ECB Must Justify QE Bond Purchase Program, German Judges Rule

(Bloomberg) -- The European Central Bank can continue its bond purchases, but will have to justify its policies within three months after Germany's top court expressed a number of concerns with the program.

The judges' critical language sets a hurdle for the ECB's crisis-fighting, though the ultimate impact may be muted. The new 750 billion-euro ($813 billion) Pandemic Emergency Purchase Program, a response to the coronavirus outbreak, isn't covered by the ruling.

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 euro plan.

The ECB's controversial asset-purchase program has been a concern for the German court since 2015, when the case was filed. In 2017, the judges asked the EU Court of Justice for an interim ruling aimed at limiting the ECB's leeway, but the EU tribunal rejected the restrictive reading of the law suggested by their German counterparts.

“After today's ruling, it is clear that the Eurozone cannot continue to muddle through with creative interpretation of EU law by the European Central Bank,” said Stanislas Jourdan, executive director of Positive Money Europe said. He suggested changes to EU laws to allow the ECB “to use its money creation power to serve the public good, so these toxic legal complaints can be put to an end for good.”

PEPP Unthreatened

Juan-Carlos Gonzalez, head of ECB's press service, said the court doesn't comment on rulings by judges at the national level. A Bundesbank spokesman declined to immediately comment.

The euro bore the brunt of the uncertainty in markets created by the ruling, sliding as much as 0.7% to $1.0826, the lowest level this month. Italian bonds led declines in Europe, with 10-year yields climbing seven basis points to 1.83%, while German government securities also fell on the prospect the Bundesbank's purchases could be restricted in the future.

“This verdict is exciting in the way that ECB has to deliver an explanation on disproportional action within three months, which I believe is impossible,” said Uwe Maderer, head of Fixed Income at LBBW Asset Management. “I don't know what the ECB is expected to do or say here or how to change the program. One could now say this is bad for bunds but it actually poses an increased risk for a euro break-up which is barely priced into markets.”

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, could bring the program into compliance with EU law.

The ruling “only concerns the duty of the ECB to scrutinize its own action under a proportionality guideline and to document that. Thus, the ECB isn't per se blocked in any way,” court president Andreas Vosskuhle said. “It depends on how the actions are being set up.”

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.

“The ECB wrote out checks that now are no longer valid,” said Peter Gauweiler, a former lawmaker and one of the plaintiffs in the case. “Instead of deciding behind closed door, the ECB now must explain in writing and for us all to see how its makes its decision.”

The ECB intensified its response as shutdowns because of Covid-19 pushed the region's economy into a record contraction.

ECB President Christine Lagarde said on April 30 that continued and ambitious efforts are needed to fight the crisis. Germany's participation is critical for the success of QE as the country's own Bundesbank is the biggest buyer of debt under the program.

QE originally ran from early 2015 until the end of 2018, and was controversially resumed last year after a decision -- in the final weeks of Mario Draghi's presidency -- that divided the ECB's Governing Council.

Total holdings were 2.7 trillion euros at the end of March, with at least another 300 billion euros scheduled for this year to help fight the recession sparked by the coronavirus.

In addition, the ECB created the 750 billion-euro PEPP in March that scraps most of the limits that constrain the other plans. Tuesday's ruling doesn't formally cover PEPP, but the court's underlying reasoning could hold legal implications for it.

Under the combined programs, the ECB will buy more than 1 trillion euros of debt through the end of this year.

Lagarde said April 30 the central bank is “fully prepared” to increase or extend the PEPP if needed.

• Case number: BVerfG, 2 BvR 859/15 et al

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