MNI SOURCES: ECB May Sidestep New Capital Key, Ponders Twist

--Fears Using New Capital Key Could Look Like "Punishing Italy"

--Twist-Like Programme Could Boost Longer-Term Debt Buys

     LONDON (MNI) - The European Central Bank could sidestep the politically

charged reshuffling of rules governing its bond purchases, but make the

so-called capital key more flexible as it considers a possible Twist-like

reinvestment of its maturing debt portfolios next year, ECB sources said.

     The key, which caps the ECB's purchases of individual eurozone countries'

sovereign debt according to their contribution to the central bank's capital, is

due for rebalancing, but this would cut Italy's share at a time when the

spending plans of the country's populist government have put its sovereign bond

prices under pressure. MNI reported in September that the political sensitivity

of the capital key decision was likely to delay announcement of its plans for

reinvestment of maturing bonds after the asset purchase programme ends as

anticipated in December, and it now appears the central bank might simply decide

not to apply the new weightings.

     While the updated version of the capital key would not imply big changes in

the amount of different countries' bonds that could be purchased, with

weightings adjusted by no more than a percentage point, the Governing Council

will still probably stick with the old one, "to avoid the impression Italy is

being punished," one ECB source told MNI, in a comment echoed by other officials

at the bank.

     --OPERATION TWIST

     Another ECB source said the key could be followed in a more flexible

manner. While reinvestment would not mimic the Federal Reserve's famous

"Operation Twist", in which it used the proceeds of bill sales to buy

longer-dated bonds, it would have some similar features. The Fed's Twist was

aimed at keeping longer-term interest rates lower to make it easier for

companies and households to borrow.

     "Even though a Fed-style Operation Twist is off the table at the moment and

it's not even being evaluated by the technical committees, there could however

be less rigid restrictions placed on what kind of bonds to be re-purchased -

i.e. whether long, medium or short-term ones," the second source said.

     "The capital key is likely to remain the underlying, generic guideline to

follow, but we could end up having a more lenient approach to it," said the

source. "There could however be less rigid restrictions placed on what kind of

bonds to be re-purchased - i.e. whether long, medium or short-term ones."

     --PROLONGED PERIOD

     The first ECB official said discussion on a Twist-like operation was still

at the working level and a decision on the matter could come in Governing

Council meetings in October or December, as the central bank weighs

uncertainties over Brexit, Italy and emerging-market economies.

     But, if the ECB decides to maintain the maturity profile of its stock of

bonds then longer-dated securities would have to be bought to replace those that

come due, the first source said.

     An ECB spokesman said he had no comment on the capital key or reinvestment.

     Once determined, the shape of the reinvestment programme will have

long-reaching implications.

     "It (reinvestment) is a fundamental element (of monetary policy goals) and

so far, there has been no discussion over its expected duration, which will

stretch over a prolonged period of time," the second ECB source said.

     "The truth is: nobody at present within the ECB has any idea of what 'for

quite a long time' means".

--MNI London Bureau; +44208-865-3829; email: Jason.Webb@marketnews.com

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