Is ECB QE Illegal? Asking For Germany

A top German court dealt the ECB’s “Whatever it takes” mantra something of a legal setback on Tuesday, delivering an ultimatum in the process: Fix it within three months or the Bundesbank has to stop buying bonds under the program.

“The Bundesbank may thus no longer participate in the implementation and execution of the ECB decisions at issue, unless the ECB Governing Council adopts a new decision that demonstrates… the PSPP (transactions) are not disproportionate to the economic and fiscal policy effects”, the court said.

At issue are purported risks to German state finances and the usual concerns about perpetuating zombie companies and endangering private savings. The court did say the asset purchases do not amount to direct government financing, though.

For now, this is seen more as an irritant (and a particularly ill-timed one at that) than anything else, but it does open the door to a potentially perilous situation where the Bundesbank would become an active seller, although as part of “a long-term strategy coordinated with” other eurozone countries.

Some analysts say it won’t be difficult for the ECB to satisfy the judges’ demands. “With its armada of specialists, it will be easy for the ECB to carry out such a check”, Commerzbank said. “The ECB’s bond purchases will continue. Today’s ruling won’t change that”.

Total APP purchases in April were €38.49 billion, with around 77% of that attributable to PSPP. As Morgan Stanley notes, “the total proportion of public sector purchases in the first six months of the APP is at 69.7%, compared to comfortably above 80% in prior APP programs”.

“An optimistic interpretation could be this is lots of barking without biting and that everything is fine as long as the ECB demonstrates that it has thought through the economic consequences of its decisions”, ING remarked, in the wake of the ruling. “But a pessimistic interpretation could be no amount of additional ECB analysis will convince German judges and could therefore spell the end of QE”.

I’d be inclined to call that pessimistic interpretation wholly unrealistic.

One problem with the court decision is that it could open the door to similar rulings from courts in countries that are similarly inclined. That, in turn, could further imperil European unity at a particularly delicate juncture.

Importantly, this is a long-running saga and doesn’t apply to the recently instituted pandemic purchase program, or “PEPP”, which has firepower of €750 billion, and is the ECB’s flagship virus response mechanism.

PEPP purchases have dominated the buying over the past several weeks, and just about the last thing Europe needs at a time when the fiscal response to the epidemic is still hampered by fractious politics across locales, is for the ECB to be constrained in its capacity to act.

“[Tuesday’s] decision did not concern the recent PEPP to tackle the COVID-19 crisis”, ING went on to say, in their quick take on the German court ruling. “Some might see it as an attempt to also hit PEPP but at the same time, the proportionality of PEPP in the midst of severe economic crisis will probably be less contested than QE”.

Danske notes that the latest update to PSPP purchases shows “a significant overweight towards Italy, while there was a significant underweight in buying Germany”. The visuals below give you a sense of the breakdown.

(Morgan Stanley)

The implication, Danske writes, is that the ECB is “spending a lot of money through the PSPP and PEPP supporting the market [and] given the significant deviation in the PSPP purchases and the flexibility of the PEPP purchases, this should provide more support for the periphery”.

It should. But not if the programs are undermined by legal challenges, hence Tuesday’s weakness in Italian bonds. The BTP-bund spread widened by another 10bps at one juncture to 243.

Italy’s yield premium to Germany has widened for three months running, and the way things are going so far in May, it’ll be four.

For his part, German Finance Minister Olaf Scholz said the court decision “essentially” backs the ECB’s purchase program, and noted that Germany will find a way to ensure that what needs doing gets done across the bloc.

Meanwhile, Italian Finance Minister Roberto Gualtieri said simply “the ruling won’t affect ECB bond buying”.


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