After an initially timid response to the outbreak of COVID-19 in Italy in February 2020, the ECB announced on March 19^th a new 750bn Pandemic Emergency Purchase Programme (PEPP). Differently from the previous rounds of QE, the ECB was very explicit in stating that PEPP would be conducted in a flexible manner that would allow “for fluctuations in the distribution of purchase flows over time, across asset classes and among jurisdictions”. As we enter the eighth month since the Coronavirus pandemic hit European countries, how has the ECB acted so far?

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What stands out at first sight is the fact that Italy’s share in the ECB sovereign purchases carried out under the Public Sector Purchase Programme (PSPP) and the Pandemic Emergency Purchase Programme (PEPP) has risen above 21%, 5.5 percentage points higher than the country’s  adjusted Capital Key share (which we obtain by correcting the official capital keys to exclude non-euro countries and Greece, and by assuming a theorical supranational capital key of 10%, in line with PSPP purchases as of February 2020). Overall, the ECB has bought about 28 bln euros of Italian debt in excess of Italy’s theoretical share, which have been compensated mainly by lower purchases of German, Dutch and Supranational assets. If we rescale deviations as a proportion of each country’s expected share, then Italy, Spain, Belgium and Cyprus emerge as the countries that so far have benefitted most from the ECB’s flexibility – mostly at the expense of small euro countries (penalised by the relatively small size of the latter’s public debt markets).  The proportional deviation for German assets, on the other hand, has been relatively limited to the downside.

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If we compare purchases by breaking it down into the two different quantitative easing programs (PSPP and PEPP), most of the imbalance actually seem to come from the PSPP, which displays a strong overweighting of Italian and French bonds in recent months, whereas German bonds have been purchased only in half the amount that should have been expected if the ECB had adhered strictly to the capital keys. Despite having been marketed as a more flexible programme in inspiration, PEPP has been so far much more balanced – although even here a bias toward Italian assets can be detected. Since PEPP outweighs PSPP in terms of size by a factor of about 2.5 in the time span we consider, the overall PSPP+PEPP portfolio is geographically less unbalanced than the PSPP holdings alone would suggest. Such discrepancy between the two programs is likely due to timing reasons: PEPP was only initiated on March 24th, at a time where those countries that had been hit first, particularly Italy, had already enacted lockdown measures and were already facing harsh economic conditions and the risk of stress on the debt markets, while others had not seen any large outbreaks yet. In this context, the ECB naturally had to rely on instruments already in place. Moreover, in view of the size of PEPP purchases and of the German Constitutional Court’s challenge to the previous PSPP programme, the ECB might have opted for caution on the geographical flexibility deployed in the early PEPP phase to avoid exposing itself to the risk of a legal challenge on the grounds of monetary financing.

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The strong geographical bias in the early phase of 2020 QE seems to have been therefore largely a frontloading of purchases to the benefit of those countries that had been disproportionately hit. During the months from March to May the deviation has been particularly striking, with Italian assets overpurchased by more than 40% and Spanish ones by 20%, while French and German ones have been underpurchased by about 15%. As lockdowns started to be eased, so has the geographical bias in the ECB purchases, which however has not been fully reversed (Figure 3). Again, Italy is the country that appears to be benefitting the most of the ECB’s flexibility. To date, even as the health situation in Italy has improved to the point of becoming better than in the majority of the neighbouring countries, the ECB is still overweighting by ~20% Italian debt in its purchases, while the bias in Spanish purchases has been reabsorbed. The under-weight position on French assets kept during the early months of the pandemics has also been corrected, whereas Germany remains under-represented in the ECB purchase portfolio by around ~10%. This suggests that the ECB is being cautious in re-normalising the geographical composition of its intervention and its action has become more need-based, including by accepting sizable geographical imbalances in the composition of its purchases for a relatively long period of time. While this may expose the ECB to further legal challenges in some corners of the Union, it will benefit the European recovery at a time when pre-existing asymmetric macroeconomic conditions risk jeopardising the economic response to COVID-19.