The European Central Bank said on Thursday it would start shrinking its balance sheet by reducing its 5 trillion euro ($5.3 trillion) bond portfolio from March, its next step towards tighter policy as it tries to combat decades-high inflation.
The ECB said it would reduce holdings of bonds bought under its Asset Purchase Programme (APP) at an average pace of 15 billion euros per month from March until the end of the second quarter, with the subsequent pace to be determined over time.
It will do so by not reinvesting all the cash it receives from maturing bonds in a process called quantitative tightening, or QT. More detailed parameters will be provided at its February meeting, the ECB said.
“We believe that it is totally legitimate, appropriate and actually efficient to go in the direction of reducing the size of our balance sheet, to do that in a measured and predictable way,” ECB President Christine Lagarde told a news conference.
By raising longer-term borrowing costs, the reduction should tighten financial conditions, making it more expensive for firms and governments to borrow.
“The Governing Council will regularly reassess the pace of the APP portfolio reduction to ensure it remains consistent with the overall monetary policy strategy and stance, to preserve market functioning, and to maintain firm control over short-term money market condition,” the ECB said in a statement.
The process will complement traditional rate hikes, which target short-term funding costs. The ECB raised its policy rates by another 50 basis points on Thursday, bringing the total rise since July to 250 basis points, an unprecedented pace.
Lagarde said the 15 billion euro amount was chosen as it represents roughly half the cash the ECB would receive from maturing bonds over that period of time.
“It seemed an appropriate number in order to normalize our balance sheet, bearing in mind that the key tool is the interest rate,” she said.
The 3.3 trillion euros of purchases made under the APP account for the bulk of the ECB’s debt holdings. Launched in 2015 to combat deflationary risks, the scheme has seen the bank evolve into the leading creditor of many euro zone governments.
The ECB will continue to support debt markets, as the plan excludes the 1.7 trillion euros of debt it has bought through its more flexible Pandemic Emergency Purchase Programme (PEPP) since the height of the COVID-19 pandemic in 2020. The ECB will continue replacing maturing PEPP debt until at least end-2024.
The ECB’s balance sheet reduction comes just as euro zone governments plan for increased borrowing next year to fund energy price support measures.
Euro zone government bond yields rose sharply after the ECB’s decision.
Yields on Italian government bonds, a leading beneficiary of the ECB’s bond purchases, jumped over 20 basis points on the day, raising the closely-watched premium over German bonds to 204 basis points, the highest in a month.
The move to start quantitative tightening follows a similar step by the U.S. Federal Reserve earlier this year.
The ECB has already reduced its balance sheet by taking back 800 billion euros of ultra-cheap funding from banks, but at 8 trillion euros its total assets remain exceptionally large by historic standards. ($1 = 0.9407 euros) (Reporting by Yoruk Bahceli; Editing by Catherine Evans)