The German court took particular issue with the CJEU’s assessment of proportionality, calling it “not comprehensible”. It claims that the CJEU disregards the “actual effects of the PSPP in its assessment of the [PSPP]’s proportionality” and by ruling the programme legal without satisfying the principle of proportionality “it exceeds the judicial mandate conferred upon the CJEU”.
“It’s a legal bombshell, but in practical terms it has very limited effect,” said Holger Schmieding, chief economist at Berenberg in London. “They’ve tried to make a legal point against the CJEU. The ECB purchases are not illegal, but it gives the ECB three months to explain why they are properly taking all effects into account.”
Accordingly, the German court has ruled that the ECB governing council must “demonstrate in a comprehensible and substantiated manner that the monetary policy objectives pursued by the PSPP are not disproportionate to the economic and fiscal policy effects resulting from the programme.”
If it fails to do so, the Bundesbank will no longer participate in the ECB’s Public Sector Purchase Programme and must sell what bonds it has bought under the programme.
“I see this as a slap on the wrist for the ECB,” said Edward Park, deputy chief investment officer at Brooks Macdonald. “A warning that Germany is watching it for scope creep — overreach of its mandate — saying ‘this isn’t illegal, but we’re in a grey area’.”
Michael Huertas, partner at Dentons and co-head of financial institutions regulatory Europe, said: “The ECB would be wise to invite in the international office of auditors to review the public and private guidelines of its programme. It’s possible the PSPP will need some tweaking. Then they can give their assessment to the Bundesbank so that it can continue to support monetary policy transmission.”
This could prove a difficult task to accomplish within three months, according to Giles Coghlan, chief currency analyst at HYCM. However, even if it fails to do so, there are unlikely to be serious technical consequences.
The Asset Purchase Programme, of which the PSPP is a part, purchases €20bn of bonds a month, plus an additional envelope of €120bn by the end of 2020. The ECB’s data indicates it purchased a net €29.6bn via the PSPP in April. It also faced some €30.3bn of redemptions.
National central banks are primarily responsible for their own country’s debt, so the Bundesbank’s PSPP holdings are likely to mainly comprise Bunds.
If the Bundesbank is forced to cease participating in these purchases, other national central banks “will be able to pick up the slack,” said Huertas.
However, Schmieding said: “This can in the end constrain the ECB’s ability to scale up its purchases.”
The Bundesbank will be able to continue to participate in the €750bn Pandemic Emergency Purchase Programme (PEPP), which purchases securities at a rate of approximately €50bn a month, much of which is likely to be eurozone government bonds.
Park said: “We would likely see some central bank chicanery, allowing the Bundesbank’s PSPP holdings to be transferred to PEPP holdings, causing the minimum disruption possible.”
Nevertheless, in spite of the fact that technical consequences of the ruling are not likely to be severe, investors had been expecting the ruling to be a non-event, and therefore had certainly not priced in the verdict. As a result, BTPs widened versus Bunds by 20bp by 1pm London time.
The Euro Stoxx 50 index, which had been trading up about 2% in the morning, fell about 1.5 percentage points in half an hour after the decision was announced, but then began to recover, and was about 1.1% up for the day by 12.20 German time.
Coghlan said: "The real threat here is the potential for a domino effect if other central courts, like Austria and Holland, also challenge the ECB."
The ruling likely increases the pressure on European fiscal policy to respond more thoroughly. Expectations will be running high for the European Commission to provide some encouragement in its announcement on the EU recovery fund, which is expected in mid-May.
Park believes that, unless the Commission is able to promise substantial support in the form of grants, the ECB will have to step up its activity to stop spreads widening dramatically.
Schmieding said that it could “raise the probablility that the Outright Monetary Transactions programme, which the Court had ruled legal, would have to be activated”. The OMT can only buy bonds of countries that are in formal supervision programmes overseen by the European Stability Mechanism.
The ECB is holding a non-monetary policy meeting at 5pm UK time on Tuesday. Coghlan said he expected some kind of announcement after the meeting, which would offer some clarity.
PEPP under threat?
Tuesday’s decision related only to the PSPP, not the PEPP. However, the PEPP is likely to be even more vulnerable to the sorts of challenges that have been levelled at the PSPP, since it is not governed by the 33% issuer limits of the PSPP and the ECB proudly touts its flexible approach to the capital key.
“If the appelants from this case go after the PEPP, that would be a death knell,” said Huertas. “It’s much bolder and more vulnerable to challenge.”
However, Schmieding said: ““This case was brought in 2015. It’s taken almost five years to decide. Unless they deliberately decide to make a fuss by speeding things up, I’m hoping it won’t cause problems during the coronavirus crisis.”
