The claim by Italy’s new government that the European Central Bank intentionally bought fewer Italian bonds during the country’s tumultuous political negotiations in May is overblown. It rests on the observation that Italian bonds made up their lowest monthly share of total bonds purchased under the ECB’s public sector purchase programme (at 14.9%) since its start in March 2015. May’s figures were more than two percentage points below the share of bonds eligible for purchase according to Italy’s ‘capital key’ – the country’s share in the ECB’s capital.
This must be viewed in context, however. May was the first and only time the ECB (via the Banca d’Italia) has purchased fewer Italian bonds than those allocated by the capital key, determined by each euro area country’s GDP and population. The under-purchase in May amounted to just €208m, out of a total allocation of €3.82bn. In April the ECB over-purchased Italian bonds by €259m, meaning that over the last two months there was a net over-purchase of €51m.
The average monthly deviation from Italy’s capital key since March 2015 is a positive €662m, amounting to total net over-purchases of Italian public sector debt of €25.8bn. The total amount of Italian bonds purchased is almost €345bn, the third highest after Germany and France. Claims that the ECB has applied pressure on Italy for political purposes are unjustified.
On a practical level, the ability of the ECB to coerce euro area members by buying fewer bonds is constrained by a scarcity of eligible assets elsewhere to compensate for smaller purchases of specific countries’ issues. In fact, every country in the euro area except Germany saw a fall in the share of their bonds purchased under the PSPP in May. Shares of bonds purchased for France, the Netherlands and Spain all fell by a similar proportion to Italy.
The significant spike in German bond purchases, which increased to 28.4% of the total from 20% the month before, was largely a result of the need to reinvest a large amount of maturing German debt. In April, German public sector bonds were under-purchased by more than €700m. Compared with a single month of under-purchases of Italian debt, Germany has faced six occasions of under-purchases under the PSPP.
The reinvestment issue is likely to become more pronounced. Germany has been buying shorter-dated bonds under the PSPP since January 2017 when the rules were changed to include assets with yields below the deposit facility rate of minus 0.4%. Since then the weighted average maturity of German PSPP bonds has fallen to below 6.4 years, a reduction of 1.8 years – the largest decline for any country. With cumulative German purchases of €486bn to date, substantial reinvestment will be needed over the coming year.
This issue is made more complex still by a long-running challenge at the German constitutional court, brought by claimants who are questioning the legality of the ECB’s bond purchase programme. The case is the subject of a public hearing at the European Court of Justice in Luxembourg on 10 July, following the constitutional court’s dispatch to Luxembourg of five toughly worded questions on the case in July 2017.
A definitive statement by the ECJ may not come before quantitative easing finishes, probably at the end of the year. But statements made to the media on 10 July, by the plaintiffs and others, could have an effect on markets. Moreover, the German constitutional court, in its 2017 request for guidance from the ECJ, used much more stringent language than in previous similar court cases. The ECJ faces more difficulties than in the past in convincing the German court that the ECB’s programme does not infringe the German constitution by burdening Berlin’s budget with unacceptable risks.
Observers will be watching for any sign that the ECJ’s ruling may concede the possibility that, in some cases, risk-sharing in the event of a default on a large country’s public debt would infringe upon various ECB legal rules. This could undermine safeguards negotiated to protect creditor country central banks and national governments from losses at debtor country central banks.
One possible judicial outcome would be to make any further Deutsche Bundesbank bond purchases subject to parliamentary scrutiny – which could be interpreted as constraining central banking independence. Such a ruling could reduce Bundesbank reinvestment in maturing German bonds in coming years. This could have a more disruptive market impact than the end of net purchases. It could also exclude the Bundesbank’s participation in future QE.
With QE becoming more politicised, public disagreements between Berlin and Rome could escalate, rattling markets. As evidenced this week, politicians close to the new Italian government are not shy of blaming the ECB for perceived unfairness. Disagreements on euro area bond purchases are likely to grow.
Ben Robinson is Deputy Head of Research at OMFIF.