MONETARY POLICY REPORT | WINTER 2023 (box 1)
(authors: Soňa Benecká, Petr Polák)
The ECB’s balance sheet grew from 39% to 64% of euro area GDP over the past three years. This growth was due to the use of unconventional monetary policy, which involved the ECB purchasing bonds to increase inflation to its target (i.e. conducting quantitative easing). This policy fostered an additional easing of euro area monetary conditions at a time when conventional easing using interest rates was no longer possible. Now, though, the situation is quite the opposite and the ECB is trying to subdue inflation pressures by raising its policy rates. Moreover, the ECB announced at its December 2022 meeting that it would also use unconventional policy to tighten monetary conditions. From spring 2023 onwards, therefore, maturing assets from the Asset Purchase Programme (APP) will no longer be fully reinvested (see Chart 1). The ECB will continue to reinvest, in full, the principal payments from maturing securities purchased under the Pandemic Emergency Purchase Programme (PEPP) at least until the end of 2024.
Chart 1 – The volume of assets purchased by the ECB will start falling in spring 2023
EUR billions; source ECB; CNB calculation and forecast
The CNB’s modelling system explicitly captures the effect of ECB monetary policy – including its unconventional part – using a “shadow rate”, which incorporates the effect of asset purchase programmes in addition to the 3M EURIBOR market rate.[1] From spring 2020 to spring 2022, the ECB purchased assets at a monthly pace of approximately EUR 75 billion on average (and now has EUR 3.26 trillion of assets in its APP portfolio). The CNB’s current outlook (see Chart 2) reflects the announced pace of decline in assets of EUR 15 billion per month from spring 2023 onwards. Subsequently, we expect the amount of non-reinvested maturing APP assets to rise to EUR 30 billion. This is reflected in the shadow rate, which will be around 0.5 pp above the 3M EURIBOR.
Chart 2 – The euro area shadow rate will move above the 3M EURIBOR due to the unconventional part
%; CNB calculation
Besides APP redemptions, the total size of the ECB’s balance sheet will decrease as a result of the repayment of loans (liquidity facilities) provided by the central bank to commercial banks. In the past, the ECB used longer-term refinancing operations (LTROs) to offer funding to euro area commercial banks in order to support lending to the real economy.[2] There have been three phases of these operations since 2014. The last one was focused on supporting the economy during the pandemic. In November 2022, the programme was adjusted to strengthen the transmission of the ECB’s key interest rates to banks’ lending conditions. The stricter conditions of the facilities and the possibility of early repayment led banks to repay loans from the ECB more quickly (see Chart 3). The volume of refinancing operations fell by about one-third between late October 2022 and mid-January 2023. Together with the end of reinvestment, this should foster a decline in the excess liquidity in the euro area banking system to the pre-pandemic level two years from now.
Chart 3 – The size of the ECB’s balance sheet will decrease over the next two years owing to repayment of refinancing operations
EUR billions; source ECB and Bloomberg; CNB calculation and forecast
In the context of LTRO loan repayment, a further tightening of credit conditions and a decline in credit growth in the euro area can be expected. In the Bank Lending Survey,[3] commercial banks repeatedly stated in the past that ECB financing was having a positive impact on their performance, lending conditions and credit supply. However, the situation started to turn around last summer. According to the latest ECB survey, banks tightened their lending conditions for households and firms in 2022 Q3. Firms’ demand for loans continued to rise slightly, but households’ demand dropped, especially in the case of loans for house purchase. According to banks, a further decline in demand and tightening of lending conditions was recorded at the end of 2022. The situation is illustrated by the composite index (see Chart 4) compiled by Bloomberg using the ECB survey data. The index has dropped to a level comparable to that seen during the euro area debt crisis. The credit impulse – the change in year-on-year credit growth – also peaked during summer and started to decline in the autumn. When the effect of the monetary policy tightening manifests itself in full, the credit impulse will also fall markedly and will probably turn negative.
Chart 4 – Euro area lending indicators suggest a distinct turnaround towards tighter conditions
left-hand scale: composite index; right-hand scale: credit impulse in pp; source Bloomberg and ECB; CNB calculation
Note: The composite index aggregates information on credit demand and supply and expected changes therein from the ECB’s lending survey. The credit impulse is the change in credit growth.
The decrease in liquidity is also being reflected in a desirable tightening of financial and monetary conditions. The increase in key ECB interest rates has passed through to a large extent to other financial market interest rates, returning the financial conditions indicator to the level observed at the start of the previous decade (see Chart 5). The spillover to client interest rates for households and firms is more gradual,[4] so the monetary conditions index lags slightly behind financial market developments. In real terms, however, financial conditions in the euro area remain very relaxed, as the swift growth in rates is lagging significantly behind the record-high inflation, which is also affecting inflation expectations. According to an ECB survey among economists, the outlook for inflation one year ahead is above 5%.
Chart 5 – Financial and monetary conditions are tightening but remain relaxed in real terms
indices; source Bloomberg and ECB; CNB calculation
Note: The financial conditions index captures the co-movement of financial market interest rates, while the monetary conditions indicator also includes client interest rates on loans to households and firms. In real terms it is adjusted for inflation expectations.
[1] This issue was examined in more detail in the October 2015 issue of Global Economic Outlook.
[2] Unlike asset purchases, credit operations do not enter the CNB’s considerations of the effective monetary policy stance of the ECB. Nonetheless, the operations do affect the expectations of analysts and markets regarding future economic developments in the euro area. The CNB forecast takes these expectations into account in the formulation of its economic outlook for the Czech Republic’s main trading partners, which are euro area countries.
[3] See the Bank Lending Survey.
[4] This topic is discussed in more detail in the thematic article of the January 2023 issue of Global Economic Outlook.