The European Central Bank is relinquishing its role as a reliable buyer of eurozone government bonds. Other market forces have stepped in.

The Eurozone countries' need for money is nearly insatiable due to rising energy prices, inflation relief for citizens, and rising armaments spending resulting from the Ukraine war.

But with the European Central Bank (ECB) tightening its monetary policy in an attempt to tame inflation, an important buyer of the bonds of those countries is falling by the wayside.

ECB's Reduced Balance Sheet

In recent months, the ECB's diminished demand for bonds has been replaced by that from banks. Financial institutions are now among the most important buyers of government bonds of the eurozone, as reported by «Reuters» citing data from the financial data specialists IFR and Refinitiv.

The main demand driver for bonds from banks is rising interest rates since the ECB announced the reduction of its presence in the market. The central bank will soon begin reducing the number of bonds on its 8 trillion euro ($8.5 trillion) balance sheet.

400 Billion More Debt

This year, eurozone countries will take on about 400 billion euros in additional debt, according to estimates, which private buyers will have to take up.

For banks, bond buying has become much more attractive as interest rates have risen, and in n many transactions they are the biggest buyers, the report said, citing bond market specialists. French bank BNP Paribas said it already bought more debt at the beginning of the year than it did all of last year.

Multi-Year Yield Highs

In January last year, yields by volume were negative territory for around half of the euro area government bonds. Since then, bond yields are reaching multi-year highs.

To meet regulatory requirements, banks must hold certain amounts of high-quality liquid assets such as cash or government bonds as a liquidity buffer. In addition, bonds can be used to replace risk-weighted assets. Fixed income is also becoming more attractive because yields are rising relative to swap rates.

The swap rate is the fixed rate investors pay to hedge interest rate risk by receiving floating rate payments. Higher yields thus make hedging costs more palatable.