Super Mario

Italy's Shrinking Safety Net

The ECB's bond squeeze leaves the country with a smaller safety net.
Photographer: Krisztian Bocsi/Bloomberg

One of Mario Draghi's hands is being tied behind his back just as bond markets may need his help the most.

Data released by the European Central Bank this week show the ECB president will have reduced scope to buy Italian bonds if markets start convulsing ahead of the country's general election in the spring.

From January, the ECB's Quantitative Easing program will pare its monthly bond purchases by 50 percent to 30 billion euros ($35 billion). Draghi has sought to soften this so-called tapering by emphasizing how the ECB can reinvest maturing bonds to pick up the shortfall.

There's a hitch -- the central bank said it intends only to reinvest proceeds from maturing bonds in debt of the same country. That leaves Draghi with only limited flexibility to use his buying power to the benefit of one country over another.

Monday's release showed that proceeds from these maturing securities, which could then fund further purchases of government bonds, will only be about 8.5 billion euros, less than analyst expectations of as much as 12 billion euros. This means the pace of bond purchases under the QE program will fall by about a third from this year's rate of 60 billion euros a month. 

ECB QE Reinvestments

The weighting of the ECB reinvestment program is skewed towards later in 2018

Source: ECB, graphic by Bloomberg Gadfly

The first quarter will be noticeably lighter in monthly redemptions compared with the rest of 2018. The big months for Italian redemptions won't come until April and October.

The ECB has already spent most of 2017 buying more Italian bonds than the capital key, a formula that determines how much of each nation's debt the central bank can buy, would suggest. That variation is allowable -- but it leaves little extra available slack to cut Italy.

Capital Key Divergence

France and Italy have gained the most from variance from the capital key formula

Source: ECB, graphic by Bloomberg Gadfly

The fragmented nature of Italian politics means the election, expected to be held in March, has the capacity to rattle markets. Yields on the country's bonds have dropped 50 basis points in the past month as the ECB managed the QE taper successfully and political fears subsided.

No Room for Error

Italian yields have fallen in recent weeks

Source: Bloomberg

The populist anti-euro Five Star movement is slightly ahead in the polls in what is essentially a three-way split. Recent electoral rule changes may have reduced the prospect of it forming a government, as it eschews coalitions with other parties -- but that isn't the only concern.

The current government is a center-left coalition but center-right parties have been making headway. Last weekend's regional elections in Sicily saw the center-right prevail, which boosted the standing of Silvio Berlusconi's Forza Italia party. The prospect of the former premier returning to, or even near, power could roil Italian markets.

Draghi's toolbox has been downsized. Investors can't say they weren't given fair warning. Their only consolation: his ability to pull a surprise at the very last moment.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Marcus Ashworth in London at

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    Edward Evans at

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