Bank of America forecasts a significant reduction in the Eurosystem's balance sheet, projecting a decrease from €6.8 trillion at the end of 2023 to €6.2 trillion by the end of 2024, and further down to €5.6 trillion by the end of 2025. This projection comes in light of the European Central Bank's (ECB) decision to initiate quantitative tightening (QT) in its pandemic emergency purchase programme (PEPP) portfolio, planning an average reduction of €7.5 billion per month. This approach by the ECB, aiming to accelerate QT, contrasts with the Federal Reserve's strategy, which is anticipated to taper QT by May 2024.
ECB's QT Strategy: The ECB's move to begin QT and reduce its PEPP portfolio marks a strategic shift in its monetary policy, aiming to gradually normalize its expansive balance sheet post-pandemic.
Contrast with Federal Reserve: The ECB's aggressive QT approach differs from the Federal Reserve's expected strategy, highlighting divergent paths in monetary policy normalization between the two central banks.
Operational Framework Review: ECB President Lagarde hinted at the conclusion of the operational framework review by the end of Spring, potentially introducing new lending operations to support banks' reserve demands amidst QT.
Risks to Balance Sheet Forecasts: BofA notes potential upside risks to their balance sheet projections, particularly if the ECB offsets its QE portfolio reduction with new loans. There's also a risk that these operations could be introduced too late or may not be attractive enough for banks to utilize.
BofA's projections for the ECB balance sheet and its QT strategy underscore a critical period of policy transition for the Eurosystem. As the ECB embarks on a path of balance sheet normalization, the outcomes of its operational framework review and the efficacy of potential new lending operations will be key factors to watch. These developments not only impact the ECB's balance sheet size but also hold implications for the broader European banking sector and monetary policy landscape.