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The beginning of QE coincided with a major Target-2 trend reversal. In January 2015, the Bundesbank experienced a €50bn increase in Target-2 claims, the biggest single monthly rise since February 2012. Since then, the German central bank’s Target-2 balances have increased constantly, reaching €600bn by January 2016. The Target-2 liabilities of Greece, Italy, Ireland, Portugal and Spain have risen correspondingly, accounting for a combined increase of €183bn Target-2 liabilities until the end of January. This is a sizable number compared to €600bn in total QE purchases up to this point. [...]
There are three possible explanations for the Target-2 resurgence. Bundesbank President Jens Weidmann has pointed out that, under QE, NCBs purchase bonds from foreign as well as domestic holders. [...]
Another reason could be a new wave of capital flight. [...]
Additionally, NCBs may be buying bonds outside the euro area. [...]
For policy-makers, it is worrisome that a substantial amount of liquidity created through QE is not staying in the jurisdiction of the purchasing NCB. Countries with liquidity problems experience a smaller benefit from QE, while countries with excess liquidity are flooded further.
From the point of view of taxpayers in creditor countries, the QE programme implies a higher cost from a potential euro break-up or the exit of individual countries. When Greece was on the brink of euro exit in summer 2015, potential Target-2 losses were certainly on policy-makers’ minds.
Increased Target-2 balances highlight an important aspect of euro area open market operations. Any central bank’s purchases of bonds expand its balance sheet – both assets and liabilities. But in Europe, with free movement of capital, the liabilities can move quickly between several countries’ NCBs – and can easily end up in Germany, the largest creditor. The risk-sharing agreement that was reached before QE started, as a key Bundesbank condition for participation in the arrangement, focused solely on the asset side – and therefore missed a major element of additional risk.
Coinciding with renewed worries in the last few days about possible Greek debt restructuring, the surge in Target-2 imbalances raises fresh doubts about the sustainability of the current structures behind monetary union and highlights the need for reforms.