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German court judgement sparks another EU row

A ruling by the German Constitutional Court questions the heart of European Central Bank policy during the Covid-19 crisis. John Redwood explains why this matters for investors.

A ruling by the German Constitutional Court questions the heart of European Central Bank policy during the Covid-19 crisis. John Redwood explains why this really matters for investors

by
John Redwood

in Features

06.05.2020

This week, Germany’s top court has introduced a new instability into the euro, as the legal judgement questions the European Central Bank’s (ECB’s) right to buy-up bonds issued by the European Union (EU) states with weaker finances. It also challenges the central bank’s policy of money printing and low interest rates. The potential consequences of this judgement are negative, as it will result in fewer investors buying euro-area bonds and bank shares. However, It seems likely the German government will wish to play down this intervention when working with the rest of the EU.

Many in Germany think the ECB’s asset purchase programme goes too far. This policy allows the central bank to create money to buy-up bonds issued by member state’s governments. They think it allows the weak and heavily-indebted countries to borrow too much, taking advantage of the common interest rate, which is low thanks to Germany’s strong finances. This creates a ‘free-ride issue’ benefitting Italy and Greece. It also worries them that it will one day prove inflationary and that German taxpayers may eventually be dragged into helping meet the big debts the highly-borrowed states have built up.

The court case was brought by a coalition of interests, mentioned by the court as including “shareholders, tenants, real estate owners, savers and insurance policy holders.” All these groups think they are losing out from ultra-low rates, as well as the drift to underwriting the finances of weaker countries.

A rules-based organisation

The European Treaties ban the direct monetary financing of individual member states by the ECB and set fiscal and monetary rules which are operated by the ECB and the EU Commission. These aim to provide discipline within the Eurozone.

Member states have strict limits placed on what they are allowed to borrow, though in current conditions they will be difficult to enforce. The implementation of past bond-buying policies placed limits on how much debt of the weaker countries could be included in the purchase programme.

In December 2018, the European Court of Justice (ECJ) found against German litigants and upheld the actions of the ECB with its quantitative-easing (QE) programmes, claiming the ECB had the powers and denying QE amounted to direct financing of member states.

A case was also taken to the German Constitutional Court, which has over the years fought to preserve some German constitutional independence – whilst usually wanting to uphold the growing powers of the EU over Germany as laid down in the Treaties. The judgement they announced on 5 May decided they could not prove or assert that the ECB has broken the rules on direct monetary financing.

German red lines

In a move described by one of the people behind the case as “a declaration of war against the ECB and against the ECJ”, the German Court found that the European Court was wrong in its judgement, which was ‘ultra vires’ or outside their powers.

The German Court found that the ECB had exceeded its Treaty powers by making judgements on QE without balancing economic policy issues. They gave the ECB three months to come up with an explanation of why their QE actions are proportionate, and how they have taken into account the impact these actions have on economic policy – which is not their remit. It concluded that if the ECB could not do so, there would need to be an agreed programme of sales of bonds already purchased. This has now run-up to more than €2 trillion.

Assertive ruling

The judgement is a tough one. The German court sweeps aside the European court’s judgement as a “view” which “manifestly fails to give consideration of the importance and scope of the principle of proportionality...and is simply untenable…given that it completely disregards the economic policy effects of the programme”.

The German ruling goes on to express the common German view of QE. “The negative effects [of QE] increase the more it grows in volume and the longer it is continued,” the ruling stressed. “The more its total volume increases, the greater the risk that the Eurosystem becomes dependent on Member states policies as it can no longer simply terminate and undo the programme without jeopardising the stability of the monetary union”.

Many will assume the German authorities will use this judgement to veto attempts to get Eurobonds issued at EU level which all member states have to back and to put the ECB off any major expansion of its already large QE programme.

It would be surprising if the German government wanted to use this judgement provocatively, threatening the Euro and EU finances at such a difficult time. It is, however, a sign of toughening German opinion about the dangers of pooling risks and printing too much money in the Eurozone, and a reminder that Germany has always claimed its Constitutional Court can, in some circumstances, override the ECJ.

The German Court has stated that: “Even under the Lisbon treaty the member states remain “the Masters of the Treaties”.” That is revolutionary language but probably does not herald follow up action to reverse Quantitative Easing in the Eurozone.

So, what is the message for investors? 

There are still unresolved tensions within the Eurozone, and still, there is no recourse to all the taxpayers of the zone for state debts that its individual members have issued. It makes the euro and its banking system higher risk than the normal model of one state, one government, one tax base and one central bank working together.

We have not seen the end of euro austerity for the weaker countries.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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