Germany's Constitutional Court - sometimes called the Kardinals of Karlsruhe for their colorful garb - stunned markets on Tuesday when it ruled that some actions by the European Central Bank may be unconstitutional, and that unless the ECB can prove that PSPP was "proportional" in the next three months, the Bundesbank should no longer participate on PSPP
In a 7-to-1 ruling, the judges said that the quantitative easing program isn’t backed by European Union treaties. That’s why German authorities acted unconstitutionally by not challenging the €2.7 trillion plan.
The court said the ECB should have discussed a number of factors on how QE may have affected a wide swath of the economy, including shareholders, renters and insurance buyers. Reviewing those issues, and the proportionality of QE, would bring the program into compliance with EU law.
The Court found that the Federal Government and the German Bundestag violated the complainants’ rights under Art. 38(1) first sentence in conjunction with Art. 20(1) and (2), and Art. 79(3) of the Basic Law (Grundgesetz – GG) by failing to take steps challenging that the ECB, in its decisions on the adoption and implementation of the PSPP, neither assessed nor substantiated that the measures provided for in these decisions satisfy the principle of proportionality," a press release read from the court.
"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 are not disproportionate to the economic and fiscal policy effects," the judges said.
The court ruled that Bundesbank will not be allowed to participate in the ECB's QE, called Public Sector Purchase Programme (PSPP), within the next three months "unless the ECB Governing Council adopts a new decision that demonstrates...the PSPP is not disproportionate to the economic and fiscal policy effects."
"The economic policy effects of the PSPP furthermore include its economic and social impact on virtually all citizens, who are at least indirectly affected, inter alia as shareholders, tenants, real estate owners, savers or insurance policy holders. For instance, there are considerable losses for private savings. Moreover, as the PSPP lowers general interest rates, it allows economically unviable companies to stay on the market. Finally, the longer the programme continues and the more its total volume increases, the greater the risk that the Eurosystem becomes dependent on Member State politics as it can no longer simply terminate and undo the programme without jeopardising the stability of the monetary union,"
The courted added: "On the same condition, the Bundesbank must ensure that the bonds already purchased and held in its portfolio are sold based on a — possibly long-term — strategy co-ordinated with the Eurosystem." However, the court also said their decision did not apply to the ECB's latest 750 billion euro pandemic-fighting virus stimulus program to support the regional economy.
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The ruling “only concerns the duty of the ECB to scrutiny its own action under a proportionality guideline and to document that. Thus, the ECB isn’t per se blocked in any way,” said court president Andreas Vosskuhle. “It depends on how the actions are being set up.”
"In short: German Constitutional Court sees no breaching of the prohibition of monetary financing of governments but German government and parliament should have challenged ECB’s decisions," Carsten Brzeski, chief economist at ING Germany, said on Twitter, which is entertaining because if there ever was a time when the ECB is openly engaging in state financing is when it is monetizing debt and funding Eurozone deficits, as it is doing right now.
The ruling deals a blow to the ECB's QE that has kept the euro zone’s economy afloat during several crises and raises the prospect of a new conflict between the ECB and its largest shareholder, Germany whose constitutional court has repeatedly provided drama in the ECB's ongoing monetization of Eurozone debt, an act which is technically forbidden, over the past decade.
In any case, the ruling does not change anything in the short term: The ruling is non-binding on the ECB, only the Bundesbank, and ultimately the ECJ, who have so far been marginally more lenient on these matters, will have the final say. The ECB can still continue with PSPP and PEPP, but now need to provide convincing evidence of proportionality, or become more innovative in relaxing their own self-imposed rules. That said, German politicians and the ECB now have some explaining to do which risks communication errors around EZ solidarity and faith in the ECB as the ultimate backstop for spreads. So while the ruling itself is not a game-changer but does highlight the political difficulties Europe may face as part of their Coronavirus recovery efforts.
While the ruling is unlikely to have an impact on the ECB's QE as it stands now, ING said the decision "could become a real program for the ECB in the next phase of the crisis when the recovery starts."
The judges added the German central bank must also sell the bonds already bought, albeit based “on a – possibly long-term – strategy coordinated with” the rest of the euro zone. German bonds bought under the PSPP were worth 533.9 billion euros at the end of April.
The decision was met with dismay by policymakers, including ECB vice president Vitor Constancio who asked on twitter which law specifically prohibited the ECB's QE:
Balance-sheet size as a monetary policy tool is forbidden by the German Court, based on which law? Or putting it differently: which laws have to be changed to put an end to these lawyers monetary/economic nonsensical views?— Vitor Constâncio (@VMRConstancio) May 5, 2020
Luis Garicano, a Spanish liberal member of the European Parliament, said the ruling posed a threat to the future of pan-European institutions.
“Very worried about the future of Europe post (the verdict). Europe cannot work if national Constitutional Courts decide unilaterally... Expect Hungary´s and Poland´s constitutional court to follow this precedent,” he said in a Twitter posting.
Amassing nearly 3 trillion euros of bonds since 2015, the ECB has long relied on bond purchases to support the economy through crises and a threat of deflation.
Tuesday's ruling dates back three years ago when Germany's top court raised objections to Bundesbank's participation in the PSPP. PSPP was launched in 2015 and accounted for about 25% of the ECB's monthly asset purchases. So far, PSPP purchases have totaled 533.9 billion euros at the end of April.
The lawsuit was filed by a group of businessmen and academics who are frequent critics of the EU. They argued that the ECB is improperly conducting economic policy instead of simply setting monetary policy.
"I assume that the ECB will follow the guidance, albeit without much enthusiasm,” said Joachim Wieland, a law professor at the University of Administrative Sciences, who sees the real challenge in the future relationship between the EU Court of Justice and national courts. “It’s an invitation for other countries to simply ignore decisions that they don’t like.”
The euro tumbled about 80bps against the dollar as the market reviewed the court decision.
The German DAX stock index plunged following the ruling, although it quickly recovered most of its losses.
Italian bonds were hit the hardest on the ruling, with the yield on the 10Y BTP rising 15bps on the day.