Germany’s constitutional court jolted eurozone investors and hit the value of the euro after judges warned that the European Central Bank’s plans to flood the financial system with cheap credit could breach German law.
The bombshell ruling by the court in Karlsruhe came after judges agreed that Germany’s central bank must stop cooperating with the ECB’s long-running stimulus scheme within the next three months unless the ECB could prove it was not excessive.
Analysts said the decision highlighted the constraints on the ECB as a lender of last resort compared with the more independent US Federal Reserve, the Bank of Japan and the Bank of England, as it wrestled with the biggest economic crisis in peacetime after the Covid-19 outbreak.
The ECB has already injected billions of euros into the reserves of high street banks across the continent to encourage them to lend to small businesses as part of a programme created by the former president Mario Draghi after the 2012 eurozone debt crisis.
Last month Draghi’s successor, Christine Lagarde, said the pandemic meant a fresh round of stimulus was needed under the banner of the public sector purchase programme (PSPP), leading many conservative politicians in Germany to accuse the ECB of over-reaching its mandate.
The court considered a claim that PSPP was illegal as it amounted to directly financing eurozone governments. The judges concluded that the ECB needed to prove that the programme was justified, through “a proportionality assessment”.
“The Bundesbank may thus no longer participate in the implementation and execution of the ECB decisions at issue, unless the ECB governing council adopts a new decision that demonstrates … the PSPP are not disproportionate to the economic and fiscal policy effects,” they said.
Carsten Brzeski, an analyst for ING, warned the ruling could undermine the authority of the ECB and its ability to protect the eurozone’s financial system during a crisis.
He said that while the judges had excluded the most recent injection of €750bn (£653bn) linked to the pandemic, they had agreed the Bundesbank could be prevented from participating in the ECB’s long-term quantitative easing (QE) programme.
“An optimistic interpretation could be this is lots of barking without biting and that everything is fine as long as the ECB demonstrates that it has thought through the economic consequences of its decisions. But a pessimistic interpretation could be that no amount of additional ECB analysis will convince German judges and could, therefore, spell the end of QE,” he said.
The euro dropped 0.7% to $1.0829 and was set for its biggest daily slide in more than a month.
Concerns about the ECB’s backing for eurozone governments, all of which have signalled large increases in debts this year to fund coronavirus-linked welfare and business subsidies, sent the interest rate government’s must pay on their debts higher.
The benchmark 10-year bond yields in the euro area were between two and nine basis points (bps) higher on the day. Germany’s 10-year Bund yield was up 2.5 bps at -0.54%, while the Italian 10-year debt yield was 7 bps higher on the day at 1.82%.
The court ruling initially rattled European stocks markets and briefly erased gains driven earlier in the morning by hopes global lockdowns would ease. However, shares later recovered: the FTSE 100 was up 1.7%, Germany’s Dax rose 2.5% and France’s CAC rose 2.4%.
Some analysts said that the three-month deadline was reassuring and lifted sentiment after the initial panic. Kenneth Broux, a strategist for Société Générale, said: “The PSPP violates German law but I think the three-month deadline is important to clarify proportionality and the ECB can move on after that.
“It illustrates the difficulties versus the Fed, for example; the Fed has no such constraints of US states challenging QE there,” he said.