Interpreting the ECB’s EUR120 billion APP envelope

Amongst the policy innovations introduced last week, the ECB’s new EUR120 billion Asset Purchase Program (APP) envelope was most interesting. The policy statement described: “a temporary envelope of additional net asset purchases of €120 billion until the end of the year, ensuring a strong contribution from the private sector purchase programmes.”
Meanwhile, when asked about the capital key, Lagarde confirmed that: “we will make use of all the flexibilities that are embedded in the framework of the asset purchase programme, and that, second, at the end of the asset purchase programme we will converge towards the capital keys.”

But there has been no technical document describing how this will me managed.
Still, it seems that the EUR120 billion envelope provides more discretion compared with the standard APP, allowing for deviations from capital key. However, by the time APP ends the capital keys will be respected.
To get a handle on the implications of this, take an extreme case. It seems that in principle the EUR120 billion can be used on any single country — except, of course, Greece, which continues to be treated disgracefully.
Suppose then that the entire EUR120 billion is used entirely on Italy — EUR20 billion per month for 6 months. And suppose the standard APP at EUR20 billion per month lasts until end-2021, end-2022, or end-2023 at EUR20 billion per month and is allocated by capital key until December 2020.
Thereafter, standard APP purchases will have to be adjusted for the use of this envelop by Italy so as to “rebalance” back to the capital keys at the end of the program. Indeed, in this thought experiment, from 2021 standard APP would  purchase fewer Italian assets and more assets elsewhere. In fact, in the case where APP ends in 2021 or 2022, The Banca d’Italia would have to”sell” Italian assets to re-balance the remaining APP to meet capital keys. If it were to end in December 2023, then purchases would fall from EUR3.5 per month to less than EUR1 billion for 3 years.
Of course, we don’t know exactly when the standard APP will end. But it implies large purchases of Italy up front will likely require smaller purchases later — it is bringing forward purchases for Italy and others. Since the end of APP cannot be known except with perhaps 6 months notice — if ever — it’s difficult envisage exactly how this will be managed. Perhaps they will agree to end APP with a capital key imbalance that they will slowly resolve during the reinvestment phase.
This is my understanding at this stage.
Anyway, an important technical nuance — tracking this stuff will be extremely important for asset prices in the years ahead.

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