ECB Balance Sheet Shrinks to 11-Month Low as Banks Repay Loans

The European Central Bank’s balance sheet shrank to the smallest in almost a year after euro-area banks started to repay emergency ECB loans.

The balance sheet dropped 159.1 billion ($215.1 billion) to 2.77 trillion euros in the week ended Feb. 1, the Frankfurt-based ECB said in a statement today. That’s the lowest level since Feb. 24 last year. ECB lending to banks declined 140.8 billion to 1.02 trillion.

The ECB’s balance sheet is shrinking just as the Federal Reserve and Bank of Japan expand theirs through further monetary stimulus. That’s pushing the euro higher, threatening to undermine European exports and a recovery from recession. The single currency has gained more than 3.5 percent against the dollar since Jan. 9 to as high as $1.3568 today.

Investor confidence has improved since ECB President Mario Draghi pledged in July last year to do whatever it takes to safeguard the euro and as signs emerge that the worst of the sovereign debt crisis may have passed.

Banks last week started repaying the three-year loans that the ECB offered them a year ago to prevent a credit crunch. Some 278 banks used the first early-repayment opportunity to return 137.2 billion euros.

‘Stronger Position’

“Banks are in a stronger position now and don’t need the ECB as much any more,” said Richard Barwell, senior European economist at Royal Bank of Scotland Plc in London. “The loan repayment and the subsequent shrinking of the ECB balance sheet are more signs that the financial system is healing.”

The ECB’s balance sheet is still bigger than the Fed’s $3 trillion and eclipses the 2.6 trillion-euro gross domestic product of Germany, Europe’s largest economy.

The balance sheet records all the assets and liabilities on the books of the ECB and the 17 national central banks of the euro area that conduct market operations on its behalf. It swelled to more than 3 trillion euros in March last year following the ECB’s second three-year loan to banks.

While those operations have “proven to be very powerful,” they aren’t “free of pitfalls,” ECB Executive Board member Peter Praet said last week.

“The use of refinancing operations with a very long maturity results in an immediate expansion of the balance sheet when implemented” and “such an expansion is not without challenges for central bank communication and for managing inflation expectations,” he said.

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