ECB, budget in the red and the rate hike is to blame

The ECB's rate hike hits – and sinks – the central bank's balance sheet, which slips into the red as it hasn't happened for decades.
The Eurotower has posted its first loss in 20 years following an unprecedented rise in borrowing costs to combat inflation.
Central banks around the world have suffered financially from the combined effects of large asset purchase programs conducted when inflation was low and the rapid rise in interest rates after the pandemic.
The deficit for 2023 – even after the total release of €6.6 billion in risk provisions – amounts to €1.27 billion.
Although the ECB warned of negative outcomes “in the coming years”, it said this would not impede its usual operations.
Why the ECB balance sheet slipped into the red The ECB posted a record annual budget hole for 2023 and said further losses were likely as its aggressive interest rate hikes force it to pay billions of euros to banks.
In detail, the loss of around €1.3 billion for 2023 reflects the impact of higher charges paid to national central banks.
The Eurotower would have suffered a much bigger hole in 2023 if it had not drawn on the remaining 6.6 billion euros of provisions accumulated in recent years to cover financial risks.
Higher rates also push up the ECB's net interest expenses, reflecting a sharp rise in what it pays to other national central banks that share the euro, from €900 million in 2022 to €7.2 billion a year last.
“The loss… reflects the role and necessary policy actions of the Eurosystem in fulfilling its primary mandate of maintaining price stability and has no impact on its ability to conduct effective monetary policy,” the statement said.
official.
The ECB said its loss before the provisions was made was 7.9 billion euros, after a deficit of 1.6 billion euros in 2022.
In summary, what happened previously is that the Eurotower it printed money to buy government bonds in the hope that abundant, cheap credit would reignite economic growth and push inflation to 2%.
When interest rates were negative, this meant little cost to the ECB, but it now has to pay a 4% interest rate on funds delivered to lenders.
What does the ECB budget hole mean? The ECB stressed that its financial position remains solid despite last year's loss, with net assets still standing at almost 45 billion euros.
The situation may even improve from here on, as the central bank's balance sheet is shrinking due to the unwinding of past bond purchases.
Interest rate charges, meanwhile, are expected to fall if borrowing costs are reduced in the coming months, as is widely expected.
After the next few years, the ECB is expected to “return to sustained profits”.
Last year's loss "will be carried forward to be offset against future profits", it was stated.
As highlighted by several experts, unlike commercial banks, a central bank can operate with depleted reserves and even negative equity.
However, these losses may raise credibility questions, deprive governments of dividends and could influence an upcoming debate on a new operational framework.
The ECB's worsening financial outlook, for example, had already forced it to give up dividends paid to national central banks last year.
These payments – which amount to €5.8 billion between 2018 and 2022 – are usually transferred from national central banks to eurozone governments.
Furthermore, some policymakers argue that the ECB should remunerate a smaller portion of bank deposits at the 4% deposit rate, thus reducing its spending on interest rates at the expense of bank profits.
However, there would be little monetary policy justification for such a move and the ECB's only mandate is price stability, so a measure to shore up its finances could be legally controversial.
It should also be highlighted that the ECB's balance sheet presents some potential risk, because the value of the bonds held has fallen drastically since their purchase.
However, bonds are held to maturity, mostly with fixed coupons and tend to have long durations and therefore should have less impact on losses.