News & analysis

The euro is among the worst performers in the G10 today, after Germany’s top constitutional court ruled on a suit against the ECB. The German Federal Constitutional Court ruled in a 7-1 decision that the ECB had not violated treaty prohibitions against monetary financing, which were the core of the claim.

However, the judges also issued extraordinary criticism of the ECB, and instructed German instruments of state to cease co-operating with ECB asset purchases within 3 months if the Bank did not offer adequate justification for why the quantitative easing program in question, the PSPP, did not breach treaty requirements for “proportionality”.

The decision is of mixed immediate importance for markets, aside from offering some downside for the euro, but in the medium term has the potential to develop into an existential threat to the Eurozone.

What happened

  • In this instance the GFCC was ruling on the legality of the ECB’s Public Sector Purchase Program in European law. The court ruled the PSPP did not breach treaty prohibitions on monetary financing, but concluded the ECB had not offered sufficient justification for a ruling on the treaty requirement for proportionality.
  • The GFCC acknowledged the primacy of the ECJ, but said that the “incomprehensibility” of the ECB’s justifications meant that it had to conduct its own review of if the PSPP met EU law requirements for “proportionality”. As a result, the PSPP was in violation of European law, as interpreted by the GFCC.
  • Most extraordinarily, the court instructed the Bundesbank to cease participation with the ECB’s PSPP program if adequate justification was not provided within 3 months.
  • Although the ruling clarified that it only applied to the PSPP and not to recent epidemic response measures, the precedent for the PSPP could very clearly threaten the ECB’s larger, more flexible PEPP. ECB policy makers will discuss the ruling on a conference call today, starting at 16:00. Although the ECB certainly seems capable of arguing a case, having done so at the ECJ successfully, the Governing Council may choose to contest the GFCC’s ruling or jurisdiction.

Further thoughts

  • The GFCC has placed itself in direct conflict with the ECJ, which clearly ruled in favor of the ECB. The ECJ has primacy on matters of European law, which the European Union Commission was quick to emphasize in a statement. The GFCC’s contention that the ECB’s explanation was “incomprehensible” and therefore merited an evaluation, risks a constitutional crisis if the matter ends up back at the ECJ.
  • The ECB is certainly capable of mustering an adequate response within three months. The ECB’s arguments on PSPP were found adequate by the ECJ, and the GFCC deferred to the senior court’s ruling on this matter. The ECB is headed up by a lawyer, and it remains likely, in our view, that an adequate response can be offered within 3 months.
  • The fact that the GFCC is claiming jurisdiction to evaluate macro policy balance is controversial and opens up a world of political risk for the Euro. The judgement said that the ECB “fails to conduct the necessary balancing of the monetary policy objective against the economic policy effects arising from the programme”. This is a political and technical question, not a strictly legal question, and may therefore draw political opposition from across the Eurozone.
  • If the GFCC successfully prevents Bundesbank participation in ECB asset purchases, ECB QE as a whole may be compromised. ECB asset purchases as currently designed rely on individual central banks purchasing their own Government’s bonds – if this is disrupted, the ECB may be less able to hold to its capital key requirements. There may be workarounds, such as the ECB buying assets directly, other central banks doing so, or even EU treaty change, but these would risk further legal opposition.
  • As a result, the ECB’s ability to serve as an effective backstop for European financial conditions is seriously threatened. The ECB’s intervention in Eurozone sovereign markets was decisive in improving financial conditions in March and reducing volatility. If a future risk-off shock should develop, participants faith in the ECB’s willingness to intervene will now be subject to heightened uncertainty.

 

EURUSD falls 0.7% on GFCC ruling

 

Author: Ranko Berich, Head of Market Analysis

 

 

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