ECB could start shrinking balance sheet next year

Bundesbank President Joachim Nagel outlined an ambitious 8.8 trillion euros balance sheet reduction plan. Nagel said the European Central Bank intends to cut a huge balance sheet from government bonds early next year.

With inflation rising to double digits, the ECB began raising interest rates at the fastest pace in the history of the European Union. The bank also announced last week possible talks in December, where it will discuss options to reduce its 3.3 trillion euros asset-buying program. However, most policymakers were cautious about assigning an exact timeline, and Nagel was the first to publicly advocate a balance sheet reduction beginning in 2023:

The Bundesbank president told the Frankfurter Allgemeine Zeitung that they would better start reducing their bond portfolio at the beginning of next year, for example by allowing existing bonds to mature.

Last month, proposals were made to prepare the main parameters of the process known as quantitative tightening (QT) by December, after which a more detailed plan could be outlined in February, with the actual launch only taking place in the second quarter.

Spanish central bank governor Pablo Hernandez de Kos, in a joint interview with Nagel, warned the ECB against hasty action, calling for cautious and "very measured" steps, as all the possible effects of balance sheet cuts on them are not yet fully known.

Over the past decade, when there has been little price growth, the ECB has bought bonds to keep inflation at an acceptable level. The bank has also reinvested all the cash from expiring bonds back into the market.

Both legislative bodies agreed the ECB still has a long way to go after raising the deposit rate by 200 basis points in a few months.

Nagel added that he is convinced — it is not the end of rate hikes. Moreover, there is still a long way to go.

De Kos also took a more cautious tone about rates, but remains convinced that the ECB is not finished with the hike. He also said that an interest rate that meets the ECB's 2% inflation target may still be a long way off.