ECB Faces Calls to Pause Quantitative Tightening Amid Bond Market Stress

The European Central Bank is facing growing pressure to pause its quantitative tightening (QT) program as bond market stress intensifies across the euro area. Rising long-term interest rates and widening gaps between core and peripheral sovereign yields have renewed concerns over market stability, prompting debates on whether the ECB should adjust its policy.

The ECB has been reducing its balance sheet since March 2023, a process that involves not replacing maturing assets. This approach has left private buyers to absorb a larger share of government bond issuance at a time when yields are already under upward pressure. However, market conditions have changed significantly since the policy began, and other major central banks have already adjusted or interrupted similar strategies in response to volatility.

One major concern is the impact of post-financial-crisis banking regulations, which require banks to hold more high-quality liquid assets, including government bonds. This could place further pressure on yields and amplify market instability. Additionally, the structure of government bond trading has evolved, with non-bank players like hedge funds taking a larger role in market-making, increasing the risk of liquidity tightens and stress episodes.

The article argues that monetary policy should primarily rely on short-term interest rates rather than further balance sheet reduction. Prudence favors putting QT on hold until market conditions are more stable and its broader effects on financial markets are better understood. The cost to banks of obtaining central bank liquidity through refinancing operations priced above the remuneration of minimum reserves could ultimately be passed on to customers, further complicating the situation.