August 7, 2017 / 3:49 PM / a year ago

UPDATE 1-ECB stretches bond-buying rules with oversized Italian purchases

* Biggest ever deviation for Italy

* ECB deviation from its capital key:

* (Writes through)

By Francesco Canepa

FRANKFURT, Aug 7 (Reuters) - The European Central Bank bought far more Italian bonds than it was supposed to in July to make up for dwindling opportunities in smaller countries such as Portugal, ECB data showed on Monday.

The data illustrated the ECB is quietly prepared to stretch its rules, including politically sensitive national quotas for bond purchases, if needed to carry out its bond-buying scheme, aimed at supporting inflation in the euro zone.

The so-called capital key rule in theory limits the proportion of a euro zone country’s bonds that the ECB can buy. It was imposed as a way of persuading critics, particularly in Germany, to accept the bond-buy programme whwn it was launched in 2015.

While it was never formally dropped, the ECB has said it would be applied flexibly.

It has been buying more French, Italian and German debt to make up for small purchases in Portugal, Slovakia and Baltic countries, while Greece and Cyprus have been exlcuded from the programme altogether.

It is a hotly debated issue as the ECB prepares to decide whether to extend the 2.3 trillion euros ($2.71 trillion)programme into 2018, with analysts speculating it would have to wind it down, ease the rules or face running out of bonds to buy.

The ECB and Bank of Italy together bought 9.6 billion euros worth of Italian bonds last month, or nearly one and a half billion euros more than the composition of the 60-billion euros monthly purchase would dictate.

This was the biggest deviation from Italy’s quota relative to the size of the overall monthly amount.

Buying of French and Spanish debt were also oversized compared to their shares of the ECB’s capital, the yardstick used to determine how many bonds must be bought.

Given the cloudy inflation outlook, ECB rate setters are reluctant to withdraw their monetary support despite strong economic growth and falling unemployment.

The Frankfurt-based central bank is likely to postpone a decision on the future of its bond-buying programme until October, rate-setters told Reuters after their July 20 policy meeting. ($1 = 0.8482 euros)

Reporting by Francesco Canepa, Graphic by IFR, Editing by Jeremy Gaunt.

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