Dhe rising interest rates are also causing economic problems for the central banks themselves. Commerzbank has examined this more closely and warns: “The central banks are threatened with losses with the rise in interest rates – this can lead to payments to the finance ministries drying up or even being reversed,” says Christoph Rieger, head of interest rate and credit research the bank.
The reason: many central banks built up huge stocks of bonds during the pandemic and in the years before. “The central banks paid for these by crediting the equivalent value of the bonds to their central bank accounts,” says Rieger.
As long as the key interest rate for these deposits was 0 percent or even negative, the central banks could finance their bonds without any problems: “That changes with rising key interest rates.”
Consequences of rising interest rates for central banks
The problem: “Many central banks now have bonds with very low, sometimes even negative yields on their balance sheets,” says Rieger. On the other side of the balance sheet would be bank deposits, which would have to bear higher and higher interest rates.
The ECB’s interest rate for such deposits, for example, was just minus 0.5 percent, now it’s plus 1.5 percent – and possibly soon 2 or 3 percent. “This leads to negative interest income for the central banks – and due to the volume of bond purchases, the interest losses are also significant.”
This can be observed week after week at the US Federal Reserve. “The distribution of surpluses to the Ministry of Finance has fallen well below zero since the end of September,” says Rieger. According to the rules in America, no reverse payments are due from the Treasury to the Federal Reserve. The Fed’s transfers to the state budget would probably be suspended for at least three years.
The effects of the phenomenon are particularly strong in Great Britain, says Rieger. There, the central bank worked with a special purpose vehicle when buying bonds. So far, the Ministry of Finance has received regular distributions. “It’s reversed there, for the near future quarterly reverse payments are to be expected, from the Treasury to the Bank of England, i.e. from the state budget to the central bank.”
In the current fiscal year, these payments are expected to total more than £11 billion. That was one of the reasons for the turbulence in Great Britain recently.
Profit warnings to finance ministers
“Similar losses will occur at the European Central Bank,” says Rieger. “She wanted to help the states and bought up a lot of bonds, especially during the pandemic, even though their yields were very low.” She paid for the bonds with money she created herself: she credited the banks with the equivalent value of the bonds in their central bank accounts. The interest rate for such deposits was negative until July, and the ECB made money from the financing. In the meantime, the ECB has had to raise its key interest rates because of inflation – and financing costs are likely to rise further next year.
The bulk of the losses are incurred by the national central banks of the individual euro states. The extent to which the individual central banks have made provisions for this varies, says Rieger: “It can be expected that payments from the central banks to the finance ministries in the euro area will now largely dry up – if that has not already happened.”
Some central banks have informed their finance ministers that the corresponding announcements can be described as a kind of profit warning: “That just happened in the Netherlands and Belgium,” says Rieger.
The main difficulties of the central banks lie in the fact that they did not finance the purchase of the bonds with matching maturities, but with variable interest rates. “What happened at the central banks could be called a ‘fixed-to-floating swap’,” says the bond specialist. The central banks would have made a kind of variable-interest bond (floater) out of the fixed-interest government bonds (fixed coupon) in a swap, so to speak, namely bank deposits, which bear interest at the respective ECB deposit rate. The ECB can set this itself, but has to raise it because of inflation. “In times of rising interest rates, this tends to be a losing proposition for the central banks.”
The next step for the central banks is now to reduce their bond holdings. The Bank of England is already selling bonds before the end of the term and in some cases has to realize high losses. The Fed and the ECB have not said so far that they want to sell bonds before maturity, says Rieger: “If you hold them to maturity, there will be no additional losses – only during the term through a yield below that of the Central bank interest to be paid on bank deposits on the other side of the central bank balance sheet.”
