By Francesco Canepa
PRAGUE (Reuters) - European Central Bank policymakers are likely to kick off a debate next month about whittling down the Bank's 4-trillion-euro bond pile, four sources told Reuters, with some hoping for a decision in December on what they see as the next step in their fight against runaway inflation.
The move, known as quantitative tightening, would impact euro zone bond markets that have relied on the ECB as a major buyer for years, likely pushing up borrowing costs for governments and firms.
The euro zone's central bank raised rates by an unprecedented 75 basis points on Thursday and promised several more hikes in the coming months to tackle euro zone inflation at its highest in nearly a half a century despite a looming recession.
Policymakers will now start discussing when to start unwinding the massive bond purchases they made in the past decade, when they were trying to raise an inflation rate that was then low, the sources said, asking not to be named because such deliberations are private.
They added the discussion was likely to start informally at a meeting of the ECB's Governing Council in Cyprus on Oct 5 and continue at a policy meeting in Frankfurt three weeks later.
Some rate-setters hoped for a decision by the end of the year although others were in no rush and saw interest rates as the ECB's main policy lever for now, the sources said.
"The Governing Council has not discussed either the substance or the timing of any future quantitative tightening," an ECB spokesman said in response to a request for comment.
The ECB has long said it will keep reinvesting proceeds from its 3 trillion euros ($3.01 trillion) Asset Purchase programme "for an extended period of time" after its first rate hike, which happened in July, and "for as long as necessary to maintain ample liquidity conditions and an appropriate monetary policy stance".
The ECB has also pledged to replace bonds that expire under its 1.7 trillion euro Pandemic Emergency Purchase Programme until at least the end of 2024, something that a source said was unlikely to change.
Some ECB governors thought letting APP bonds mature would be the logical next step and could go some way in reducing excess cash in the banking system, on much of which the ECB and the other central banks of the eurozone are now paying a 0.75% interest rate, the sources said.
It could also make room for any emergency purchase under the ECB's Transmission Protection Scheme, which is aimed at keeping financing costs in check for weaker countries such as Italy and Greece, they added.
But others feared that long-term rates would rise too fast if the ECB stopped APP reinvestments and feared about the side effects on market liquidity, the sources said.
A paper presented at the Fed's Jackson Hole Economic Symposium last month argued that copious asset purchases left the financial sector more sensitive to liquidity shocks when the Fed shrank its balance sheet in 2018.
The Fed began reducing its bond holdings in June and this so called quantitative tightening will pick up steam this month when the monthly reduction target doubles to $95 billion.
($1 = 0.9953 euros)
(Additional reporting by Balazs Koranyi and Lindsay Dunsmuir; Editing by Frank Jack Daniel)