The Bundesbank has suffered a €1bn hit from its substantial bond holdings and warned future losses will remove the remaining financial buffer as the German central bank grapples with the impact of higher interest rates.
Joachim Nagel, president of the Bundesbank, told a press conference to present the annual report in Frankfurt on Friday that the damage to the central bank’s earnings was “the result of the extraordinarily expansive monetary policy of the past few years”.
The Bundesbank has bought €1tn of German government debt mostly since 2015 as part of the European Central Bank’s bond-buying program, which Nagel’s predecessor Jens Weidmann repeatedly voted for.
The scale of central bank purchases is driving up bond prices, meaning many are yielding negative rates. That negative rate – and the recent ECB rate hike – means that the bank is burdened by a wide gap between the interest paid to commercial banks on deposits and what they earn on bonds.
The Bundesbank said on Wednesday it had absorbed last year’s shortfall by drawing on buffers set aside in previous years.
However, the bank admitted that expected losses in the coming years would “probably” exceed the remaining €19.2bn of provisions and €2.5bn of capital. It plans to postpone the hit to earnings by carrying forward losses to be balanced with future profits, as the last time the Frankfurt-based institution lost in the 1970s.
Daniel Gros, a fellow at the Center for European Policy Studies think-tank, estimates that the German central bank will suffer losses of €193bn from investments in government bonds over the next decade, more than any other national central bank in the eurozone.
Analysts warned that consecutive years of losses could undermine the Bundesbank’s credibility.
“Public criticism will increase,” said Ulrike Neyer, professor of monetary economics at Düsseldorf’s Heinrich Heine University. “First of all, because there will be no payment [the] government. Second, because one could argue that central bank independence is at risk. However, I think this criticism is not entirely correct.
A legal challenge to the bond purchase is pending in Germany’s constitutional court. Bild recently dubbed ECB president Christine Lagarde “Madame Inflation”, blaming her for being too slow to raise rates in response to record inflation. The German press also portrayed Mario Draghi’s ancestors as vampires and gangsters.
Nagel played down the losses, saying the Bundesbank could “cope” them. “The burden will pass, and then we will be profitable again.”
He added that while the Bundesbank’s balance sheet is “equal” and does not require a capital injection, the decline in financial performance will have an impact on the German government after not paying dividends to Berlin for the third time. consecutive years.
Over the past decade, the central bank has distributed more than €22bn of profits to the government.
The Bundesbank’s dividend shortfall comes as Berlin’s finances are also strained by rising interest rates.
German finance minister Christian Lindner warned this week that the annual interest paid by the country on debt has increased tenfold in two years – from €4bn to €40bn – after the ECB’s decision to stop buying additional bonds and raise interest rates by 3 percentage points. “This is money that cannot be spent elsewhere,” said Bild Zeitung, a German tabloid.
“German finance ministers have long profited from low interest rates,” said Frank Schäffler, an MP from Germany’s Eurosceptic FDP party. “Now the boomerang is coming back – not only in terms of higher interest costs in the budget but also in the absence of Bundesbank profits. There is no such thing as a free lunch.”
Nagel, one of the more hawkish members of the ECB’s rate-setting board, said the German economy would shrink in the first quarter and overall in 2023. But he added that inflation would fall “only gradually” and warned that it was “at the top.” – the increase in average wages will likely be reflected in prices “.
Nagel said interest rates should be “fairly high” and remain there “until we see strong enough evidence in data and projections for inflation to return to the medium-term target of 2 percent”. The ECB has raised rates by 3 percentage points since the summer and is expected to increase borrowing costs by another half point this month.
“To act hesitantly now, to stop early tightening, or even to relax, would be a major mistake,” he said, calling on the ECB to accelerate the shrinking of its balance sheet from the €15bn monthly reduction since March. when this pace was reviewed in July.
Germany’s central bank is not the only one facing tougher times. Several national central banks, including those in the Netherlands and Belgium, have warned governments that they expect significant losses and stopped paying dividends.
The ECB said last week it will not make a profit in 2022 and is canceling its dividend for the first time in 15 years. In January, the Swiss central bank reported an annual loss of SFr132bn ($141bn), mainly due to foreign exchange losses.
Most analysts think that the shortfall is not a problem because central banks do not aim to generate profits and cannot stop when they have the power to print money.
“Profits are always better than losses,” said Jörg Krämer, chief economist at Commerzbank. “But various central bankers have made it clear that they can do with negative equity if their credibility with the public is intact.”
Additional reporting by Guy Chazan in Berlin