Germany’s constitutional court has embarked on a fresh hearing about the legality of the European Central Bank’s programme of asset purchases — just as the ECB gears up for an expansion of its economic stimulus measures.
After more than four years and with around €2.6tn-worth of bonds already bought, the quantitative easing programme remains controversial in northern eurozone states. Nowhere more so than in Germany, where the Karlsruhe court’s hearing is part of a long-running case that centres on whether the purchases constitute so-called “monetary financing”, which is prohibited under EU law.
The timing of the hearing is delicate. Last week ECB president Mario Draghi said that the bank’s officials would look at a range of stimulus options — including rate cuts, a commitment to keep policy exceptionally loose for years to come and another round of QE — to counter fears that the bank would persistently undershoot its inflation target of just under 2 per cent.
What is monetary financing?
Eurozone treaties prevent the ECB from financing member states’ governments by buying their debt, a tactic known as monetary financing. This rule aims to protect the central bank from political pressure and avoid stoking inflation.
QE involves the central banks of eurozone member states buying government bonds in massive quantities, financed by the ECB.
The complainants in the case — a group of almost 2,000 people, led by German economists and law professors — argue that it is therefore illegal. They want the Bundesbank, which has been the biggest purchaser of bonds under QE, to stop participating in the ECB programme.
They first brought their case against the ECB after the eurozone’s central bank embarked on QE in 2015, attempting to get the German constitutional court to block it.
The ECB argues that QE does not constitute monetary financing because it is only buying the bonds in secondary markets from other investors, rather than purchasing the debt directly from governments. And the ECB’s QE rules prevent it from holding more than a third of any member state’s outstanding debt.
What have the courts said?
The German courts have been busy for years with a series of court cases about the scope of the ECB’s mandate.
But when asked to look at QE in July 2017 the court said it was “doubtful whether [QE] was compatible with the prohibition of monetary financing” and that QE “may not be covered by the ECB’s mandate” but it reserved judgment and referred the case to the European Court of Justice in Luxembourg.
In December last year the ECJ found in favour of the ECB, saying that QE as currently designed is legal.
The case now goes back to the German court to interpret the ECJ finding in the context of German domestic law.
What are the ramifications?
The legal ramifications go far beyond this one case; they also concern whether the judgments of Germany’s highest court should take precedence over European law.
The complainants brought their case under the German constitution; until now it has been unclear whether the constitution’s power can be superseded by EU law.
And the dangers for the ECB’s QE programme are twofold.
First, if Karlsruhe rules in favour of the complainants the Bundesbank may decide it is preferable to obey German constitutional law rather than requests of the ECB.
Second, it could constrain the ECB in the design of any new QE package.
The ECB believes the ECJ judgment was flexible enough to enable the bank to raise the amount of outstanding bonds of any one member state it can buy — known as the issuer limit — from a third to as high as 50 per cent.
But the Bundesbank could contradict that.
The German central bank will send two witnesses to Karlsruhe this week, its head of legal and its head of economics.
Although they are set to argue against the complainants, saying that QE in its current form is legal, they could stress that the rules cannot be bent much more without reaching the boundary of what constitutes monetary financing — in other words the ECB has little further scope for bond buying.
This may make it tricky for the ECB to raise the issuer limit — and that is important. The ECB only has a limited amount of headroom for new QE, largely because only a small amount of outstanding German debt remains in the market that is eligible for the ECB to buy under the status quo.
The outcome of the case could take a while given the sensitivities involved; some observers do not expect a decision until the end of the year.
By that time, the ECB’s plan to launch a fresh round of stimulus could already be under way.