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© Reuters. FILE PHOTO: European Union flags flutter outside the European Central Bank (ECB) headquarters in Frankfurt, Germany, April 26, 2018. REUTERS/Kai Pfaffenbach/File Photo
By Balazs Koranyi
WASHINGTON (Reuters) -Two key European Central Bank policymakers made the case on Saturday for a cut in the bank's oversized balance sheet, indicating that the next key policy debate will be on how to run down the ECB's more than 5 trillion euros worth of bonds.
Bundesbank President Joachim Nagel and Dutch central bank chief Klaas Knot both said that the time for this so-called quantitative tightening is approaching, joining a still small but growing group advocating a run-off in assets.
"Once we will have reached neutral territory with our policy rate, it makes sense to consider the roll-off of asset purchases by limiting reinvestments," Knot said in a speech in Washington. "I do believe that we should move gradually here."
The balance sheet run off, part of a broader scheme of monetary policy tightening, is needed as inflation is running at 10% and will stay above the ECB's 2% target for years to come.
At 0.75%, the ECB's deposit rate is still far below most estimates of the neutral rate, which neither stimulates nor holds back growth, but rate hikes in October and December should put it close to 2%, the upper end of estimates.
"As monetary policy continues to normalise, we will also need to look into scaling back Eurosystem asset holdings, which amount to almost 5 trillion euros," Nagel told a separate event.
A presentation to policymakers earlier this month provided a possible timeline for a balance sheet run-off starting in the second quarter but there has been no firm decision by the 25-member Governing Council, sources told Reuters earlier.
Others on the Governing Council have also said quantitative tightening should start soon but none have called for immediate action, indicating that policymakers are keen to be done with the bulk of rate hikes before dealing with the balance sheet.
Quantitative tightening would start not with outright bond sales, but with a reduction in the reinvestment of funds maturing.
Knot also said that rate hikes should not end at the neutral rate, an undefined level, and the ECB will likely have to enter a territory that brakes growth.
"I am increasingly convinced that we need to do more than just removing accommodation to fulfil our price stability mandate," Knot said.
While Knot in the past made the case for a big rate hike on Oct 27, he also said that moves should eventually become smaller as the ECB gets closer to a level that could credibly bring inflation back to target.
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