ECB´S BALANCE-SHEET GOAL TAKES A HIT / THE WALL STREET JOURNAL

November 11, 2014, 11:50 AM ET

ECB’s Balance-Sheet Goal Takes a Hit

By Todd Buell


The ECB’s climb to €3 trillion just got a little steeper.

According to the European Central Bank’s weekly update, its balance sheet—the value of assets it holds—fell by about €22 billion last week, settling at €2.03 trillion. This came despite new purchases of covered bonds under a new plan.

The reason for last week’s drop: Banks paid back far more in ECB loans than the ECB bought in assets.

At his most recent press conference, held last Thursday, ECB President Mario Draghi said that the ECB expects its latest measures, including four-year bank loans and purchases of covered bonds and asset-backed securities, to push the balance sheet back to early 2012 levels. Pressed for the specific period the ECB had in mind, Mr. Draghi responded March 2012, when the balance sheet was around €3 trillion.

The size of the balance sheet is a rough proxy for the level of accommodation of the central bank. As the ECB buys more assets and lends more funds to banks, its balance sheet expands. It hopes in turn that these new funds are passed on to consumers and firms, who will invest, creating economic growth and raising inflation.

Both these things desperately need to happen in the eurozone, and soon. The economy is stagnating and inflation is at rock-bottom levels, coming in at only 0.4% in October, way off of the ECB’s just-below-2% target.

With balance sheets of the Federal Reserve and Bank of England stabilizing after they concluded their own asset-purchase programs, this also highlights the divergence between the ECB and other big central banks, which should cheapen the euro.

But a big chunk of the ECB’s balance sheet—about €500 billion—is comprised of loans to banks. When banks pay these loans back, or opt not to borrow more from the ECB, the balance sheet shrinks.

“The ECB has very little control over the size of its balance sheet,” said Lorcan Roche Kelly, an economist with Agenda Research in Ireland. The ECB really only controls what it buys on the open market, currently covered bonds and, soon, asset-backed securities.

Its bank loans are dictated by demand, and the size of its targeted long-term lending programs are determined by banks’ lending. Moreover, until about March, as the ECB is issuing new four-year loans, banks are also repaying earlier three-year loans, offsetting the expansionary impact.

If the balance sheet doesn’t start to grow in the next few months, it poses a “credibility problem” for the ECB, said Mr. Kelly, raising the likelihood that the central bank will need to widen its net of purchases to corporate bonds. He also said it could become a problem for the central bank should the balance-sheet volume drop below €2 trillion, which it is close to.

“That’s a headline generator,” he said.