Greater scrutiny, reduced flexibility, and perhaps new legal risk
We expect today’s ruling by the German Constitutional Court (CC) to expose the ECB’s monetary policy decisions to greater scrutiny and to potentially reduce the ECB’s flexibility to act quickly in emergency situations and in innovative ways. We think the ECB will make it a priority to quickly fulfil the German court’s demand and issue a more comprehensive justification for its asset purchase programme, including the recently launched PEPP. Therefore, technical challenges to the QE and PEPP programme in the short term should be limited. Nevertheless, we suspect that trust in the ECB’s ability to forcefully fight the current crisis and to keep Eurozone sovereign debt sustainable over the coming years might have suffered.
After today’s ruling, we also see a risk that the ECB’s PEPP programme might be challenged in the German Constitutional Court. Should the ECB not have finalised its justification of QE by the time of the next policy meeting on 6 June, we think it would be an argument to not raise the PEPP envelope from €750 bn to €1 trn in that meeting (as our base case scenario implies); in this case, the ECB might only increase the PEPP envelope in the following meeting on 16 July.
Will the ruling slow down the ECB’s decision making?
We expect the ECB to immediately start working on a thorough justification of its asset purchase programme, including the recently launched PEPP. We think the ECB will have to make it a routine, in future decisions related to public sector asset purchases, to issue more detailed and technical justifications in addition to its conventional policy statements. This will probably require more preparation ahead of policy decisions.
While this should not normally be a problem given the ECB’s institutional capabilities, we are concerned that the additional administrative effort might make it harder for the ECB to make far-reaching emergency decisions (like the recent PEPP) within a very short period of time. We would also think that the hurdle towards innovative policy measures could from now on be higher. Our understanding is that the additional justification of ECB policy action refers to public sector but not private sector asset purchases – it remains to be seen whether this might skew the ECB’s policy action more towards private sector assets in the future (e.g. lower-rated corporate bonds, bank loans covered by state guarantees, equity).
New legal risk related to the PEPP? Might a fresh look at OMT be required?
The CC stated upfront that the PEPP was not subject to its verdict – but as we argued earlier, we do not think it would be possible to separate the “old” QE programme from the PEPP programme. This would suggest that future increases in the PEPP have to be thoroughly justified by the ECB as well. But more trouble might lie ahead. The German CC ruled that the QE programme does not violate the prohibition of monetary finance (Art. 123 Lisbon treaty) because it is subject to limitations, such as the 33% issuer limit, a certain minimum rating or the capital key. Given that some of these conditions were softened under the PEPP, we think the PEPP might well be challenged in the CC as well.
In other words, issuing a comprehensive explanation for PEPP to justify its proportionality is one thing, but fending off future legal challenges might be another.
As we argued last week, we were surprised that Christine Lagarde played down the relevance of the ECB’s OMT instrument as a potential policy response in the current crisis, relative to PEPP. Following today’s ruling, the relative value of OMT might have increased, given that the German Constitutional Court confirmed the legality of OMT in 2016, in accordance with the European Court of Justice. Last but not least, by limiting the degrees of freedom for ECB policymaking, today’s ruling has arguably increased the urgency for Eurozone government to address the issue of burden sharing.
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