The scale of the European Central Bank's next bout of quantitative easing could be limited to less than half of its previous €2.6 trillion program after Germany's outstanding government debt plummeted following years of disciplined spending under Chancellor Angela Merkel.

The ECB is widely expected to announce a new quantitative easing package at its September meeting, in an attempt to reenergize the flagging eurozone economy. But the discrepancy in fiscal policies between more frugal states, such as Germany, and the more spendthrift, such as Italy, means there are differing amounts of paper available to the ECB.

Having talked up the prospects of a return to the asset-purchase program it halted at the end of 2018, the ECB will be hamstrung by the so-called capital key, the mechanism through which the ECB apportions asset purchases by country based on the size of the economy and its population. No more than one-third of a country's eligible securities can be held by the ECB at any time, so that it doesn't become the main creditor of any single nation.

"If the ECB lifted its self-imposed 33% issuer limit to 50%, it could make new net purchases of up to €1.1 trillion before it would face a shortage of German paper," said Florian Hense, European economist at Berenberg Economics.

Italian public debt totaled €2.321 trillion in 2018, of which 84% was outstanding government bonds, according to the Italian Treasury department. The total exceeds the entire debt stock of Germany, a far larger economy, which fell to €2.063 trillion in 2018 from €2.115 trillion in 2017, according to data from the Bundesbank.

The ECB is allowed to buy national government bonds, regional and local government bonds, and commercial bank and corporate bonds with a maturity of between 12 months and 30 years with a remit to reinvest the coupons and the principal when they mature.

"The ECB may struggle to allocate stock purchases equally among eurozone member states as their current practice requires," the economics division of PNC wrote in a report.

PNC expects purchases to restart at the same €30 billion a month level as the first three quarters of 2018 before the ECB tapered them to €15 billion.

Berenberg's Hense predicts the ECB will buy €35 billion of government bonds a month for the first year, and €5 billion in corporate bonds for a total of €40 billion a month.

Running out of German debt

The shortage of German paper available to the ECB may ease if the government bows to pressure and swings open the coffers to help tackle what looks like a looming recession.

Germany's economy shrank by 0.1% in the second quarter as the crucial export sector fell by 1.3% from the previous quarter, hammering manufacturing which recorded a seven-year low PMI of 43.2 in July. The Bundesbank used its monthly update for August to warn the German economy "could continue to decline slightly" in the third quarter, meaning the country enters a technical recession.

The conditions for Germany to tap the debt markets could hardly be more attractive, with even the longest-dated sovereign German bonds — 30 years — yielding negative returns, meaning the government would be effectively paid to borrow.

The 30-year bund was yielding negative 0.22% at about 8.30 a.m. ET, while the 10-year note was at -0.71%.

However, there is entrenched resistance to loosening the fiscal belt even as Germany's debt load shrinks.

The government's structural budget has been in surplus since 2013 and IMF data shows Germany's debt to GDP fell to 59.8% in 2018, down from 63.9% in 2017 — and a recent peak of 81% in 2010. Whereas the IMF outlook suggests Italian debt will rise from 132.1% in 2018 to 138.5% in 2024, German debt will continue to fall, to 43.7% by 2024.

It means Germany is in line with the EU target of 60%, whereas the broader euro area was at 85%. Before it begins splashing the cash, Germany would have to amend the debt brake rule "Schuldenbremse," which limits the expenditure of the federal government and states, has been in the constitution since 2009.

In practice, this means expenditure and revenues should match, with a deficit no larger than 0.35% of GDP.

"There is room for a discretionary fiscal impulse of limited scale but not for a multi-year deficit-financed capex program," according to a research report by Bank of America Merrill Lynch economists Evelyn Herrmann and Ruben Segura-Cayuela. "For a fiscal stimulus within current rules, the outlook has to worsen a lot."

Herrmann and Segura-Cayuela calculate that the federal government could have room for a stimulus of up to 2.6% of GDP (€84 billion) "if the rules were stretched to their maximum." Finance Minister Olaf Scholz has publicly suggested Germany could spend €50 billion should a recession hit.

Without greater issuance of German debt, the ECB's so-called bazooka will not only be limited in how much Germany debt it can buy, which itself may have little effect with yields already below zero, but will hinder its ability to push down yields in other European countries, such as Italy, where there is still room for yields to fall.