Explaining the Surge of TARGET2 Liabilities in Italy : Less Simple than the ECB's Narrative

Since August 2014 the Target2 liabilities of the Bank of Italy to the Eurosystem are on an upward trend. From August 2014 to September 2016 they have increased by € 223.7 billion. According to the narrative of the ECB, surging Target2 liabilities of peripheral countries of the euro area would be a purely mechanical consequence of the QE, without implying any distrust of Italian assets among domestic or foreign investors. The central banks of the periphery would massively buy their national government bonds from foreign investors accessing Target2 through central banks of the core of the euro area, like the Bundesbank. These net outflows would mechanically trigger an increase of the Target2 liabilities of the countries of the periphery of the euro area. This explanation is however totally inappropriate for Italy. Indeed this note shows that the bank of Italy has bought government bonds essentially from domestic investors.Clearly these domestic investors have used the proceeds of the sale of their national government bonds to buy foreign assets. There is nothing mechanical here. Domestic investors could have decided to reinvest the proceeds in domestic assets, but they preferred to buy foreign assets. It is simply a part of the massive reallocation of their financial investments which started well before the QE, away from domestic assets and towards foreign assets. The amount of these financial outflows is much higher than the size of the PSPP in the country. The QE just indirectly contributed to this phenomenon. It thus mean that there is a growing distrust of Italian assets among domestic investors. This distrust is probably due to the low growth perspectives of the country. The problems related to its banks have also triggered a decrease of foreign holding of liabilities issued by its banks