The Eurosystem’s balance sheet is expected to contract significantly over the next two years as the European Central Bank (ECB) continues its quantitative tightening (QT) strategy, says a report by Bank of America Global Research published on 16 April 2025. The report’s lead author and Bank of America rates strategist, Ronald Man, forecast that ECB’s balance sheet will decline from €6.4trn at the end of 2024 to €6.0trn by the end of 2025, and further to €5.7trn by the end of 2026--an 11% drop. As a share of GDP, this equates to a decrease from 42% to 38% and then to 36%, respectively. This reduction is expected to limit the ECB’s financial capacity and may hinder its ability to respond to economic fluctuations.
Excess liquidity
Excess liquidity in the euro area banking system--defined as the current account balance plus the deposit facility balance, minus minimum reserve requirements and the marginal lending facility balance--is forecast to decline from €2.8trn at the end of 2024 to €2.5trn by the end of 2025 and €2.2trn by the end of 2026. This represents a 21% decline over the two-year period and could lead to higher borrowing costs for both banks and businesses, impacting overall credit conditions.
Man anticipated an increase in reserve demand across the euro area, particularly in countries like Italy, where banking systems are expected to raise reserves before the end of 2025. This is likely to increase borrowing costs in both the secured and unsecured markets. The report concluded that banks would increasingly rely on central bank funding as their reserves decline and market rates rise. This may further raise the cost of borrowing and impact liquidity in the financial system.
Quantitative tightening
The report noted that the ECB stopped reinvestments in its asset purchase programme (APP) and pandemic emergency purchase programme (Pepp) portfolios in July 2023 and January 2025, respectively. Based on the ECB’s redemption profiles, Man estimated monthly reductions of approximately €30bn in APP holdings and €15bn in Pepp holdings, with this trend expected to continue.
Man assessed the likelihood of active QT--defined as selling assets before maturity--as low due to the risks of realised losses and already high levels of net bond supply. However, he identified risks of slower QT, which could arise from the activation of the transmission protection instrument (TPI), weaker-than-expected growth or inflation, or the potential return of quantitative easing (QE). Whilst the likelihood of QE was considered low, Man did not rule it out entirely, citing persistent weak aggregate demand. The ECB, however, reiterated in March 2025 that its mandate did not include financing defence and infrastructure spending.
Man also did not dismiss the possibility of the ECB initiating a structural bond portfolio, which could increase the balance sheet, but he did not expect sustainable growth in the balance sheet in the near future.
Lending operations and central bank funding
Demand for reserves related to the liquidity coverage ratio (LCR) was estimated at €1.7trn to €2.8trn. Bank of America projected a gradual increase in the take-up of the main refinancing operations (MRO) and longer-term refinancing operations (LTRO), reaching approximately €70bn by the end of 2025, €350bn by the end of 2026, and €720bn by the end of 2027. Initially, this increase was expected to reflect reserve redistribution, reduced bank appetite for holding reserves in high-quality liquid assets, and the stigma associated with using ECB open market operations.
Take-up projections were based on country-specific estimates of reserve shortfalls, assuming that banks would cover about 50% of their shortfall via central bank funding. As the ECB’s QT programme progresses and competition for remaining reserves intensifies, reliance on central bank funding is expected to increase.
The report outlined risks to these estimates: take-up could exceed forecasts if banks require more reserves than expected, if reserve redistribution is slower, or if QT progresses faster. Conversely, take-up might be lower due to continued stigma, efficient cross-border flows, or if QE is restarted.
Structural longer-term refinancing operations could be introduced once the balance sheet resumes durable growth. However, Bank of America’s Man did not expect these to be designed in a way that would make the ECB a lender of first resort.
Currency and reserve requirements
Bank of America assumed that the euro currency in circulation--coins and banknotes--would grow at a rate of 0.1% per month, thereby reducing excess liquidity. However, this would not affect the overall size of the Eurosystem’s balance sheet, as it would represent a liability-side shift.
No changes were assumed to the minimum reserve requirement of 1%.
Overall, Bank of America strategists pointed out that the ECB’s ongoing monetary tightening strategy could lead to tighter financial conditions, increased borrowing costs and a greater reliance on central bank funding. Furthermore, the EU’s economic growth could be impacted, particularly in countries facing liquidity constraints.