Quantitative Easing

Analysis-ECB ‘QT’ could be the next challenge for turbulent markets

By Yoruk Bahceli and Dhara Ranasinghe

LONDON (Reuters) – The European Central Bank is considering stepping into the whirlwind of volatile global markets to start trimming its massive bond holdings – just as governments are ramping up spending to respond to an energy crisis that could trigger a recession.

The ECB, which has bought 5 trillion euros ($4.9 trillion) in bonds over the past decade to lift low inflation, now finds itself struggling with record inflation at 10%.

In addition to aggressive interest rate hikes, including an unprecedented 75 basis point move last month, political hawks want to begin quantitative tightening (QT): the reduction in the ECB’s bond holdings.

ECB chief Christine Lagarde acknowledged this week that the discussion had begun and would continue.

The process may still take months and will likely come after the ECB has hiked around 2% and will be very gradual, but bond markets – reeling from aggressive global rate hikes, an energy crisis and a a rout of UK bonds – are nervous.

“There’s a lot at stake in the eurozone when it comes to QT,” said Benjamin Schroeder, senior rates strategist at ING, adding that the closely watched spread between Italian and German yields was the main focus.

“But beyond spreads, there is also the fear of further stoking market volatility, particularly when government funding plans in the eurozone are subject to increasing upside risk.”

At 2.35%, Germany’s 10-year bond yield has risen 250 basis points this year and Italy’s by almost 360 basis points – the biggest increases in decades.

Germany last month unveiled a 200 billion euro package financed by new borrowing to help cushion the blow of the energy shock. BofA expects the net supply of European government bonds to rise by almost 400 billion euros next year, the highest on record and well above 120-145 billion euros expected this year, partly mitigated by ECB bond purchases.

“This consideration also makes the practical implementation of ECB QT much more difficult,” BofA said.


Analysts expect the ECB to first phase out reinvestments of maturing bonds under its conventional bond-buying program. This would reduce its balance sheet by a “manageable” €155 billion in 2023 and €300 billion in 2024, ING estimates.

Goldman Sachs estimates that the bond markets should be able to digest an annual settlement of 250 billion euros of these assets. Ten-year bond yields in higher-rated states would rise only 6 basis points and 15 basis points in Southern Europe.

Even if those holdings were to be unwound, analysts widely expect the ECB to continue reinvesting under its Pandemic Emergency Bond Purchase Program (PEPP), which it moved to countries such as Italy and Spain over the summer as a first line of defense in the event of a divergence. of the yield spread they pay compared to the best German securities is considered “unjustified”.

Eric Oynoyan, head of European rates strategy at Morgan Stanley, estimates that PEPP redemptions will be worth around 151 billion euros next year.

“To some extent, ironically, PEPP flexibility is a way to continue doing QE for peripheral debt while doing QT and could even eventually lead to tighter spreads,” he said, making reference to the first half of next year.

A possible reduction in PEPP holdings could add to balance sheet reductions in 2025 worth a total of 388 billion euros, ING said. Analysts do not expect the ECB to speed up the process with outright bond sales.


How QT will play out is largely unknown, in the same way that quantitative easing was a relatively new experience.

The Federal Reserve has begun trimming its $9 trillion balance sheet, and staff recently concluded that bond market tensions could complicate QT by amplifying its impact and raising rates more than expected.

The Bank of England‘s plans to launch QT in early October were postponed until October 31 as it launched an emergency bond-buying program to stem a bond market rout triggered by the government’s announcement. UK on September 23 with a “mini-budget”.

“The lesson from the Bank of England is that basically if you don’t have financial stability, there’s no point in trying to pursue price stability,” said Piet Haines Christiansen, chief analyst at Danske Bank.

The big headache for the ECB is to contain bond spreads.

In addition to PEPP reinvestments, it also launched a new tool, the Transmission Protection Instrument (TPI), under which it would buy government bonds seeing an “unjustified” widening of spreads on Germany.

AllianceBernstein portfolio manager Nick Sanders said he was “skeptical” about how the ECB could achieve QT with these protections in place.

“If you have Eurozone yields supported by the backstop they have put in place, it will be very difficult for them to move into the QT environment without a shock to peripheral spreads, especially Italy.”

The ECB could also find itself undertaking a QT during a recession, which would lead to “excessive tightening” of policy, said Annalisa Piazza, an analyst at MFS Investment Management.

There is no doubt that the ECB, whose assets rival those of the Fed, adding to the liquidation of balance sheets globally would be another source of uncertainty for broader markets.

A rough rule of thumb is that $1 trillion of QT is consistently worth around 10% less than global stocks, the strategists said.

($1 = 1.0306 euros)

(Reporting by Yoruk Bahceli and Dhara Ranasinghe, additional reporting by Samuel Indyk in London; Editing by Hugh Lawson)