In an interview with Expansión, member of the European Central Bank’s Executive Board, Piero Cipollone elaborated on recent signals that the central bank shrinking its balance sheet could make monetary policy more restrictive and demand larger rate cuts. “It’s more complicated than that,” he said.
The large asset purchases we carried out in the past lowered long-term sovereign bond yields by as much as 175 basis points. Now, because of the reduction in the size of our balance sheet, this figure is 75 basis points and falling.
But there’s another important factor, he added. It’s not just about the size of central bank reserves, it’s also about their composition. ECB research shows that the composition of these reserves is very important for banks’ lending ability.
The research estimates that debt portfolio holdings (under the ECB’s asset purchase programme (APP) and pandemic emergency purchase programme (PEPP)) will decrease by around €500 billion ($540.6bn) in 2025. This is associated with a possible €75 billion decline in credit supply. To put this into perspective, it is roughly equivalent to the amount of loans that banks granted to non-financial corporations in 2024.
“Therefore, we should bear in mind that, if nothing else happens, the reduction of the central bank balance sheet is putting pressure on banks’ lending capacity. So we need to monitor this effect and take it into consideration when calibrating our monetary policy stance,” said Cipollone.