The ECB raised interest rates again yesterday, but monetary policy in the eurozone is tightening on more than one front.
Yesterday, the ECB announced yet another interest rate hike, bringing its policy rate to 2.5%. Although financial markets had anticipated this move, the ECB’s second rate hike in three months comes despite the fact that there are currently few signs of second-round effects, in which higher energy prices are passing through to the prices of goods and services. As we noted in last week’s MacroFriday, the current rise in inflation is primarily the result of a supply problem in the energy market and is hardly demand-driven. At the same time, the recent rise in long-term interest rates in the markets signifies a further tightening of financial conditions, which may weigh on investment and economic growth in the eurozone.
I was curious to see whether the ECB would also address the ongoing reduction of its balance sheet, a process that began as early as March 2023. As of today, maturing bonds from the APP and PEPP will no longer be reinvested. As a result, the ECB is gradually reducing its presence in the bond markets, and a larger share of government financing is once again flowing to private investors. This, too, is putting upward pressure on market interest rates. It is noteworthy that the pace at which the balance sheet is shrinking appears to have slowed in recent years. However, this primarily reflects the sharp rise in the value of the ECB’s gold reserves rather than a change in its balance sheet reduction policy.
Of course, economic conditions and dynamics vary from region to region, so comparisons must be made with due caution. Nevertheless, the Federal Reserve serves as an interesting point of reference. The Fed’s quantitative tightening ran from June 2022 to December 2025—a period of 42 months—after which the central bank stopped further reducing its balance sheet. And this September marks exactly… 42 months since the ECB began its own quantitative tightening.
