Bundesbank Hoards Money Against Losses When ECB Hikes Rates

Germany’s Bundesbank increased the money it puts aside to cover any losses when the European Central Bank starts to raise interest rates.

The central bank boosted provisions by 1.1 billion euros ($1.4 billion) to 16.4 billion euros at the end of 2017, it said in its annual report published Tuesday. The Bundesbank posted a profit of 2 billion euros for the year, of which it transferred 1.9 billion euros to the government.

With confidence increasing among ECB officials that euro-area inflation will gradually pick up amid robust economic growth, the end of unprecedented monetary stimulus is nearing. Policy makers are already discussing the need for changing forward guidance, a step that’ll take them closer to phasing out asset purchases and tightening borrowing costs, and central banks are preparing their accounts for a shift in policy that may erode interest income.

“The continuation of the asset purchases has driven up interest-rate risk,” Bundesbank President Jens Weidmann said in a speech in Frankfurt. At the same time, profit was bolstered by a higher volume of excess liquidity and income from the negative deposit rate, he said. With price stability its sole mandate, “it would be wrong to benchmark the monetary-policy decisions against the central bank’s profit or loss.”

Total interest income was 5.2 billion euros in 2017, up from 3.7 billion euros the previous year.

Income from the deposit facility and previous asset-purchase plans such as the Securities Markets Program is bound to fade as bonds mature and interest rates begin to rise. At the same time, the ECB’s reinvestment policy means losses on the public-sector bond portfolio — incurred through the purchase of negative yielding debt — are set to remain with the Bundesbank for years.

“The market has certain expectations on a possible interest-rate change in 2019, based not only on the dataset, but also on our communication, and these expectations are — I’d say — not completely unrealistic, they seem to be ‘prima vista’ plausible,” Weidmann said.

Economic Outlook
Turning to the economy, he said the performances in Germany and the euro area were “very satisfactory” last year. “The upswing now rests on a broad base everywhere,” he said.

“What this also means is that the real economic situation and the monetary-policy stance have rarely diverged as much as they do now,” he said, adding that there would have been a case for reducing asset buying sooner and setting a clear end date for the program. “If the upturn continues and prices rise accordingly, I see no reason why the ECB Governing Council shouldn’t end the net asset purchases in the current year.”

The ECB decided in October to halve the monthly purchase amount to 30 billion euros starting in January, while continuing to pledge that quantitative easing could be extended if necessary. At their policy meeting last month, some officials were ready to remove that pledge but failed to convince their peers. Instead, the Governing Council agreed that they could review their stance early in the year.

Weidmann said he sees signs that increasing domestic price pressures are likely to be sustained, citing the latest wage deal for metalworkers and engineers in Germany. He said the recent appreciation of the euro doesn’t change the ECB’s accommodative policy stance, adding that officials will “keep a close eye” on the impact exchange-rate changes have on inflation.

Other highlights of Weidmann’s speech:

Financial companies wishing to operate in the euro area after Brexit “should at least establish the necessary base units there. And for the European Union, base unit means more than just a ‘letterbox’ company.”
Gold transfers were completed ahead of schedule in 2017; 50 percent of reserves are now held at the Bundesbank in Frankfurt
Governments should use the current positive economic climate as an opportunity to implement reforms
Institutional architecture of monetary union needs to be overhauled
Source: Bloomberg