The European Central Bank will soon learn to live without bond-buying. President Christine Lagarde will on Thursday outline how ratesetters plan to shrink the bank’s 5-trillion-euro portfolio of government and corporate bonds. Rising yields and a still frail euro zone mean that Europe’s so-called quantitative tightening (QT) should be slow.
Unlike the other two, the ECB is not expected to start selling assets, but instead may simply stop replacing maturing bonds in its 3.4-trillion-euro pre-pandemic asset purchase. Hawks like Bundesbank head Joachim Nagel, have called for a quick run-off, but market conditions suggest a more prudent path.
Higher yields may worsen the euro zone’s recession, and make investors more worried about indebted sovereigns, like Italy. The spread between 10-year Italian debt and German bunds was around 210 basis points at the start of 2014, before quantitative easing started, 20 basis points above current levels. Goldman Sachs analysts expect 10-year German yields to reach 2.75% in March 2023, from 1.95% currently. That implies that without any bond-buying, Italian funding costs could reach nearly 5%.
If bond yields do spike, the ECB can step in with an emergency bond-buying programme, called the Transmission Protection Instrument. Yet such a tool may exacerbate tensions on the governing council, further unsettling markets. The real dangers of a disorderly exit mean the ECB has little choice but to remove the punchbowl slowly.The European Central Bank will explain how it will unwind its 5-trillion-euro bond portfolio on Dec. 15, as it ramps up efforts to bring down inflation in the euro zone.
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