Along with a continued series of interest rate hikes, he hopes the so-called quantitative tightening, or QT, will raise borrowing costs and thus slow demand for goods and services in the 19 countries that use the euro.
The change in policy will be historic, after the ECB spent nearly a decade doing the exact opposite via multiple stimulus programs that kept the eurozone economy afloat through successive crises.
It also poses a challenge for governments that have relied on the ECB as their main lender for years, particularly in the bloc’s indebted south.
The ECB will present the “key principles” of the QT program on December 15, with a planned launch in the first months of 2023.
Here are the main questions investors are asking about the ECB’s plans.
WHAT IS QT AND HOW IS IT SUPPOSED TO WORK?
Generally speaking, quantitative tightening is meant to be a mirror image of the quantitative easing (QE) policies that have dominated the past decade.
As part of QE, the ECB cut borrowing costs by buying government bonds, hoping this would encourage banks and other investors to use their money more fruitfully, such as finance companies.
Through quantitative tightening, the ECB will mop up the liquidity created by QE by shedding its bond holdings.
This should increase the cost of money and cool credit and investment.
WHAT WOULD IT BE IN PRACTICE?
The ECB has hinted that it does not plan to sell its bonds but will simply stop replacing some of those maturing, as the US Federal Reserve did when it launched its own QT plus program. early this year.
The Fed said it would only reinvest proceeds from maturing bonds above a certain monthly threshold.
WILL THE ECB SIMPLY COPY THE FED?
Probably not, since the monthly repayments of the ECB’s asset purchase program range between 17.8 billion euros next August and 52.7 billion euros in October.
That means he might need to use a redemption percentage as a yardstick or reinvest smoothly over several months, as he has done in the past.
But ECB policymakers insisted they wanted the QT to be predictable and gradual, so don’t expect too much variation.
The idea is to put it on autopilot so that policymakers don’t have to make regular decisions about the pace of repayments, ensuring that interest rates remain their key tool.
HOW MUCH MONEY ARE WE TALKING HERE?
The ECB bought €3.3 trillion in assets under the APP, most of which are government bonds.
These have an average maturity of just over seven years and analysts expect the ECB to reduce its portfolio by only 15 to 20 billion euros per month on average. This means that it will take a long time for the ECB to reduce its balance sheet if it does not sell assets.
The ECB also has a separate pandemic emergency purchase program worth €1.7 trillion. He said he would continue to reinvest proceeds from this program until the end of 2024.
WHAT DOES THIS MEAN FOR BORROWERS?
The ECB has been a major buyer of government bonds since 2015. For a few months at the height of the pandemic, it was buying more sovereign debt than countries were issuing.
That is set to change under QT, forcing eurozone governments – most of which are still in deficit – to raise funds from private investors.
UniCredit estimates the market will need to absorb an additional 500 billion euros of eurozone government bonds next year, the biggest increase since 2010.
Should we expect market turbulence?
Markets appear to have priced in some QT already, with eurozone government bond yields hitting multi-year highs in September before pulling back in recent weeks.
German 10-year bonds are currently yielding 1.8% versus minus 0.4% a year ago, while similar bonds for highly indebted Italy are at 3.7%.
But the ECB has already provided a safety net for these countries, in the form of a system that would allow it to buy unlimited amounts of their bonds if the market crashed.
($1 = 0.9497 euros)
(Reporting by Francesco Canepa; Editing by Catherine Evans)