The European Central Bank (ECB) is expected to continue cutting interest rates to offset the impact of monetary tightening from shrinking bank balance sheets, ECB board member Piero Cipollone said on Tuesday.
He signaled that borrowing costs may need to be cut by less than market expectations to ensure the eurozone economy does not continue to be squeezed.
The ECB plans to let hundreds of billions, perhaps trillions, of euros of debt mature over the next few years. In 2025 alone, around €500 billion ($522 billion) in bonds—mostly government debt—will mature as part of a previously agreed normalization process.
But the strategy, known as quantitative tightening (QT), was originally introduced when inflation was too high. It now runs counter to the ECB’s goal of easing borrowing costs in an economy that has barely grown in the past two years.
“While interest rate cuts put downward pressure on short-term yields, balance sheet reduction puts upward pressure on long-term yields,” Cipollone said at an event with MNI.
“This is causing a tightening in financial conditions.”
He stressed that the ECB needs to ensure that interest rate cuts are able to offset the tightening effects of balance sheet reduction.
Cipollone’s remarks suggested that he may support continued interest rate cuts, given that QT is expected to last for several more years and continue to put pressure on long-term borrowing costs.
Currently, markets expect the ECB to implement three more rate cuts in 2025, bringing the benchmark deposit rate to 2%, which is expected to be the low point of the current easing cycle.
“At its peak in early 2022, the ECB’s bond holdings had lowered 10-year government bond yields by 175 basis points, but now the effect has subsided to around 75 basis points and is continuing to decline,” Cipollone said.
Cipollone declined to set an optimal size for the ECB’s balance sheet, arguing that it would depend on liquidity demands from commercial banks.
The ECB currently holds around €4.2 trillion in bonds purchased for monetary policy purposes.
“Further reductions in our balance sheet must remain gradual and predictable to avoid unintended monetary tightening effects,” he added.
