Chart of the week: The ECB’s balance sheet

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• The chart illustrates the task facing the ECB as it seeks to expand its balance sheet and head off the disinflationary pressures that are prevalent in the eurozone. Right now, the ECB’s balance sheet is shrinking week by week. As it does so, the monetary base in the eurozone contracts. This tends to weigh on prices.

• The recent depreciation of the euro (click here for a graph showing the trade-weighted euro versus the US dollar) is unlikely to be enough to lift the eurozone economy out of the doldrums, at least in the near term.

• ECB president Mario Draghi has indicated that the ECB must expand its balance sheet by at least EUR 1 trillion. However, this is probably easier said than done – the ECB’s balance sheet will continue to shrink over the coming year as assets the ECB holds under its earlier long-term refinancing operations (LTRO) roll off. To counter this, the ECB will need to purchase closer to EUR 1.5 trillion of assets.

• The ECB intends to purchase asset-backed securities (ABS). But the ABS market is relatively small and we estimate this programme will only yield about EUR 500 billion in assets over the next two years.

• The ECB’s new targeted LTRO (TLTRO) may provide some respite, yet with sovereign bond yields so low it seems unlikely that the ECB will be able to expand its balance sheet sufficiently through this channel (click here to see my note from September 18 on the disappointing take up of the first round of TLTROs).

• Outright purchases of sovereign debt would provide a solution but this is politically difficult as there may not be a legal basis for such purchases under the ECB’s mandate.

Joost van Leenders

Portfolio Manager, Multi Asset Solutions, CFA Charterholder

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