Target 2: Don’t Panic

by Robert Sierra - 22 September 2016

It is extremely appealing to be able to look at a single chart to know whether the grand European project is succeeding or failing. For many, that chart shows the Target 2 balances for Germany versus Italy and Spain, pictured below. However, since the ECB began its sizeable asset purchase programme last year, the interpretation of the Target 2 balances has become clouded. The chart speaks of disintegration and panic, but the reality is otherwise. 
During the financial and sovereign debt crisis, Target balances (which stands for Trans-European Automated Real-time Gross Settlement Express Transfer System) rose sharply within the Euro area as a result of rising fragmentation and financial market stress. Today, those same balances are diverging once again but the explanation of the divergence is less of a concern, as we highlighted in our Research Digest publication in May 2016.
The story runs as follows: in the run up to mid-2012, central banks in the periphery were lending to commercial banks in their own countries and those banks were then using that money to repay debts to banks in the core.  Since the ECB started its Asset Purchase Programme (APP) last year, national central banks have once again creating money, but this time they are not crediting banks' own accounts but rather crediting the bank accounts of the holders of the bonds they are purchasing. This time round, it is the location of those bank accounts that is responsible for the imbalance.
As influential ECB executive board member, Peter Praet, commented in a recent speech (link), “As around 80% of Eurosystem asset purchases by volume have been carried out through non-domestic counterparties, cross border flows of central bank money are happening on a large scale as a direct result of APP”. According to ECB staff estimates, some 60% of purchases by volume under APP have been made from counterparties that participate in Target 2 via Germany, while only around 5% have been made from counterparties that participate via Spain. As the chart shows, since the start of 2015 Germany’s Target claim has increased by close to €140bn while Spain and Italy have seen their liabilities rise (shown as a decline in the chart) by €102bn and €92bn, respectively.
As the ECB continues to buy up assets until March 2017 and possibly beyond, central bankers expect this monetary injection to reduce financial market fragmentation and cement the still modest recovery. In the meantime, expect Target 2 balances to keep on diverging as long as Germany remains the destination of choice. The demise of the Eurosystem must wait for another day.

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