What the German court ruling against the ECB means for the euro

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A symbol of the euro currency is on display in the visitor center of the European Central Bank (ECB) building in Frankfurt, Germany.

Alex Kraus | Bloomberg | Getty Images

Stability in the eurozone is under surveillance again after the German Constitutional Court issued a decision last week that surprised financial markets and policymakers in Europe.

Germany’s highest court said Tuesday that parts of the actions of the European Central Bank (ECB) were illegal under German law. The court said that one of the ECB’s tools – its quantitative easing program – did not respect “the principle of proportionality” and that the German central bank and government should have challenged the central bank in this regard.

The ECB was quick to respond, arguing that it is following decisions made by the European Court of Justice – and not by national courts. However, the German move has unleashed an unprecedented legal minefield and has led to new questions about the future of the euro area.

“People will ask, ‘Will this increase the risk of (eurozone) break-up? “” Marchel Alexandrovich, a senior European economist at Jefferies, told CNBC on Monday on a phone call.

He said the German court’s decision was unlikely to directly separate the 19 countries that use the euro, but said he would support more hawkish views on monetary policy.

“It strengthens the ammunition of more hawkish countries,” said Alexandrovich, referring to countries like Austria and Finland, where policymakers tend to be more aggressive and favor higher interest rates. This contrasts with the ECB over the past decade, where the Governing Council has learned to ease monetary policy.

The euro area has a unique configuration, where the 19 member governments oversee their own fiscal policy, but the ECB decides on monetary policy across the region. The judgment of the German Constitutional Court is the latest incident highlighting the differences between national and European institutions.

Stephen Gallo, chief of forex strategy at the Bank of Montreal, told CNBC on Monday that the court ruling “could ultimately reinforce the extent of legal, economic and financial fragmentation within the bloc.”

Risky QE

“Unless there are major changes to German and / or EU law, the ECB may not be able to absorb as much risk on its own balance sheet through QE (quantitative easing), which should mean that these risks remain stationed in the EU financial systems. “Individual member states,” said Gallo.

This would become particularly problematic for countries like Italy, which has very high levels of public debt. Their borrowing costs would increase if the ECB were prevented from buying Italian bonds, as investors would associate higher risk with the possibility of the Italian government defaulting on its debt.

The picture is essentially one in which individual Member States have a wide range of different priorities, compared to a number of EU institutions.

Stephen Gallo

Head of forex strategy at Bank of Montreal

The ECB, led by Christine Lagarde, began buying government bonds in 2015 in an effort to support moribund prices and economic growth in the euro area. This stimulus program ended in 2018, but was relaunched at the end of 2019, the economic indicators remaining weak.

Germany’s highest court said the ECB should explain why these public purchases were necessary.

“By taking a much broader picture of the bloc, the picture is essentially one in which different member states have a wide range of different priorities, compared to a number of EU institutions, which seem determined to try to centralize everything, “Gallo added by e-mail.

In a statement published on Sunday, the President of the European Commission, Ursula von der Leyen, said: “The recent decision of the German Constitutional Court has highlighted two problems of the European Union: the Eurosystem and the European legal system “

She added that European law takes precedence over national law and that the decisions of the European Court of Justice are binding on all national courts.

Political challenges too

However, some fear that the court decision will be used by Member States in contradiction with the European institutions.

“The risk that this sets a precedent is great. It may even be more relevant politically than economically and financially – think for example of Hungary and Poland, whose leaders have their own differences with the European institutions, ”said Holger Schmieding, European economist. in Berenberg, said in an email last week.

Hungary and Poland under investigation by EU Commission, executive branch of EU, for appearing to ignore some of the values ​​of the union. It is feared that the German decision would encourage these two countries to challenge any decision taken in Brussels.

Erik Nielsen, chief economist at UniCredit, said the embarrassment of the Bundestag (German parliament) decision was notable.

“As illustrated by the President of the Bundestag, and longtime critic of the ECB, Wolfgang Schäuble, said … that the existence of the euro may now be called into question in other Member States of the EU – because each national constitutional court can judge for itself, “he said in a note on Sunday.

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