meeting,” noted a senior ECB official. «He He will be part of the“ journey ”he undertook a year ago, and he will not be able to slow down any longer. The price formation dynamics are such that there can be no further delays in the analysis of the costs and benefits of Qt », he continues. The line of the Northern countries could also be the one chosen by Lagarde, to compensate for further rate hikes to come. Moreover, the words of Joachim Nagel, head of the Bundesbank, go in this direction. The ECB must continue to raise interest rates decisively and should kick off Quantitative tightening from the beginning of 2023. Thus the president of the Buba. “We must decisively raise our reference rates and adopt a restrictive stance – said Nagel -. We can’t stop here. Further decisive steps are needed.” At the beginning of next year, “we should start reducing our balance sheet, no longer fully reinvesting all maturing securities,” said the head of Buba.
Frederik Ducrozet, head of macroeconomic research at Pictet, has little doubts about the dynamics that will take place in the coming months. According to the French economist, “the elephant in the room could be the size of the ECB’s budget”. Possible, according to Ducrozet, the start of passive Qt in the second quarter of next year. Based on our assumptions for Qt and Tltro repayments, the ECB’s balance sheet would shrink from €8.8 trillion at its peak (70% of euro area GDP) to €7.0 trillion at the end of 2023. (53% of eurozone GDP),” he says. However, there are many unknowns. Starting with the rifts within the Governing Council and ending with the trend of inflation and the depth of the recession that will be.