This morning, the Bank of Italy reported that Italy’s Target 2 deficit rose to new highs in March at €420bn, from €386bn in February. As a way of comparison, during the peak of the EU Sovereign crisis in 2012 crisis, Italy’s liabilities stood at Eur 290bn. 

As Francesco Filia of Fasanara Capital notes, while we are told that record T2 balances are pure accounting values and should be viewed as a benign by-product of the decentralized implementation of the asset purchase program (APP) rather than renewed capital flight, and while Draghi refers to them as a form of solidarity within the European system, in a letter to Italian EU politicians Draghi also maintained that such debts should be settled in full should Italy decide to leave the euro. So, the number matters and represents a liability.

Target II liabilities are now above 25% of GDP In Italy (from 22% in January), and above 30% of GDP in Spain. 

Similarly to what happened in 2012, it is imaginable for Germany to soon start to feel uncomfortable with such levels of exposure and demand more vocally a reversal of the trend. At the time, it sufficed for Draghi to cheap talk about the ‘irreversibility’ of the EUR for the trend to reverse. In contrast, this time around, the ECB is tapering, on the presumption of economic growth to take firm hold, and on evidence of inflation having resurfaced. Tapering can be seen as a way to reverse those Target II flows, or at least prevent them from rising further. Incidentally, tapering is today also needed to prevent too heavy a tax on German savers/electorate, as they are hit hard by negative real rates, now that inflation spiked up for the first time in a while: with inflation at 1.9% and short-term rates at almost -1%, real rates are negative by 2% to 3%, and the German electorate is paying for the EMU party more than ever before.

It should also be said that Target II deficit should be seen as one of the components of country risk, not the only one or the most relevant one. Take the case of Italy, for example, where the Target 2 euro system exposure at €420bn is to be added to BTP owned by foreigners (approx. €710bn at the end of 2016), funding (non-financial deposits and interbank funding) for Italian banks (in excess of €350BN), financing to Italian companies made by foreigners (€700bn+). On the side of public debt alone, Italy spends 5% of GDP in interest payments alone.