The Bundesbank has suffered a €1bn hit from its substantial bond holdings and warned future losses would wipe out its remaining financial buffers as the German central bank grapples with the impact of higher interest rates.
Joachim Nagel, Bundesbank president, told a press conference to present its annual report in Frankfurt on Wednesday that the damage to his central bank’s earnings was “ultimately the result of the extraordinarily expansive monetary policy of the past few years”.
The Bundesbank has bought €1tn of mostly German government debt since 2015 as part of the European Central Bank’s bond-buying programmes, which Nagel’s predecessor Jens Weidmann repeatedly voted against.
The scale of the central bank’s purchases pushed up the price of the bonds, meaning many of them yield negative rates. Those negative rates — and the ECB’s recent spate of rate rises — have meant the bank is being squeezed by the growing gap between the interest it pays to commercial banks on their deposits and what it earns on the bonds.
The Bundesbank said on Wednesday it had absorbed last year’s shortfall by drawing on buffers set aside in earlier years.
However, the bank acknowledged that its expected losses in future years would “probably” exceed its remaining €19.2bn of provisions and its €2.5bn of capital. It plans to defer the hit to its earnings by carrying forward the losses to be offset against future profits, as it did the last time the Frankfurt-based institution made a loss in the 1970s.
Daniel Gros, a fellow at the Centre for European Policy Studies think-tank, estimated the German central bank would suffer €193bn of losses on its investments in government bonds over the next decade, more than any other national central bank in the eurozone.
Analysts warn that years of successive losses could dent the Bundesbank’s hard-earned credibility.
“The public criticism will increase,” said Ulrike Neyer, professor of monetary economics at Heinrich Heine University Düsseldorf. “First, because there will be no payments to [the] government. Second, because people may argue that the central bank’s independence is at risk. However, I think this criticism is not totally justified.”
A legal challenge against the bond purchases is still 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 depicted her predecessor Mario Draghi as a vampire and a gangster.
Nagel downplayed the losses, saying the Bundesbank could “cope” with them. “The burdens will pass, after which we will start making profits again.”
He added that, while the Bundesbank’s balance sheet was “solid” and would not require a capital injection, the deterioration of its financial performance will have a knock-on effect on German government revenues after it did not pay a dividend to Berlin for the third consecutive year.
Over the past decade, the central bank has distributed more than €22bn of its profits to the government.
The lack of Bundesbank dividends comes at a time when Berlin’s finances are also under strain from rising interest rates.
German finance minister Christian Lindner warned this week that the annual interest the country paid on its debt had risen tenfold in two years — from €4bn to €40bn — following the ECB’s decision to stop buying extra bonds and to raise interest rates by 3 percentage points. “That is money that cannot be spent elsewhere,” he told Bild Zeitung, the German tabloid.
“German finance ministers profited for a long time from cheap interest rates,” said Frank Schäffler, an MP from Germany’s Eurosceptic FDP party. “Now the boomerang is coming back — not only in terms of massively higher interest costs in the budget but also 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 governing council, said he expected the German economy to shrink in the first quarter and overall in 2023. But he added that inflation would fall “only gradually” and warned that “above-average wage increases are likely to be increasingly reflected in prices”.
Nagel said interest rates needed to be “sufficiently high” and to stay there “until we see strong enough evidence in the data and projections for inflation to return to our 2 per cent medium-term target”. The ECB has raised rates by 3 percentage points since the summer and is expected to increase borrowing costs by a further half-point later this month.
“To act hesitantly now, to end the tightening early, or even to relax it, would be a cardinal mistake,” he said, calling on the ECB to speed up the shrinking of its balance sheet from the €15bn monthly reduction starting in March when this pace is reviewed in July.
The German central bank is not alone in confronting tougher times. Several national central banks, including those in the Netherlands and Belgium, have warned their governments that they expect to make significant losses and to stop paying dividends.
The ECB said last week it made no profits in 2022 and scrapped its dividend for the first time in 15 years. In January, the Swiss central bank reported a record annual loss of SFr132bn ($141bn), mainly caused by foreign exchange losses.
Most analysts think these shortfalls should not matter as central banks do not aim to make profits and cannot go bust 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 rightly made clear in the past that they could even operate at negative equity as long as their credibility with the people is intact.”
Additional reporting by Guy Chazan in Berlin