Weekly Update - Cat Among the Pigeons

In previous cases, the BVG has ruled in favour of EU institutions. In 2016 for example, it rejected a challenge to the EU-Canada free trade deal. And in 2014, it decided that the legality of government bond purchases via quantitative easing should be determined by the European Court of Justice (ECJ), which duly ruled in the ECB’s favour. So this month’s decision – which challenges the ECJ’s ruling – came as a surprise to markets. The BVG has given the German Bundestag and government three months to ensure that the ECB has conducted a “proportionality assessment” of its Public Sector Purchase Programme (PSPP) for buying government bonds. This means that the central bank should demonstrate its assessment that the PSPP’s impact on achieving the ECB’s policy objective (to keep inflation close to but below 2%) is not outweighed by other “economic and fiscal policy effects”. And if the proportionality assessment is not forthcoming, the BVG indicated that the Bundesbank may not continue with PSPP purchases. Interestingly, the BVG found no problem with the possibility that the PSPP could be considered a form of monetary financing of government debt. Moreover, the ECB’s economists will certainly have produced vast amounts of research into the PSPP’s consequences before the governing council decided to go ahead. However, the ECB may prove reluctant to provide such data – it is after all independent from government influence and subject only to the ECJ’s jurisdiction, not that of the BVG. Further, the vast majority of the ECB’s purchases this year fall under the Pandemic Emergency Purchase Plan (PEPP) which was not covered by the BVG’s ruling. The BVG’s ruling leaves all parties in a bind – the German government, the Bundesbank, the European Commission, the ECB and the ECJ. The issue lies less with the continuation of asset purchases. Bundesbank president Weidmann has indicated he is confident that a way forward can be found. And the ECB intends to continue with its current policies regardless. The issue rather lies in the constitutional and political domain. By judging that the ECJ’s ruling in favour of the PSPP was “incomprehensible”, the BVG has opened the door to further national challenges to the ECJ’s precedence over domestic laws. In this respect, Chancellor Merkel’s reaction has been instructive. She told the Bundestag that Germany should be guided by a “clear political compass” which for her means a “strong single currency”. Merkel added that the BVG ruling should spur the euro zone on to “more integration, rather than less”. Clearly, she wants to avoid a political and constitutional crisis at this juncture. As illustrated by the left-hand chart, the euro zone’s response to the coronavirus-induced recession has been lopsided. National governments have done more than the EU in terms of support programmes. And among countries, those with the healthiest public finances – such as Germany – have done more than weaker members such as Italy and Spain, although the latter need the support much more than Germany does. However, there will be an opportunity to redress the balance next week when the Commission presents its blueprint for the Recovery Fund ahead of the next European Council summit on June 18-19.

Bottom line. The market reaction to the BVG bombshell has been muted as investors have judged – correctly in our view – that there would be no immediate interruption to ECB purchases. However, the political and constitutional consequences could be much further-reaching and can only be addressed by EU leaders following through on their ambitions for more integration.

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