Managing the risks of quantitative tightening in the euro area

Abstract

The Governing Council of the European Central Bank (ECB) agreed on October 27th, 2022, to encourage early repayment of loans given out to banks through targeted long-term refinancing operations during the COVID-19 pandemic. On December 15th, the Governing Council announced that it would slow down the reinvestment of the maturing principal on assets held within the large-scale asset purchase programme to shrink those holdings by roughly €15 billion per month starting in March 2023. These two decisions are important to reduce surplus liquidity in the euro area and to improve the functioning of the ECB’s monetary transmission mechanism. Nevertheless, they pose important risks for commercial banks, central banks, government finances, and the ECB itself. Managing those risks will progressively dominate concerns in the Governing Council as the pace of interest rate rises that started in July 2022 begins to slow in the second quarter of 2023.