ECB purchases lead to rising Target2 balances

In recent months, the Target2 balances of the various Eurozone countries have continued to drift apart. Since the start of the year, Bundesbank receivables from the ECB as the central counterparty to the Target2 system have risen by around EUR 61bn to their current level of EUR 856bn (as at July). Germany and, to a much lesser but still significant extent, Luxembourg, Finland and the Netherlands are currently reporting positive Target2 balances. In June, the Target2 receivables of these countries amounted to around EUR 1,186bn, which is only slightly below the previous month’s record level of EUR 1,214bn. In contrast, the central banks of the European periphery, in particular, have accumulated substantial liabilities to the Eurosystem. Italy is currently the leader here in negative terms with a volume totalling EUR 413bn, closely followed by Spain with a negative balance amounting to EUR 371bn.

At the height of the euro debt crisis, rising Target2 balances reflected the fact that, in light of the dwindling inflow of available private capital, the banking sector at the European periphery had become increasingly dependent on central bank liquidity. Against this background, theTarget2 balance development has been a significant crisis indicator for tensions in the European banking system in the past. In the current environment, the aftermath of the banking crisis alone cannot explain the renewed rise in balances. It is evident that, to a large extent, Spanish and Italian commercial banks are parking their liquidity in their own central banks. This contradicts the hypothesis that the current rise in Target2 balances is mainly due to the sustained capital drain from countries at the European periphery. Rather, it can be assumed that there is direct correlation between the current rise in Target2 balances and the ECB’s bond purchase programme which has been running since March 2015. Accordingly, the rise in the positive Target2 balances in Germany, Finland, Luxembourg and the Netherlands is comparatively closely linked to the rise in the ECB’s bond portfolio.

The following example shows one possibility regarding how the bond purchase programme might be contributing to Target2 balances drifting apart: if the Italian central bank acting for the ECB acquires Italian government securities from a German and not an Italian commercial bank, this will have a direct effect on Target2 balances, since central bank liquidity is credited across borders. Consequently, the Bundesbank would record a rising Target2 receivable, while the Italian central bank would post a higher Target2 liability.

Bond purchases by financial institutions located outside the Eurozone are another factor which fundamentally impacts on Target2 balances. In this context, which national central bank the international business partner uses to connect to the Target2 system is decisive when it comes to the Target2 balance development. For example, if the international financial institution has an account with the Bundesbank, bond purchases by other Eurosystem central banks would lead to inflows of funds to the Bundesbank and prompt a rise in its Target2 receivables.

Finally, the uneven distribution of the central bank liquidity pumped into the market by the ECB is reflected in the fact that Target2 balances are drifting apart. This fragmentation between the individual euro countries should, however, be less marked in a currency union. Indications that the European economy is noticeably kicking into gear might lead to renewed confidence in the European periphery on the part of investors. This and the decline in bond purchases by the ECB anticipated for the medium-term could slow or even completely stop Target2 balances from drifting apart.

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