Belgium (Brussels Morning Newspaper) The European Central Bank (ECB) will likely be forced to go into red as decades of low interest, money printing and bond-buying are catching up with the institution.
The ECB started increasing its interest rate in July in response to rising inflation, following the markets’ reaction to the coronavirus aid measures and growing energy prices resulting from the Russian invasion of Ukraine. Its interest rates had been negative for eight previous years.
Late last month, the bank upped its deposit rate by further 75 basis points, bringing it to current 1.5% interest rate, with the ECB President Christine Lagarde announcing that the bank will have “further rate increases in the future.”
The bank is forced to increase its interest rate to combat inflation, which Eurostat estimated at 10.7% in October this year, with most of the inflation hike caused by growing energy prices, which accounted for 41.9% of total inflation rate.
The increase in bank’s interest rate means that the ECB will now have to make huge interest payments to commercial banks, on some 5 trillion euro worth of deposits the central bank created through massive bond purchases and cheap loans intended to stimulate the coronavirus-hit economy of eurozone countries.
As the bank purchased assets, it was transferring the risk of future interest rate changes from the market to the central bank’s balance sheets, the ECB wrote in an explainer article on Tuesday. “This risk starts materialising now across the world, as a series of unprecedented shocks has led to record-high inflation rates that we have to fight by raising interest rates, which results in higher interest expenses that we pay to banks,” the bank wrote. “In this case our profit falls, and we might even make losses.”
If these losses end up larger than the bank’s general risk provision, it might fall onto its shareholders, national central banks of eurozone countries, to cover the remaining loss with their own assets. Some national central banks might even be forced to seek government bailouts.
De Nederlandische Bank governor Klaas Knot warned the Dutch government as far back in September that the Dutch bank is currently in danger of potentially needing recapitalisation by its government.
Any losses not covered by national central banks could be deferred by writing them on the bank’s balance sheets against future profits, with the Bundesbank’s governor Joachim Nagel touting this option last week, while dismissing the danger of the German central bank having to seek government bailouts over the ECB liabilities.
This possibility also seems likely in view that the ECB expects a slow, but sure return to profitability in the medium term, as the bank adapts to a positive interest rate environment. “It is important to remember that central banks are not like ordinary companies: they can lose money and still operate effectively,” said the ECB on Tuesday.
