German BC warns that losses on bond purchases will wipe out reserves – 03/01/2023 – Market

The Bundesbank, Germany’s central bank, took a 1 billion euro hit to its substantial bond holdings and warned that future losses would wipe out its remaining financial reserves, as the German central bank grapples with the impact of higher interest rates.

Joachim Nagel, president of the Bundesbank, told a news conference held to present its annual report in Frankfurt on Wednesday that the damage was “ultimately the result of the extraordinarily expansive monetary policy of recent years”.

The Bundesbank has bought €1 trillion of mostly German government debt since 2015 as part of the European Central Bank’s bond-buying programs, which Nagel’s predecessor Jens Weidmann repeatedly voted against.

The scale of the central bank’s purchases has driven up bond prices, meaning many of them yield negative rates. Those negative rates — and the ECB’s recent wave of rate hikes — mean the bank is being squeezed by the widening gap between the interest it pays commercial banks on its deposits and what it earns on the bonds.

The Bundesbank absorbed last year’s deficit of 1 billion euros using cash reserves from previous years.

Expected losses in future years will “probably” exceed the remaining 19.2 billion euros in provisions and 2.5 billion euros in capital. The bank plans to delay the impact on its earnings, carrying forward losses to be offset by future earnings.

Daniel Gros, a researcher at the Center for European Policy Studies, estimated that the German central bank will suffer losses of 193 billion euros on its investments in government bonds over the next decade, more than any other national central bank in the euro zone.

Analysts have warned that years of successive losses could undermine the Bundesbank’s hard-earned credibility.

“Public criticism will increase,” said Ulrike Neyer, professor of monetary economics at the Heinrich Heine University of Düsseldorf. “First, because there will be no payments to the government. Second, because people will be able to claim that central bank independence is at risk. However, I think this criticism is not fully justified.”

A legal challenge against the bond purchases is still pending in Germany’s constitutional court.

“Inflation and future depreciation losses arising from the ECB’s monetary policy – adopted in violation of its mandate – will be the nail in the coffin of Europe’s prosperity and the end of the euro,” said Alice Weidel, a leader of the right-wing party. Alternative for Germany (AfD), eurosceptic. “And no one can say they weren’t warned.”

Nagel played down the losses, saying the Bundesbank could “handle” them. “The difficulties will pass, and then we will start to profit again.”

He added that while the Bundesbank’s balance sheet is “solid” and does not require a capital injection, the deterioration in its financial performance will have a knock-on effect on German government revenues.

Over the past decade, the central bank has distributed more than €22 billion of its profits to the government.

The lack of dividends from the Bundesbank comes as Berlin’s finances are also under pressure from rising interest rates.

German Finance Minister Christian Lindner warned this week that the annual interest paid by the country on its debt had increased tenfold in two years – from 4 billion euros to 40 billion euros. “It’s money that can’t be spent elsewhere,” he told German tabloid Bild Zeitung.

“German finance ministers have long profited from cheap interest rates,” said Frank Schäffler, a lawmaker from the pro-business FDP led by Lindner. “Now the boomerang is coming back – not just in terms of massively higher interest costs in the budget, but also in the absence of Bundesbank profits. There is no such thing as a free lunch.”

AfD MP Peter Boehringer, former head of the Bundestag budget committee, said: “The AfD has long been critical of the fact that a non-independent Bundesbank has become a pawn of others’ interests, and we therefore demand that Germany withdraw from the Eurosystem”.

Most analysts think the deficits shouldn’t matter.

“Profits are always better than losses,” said Jörg Krämer, chief economist at Commerzbank. “But several previous central bankers have made it clear that they could even operate at negative equity as long as their credibility with the public was intact.”

Translated by Luiz Roberto M. Gonçalves