Tuesday, June 16, 2015

European Court backs ECB

The ECB’s Outright Monetary Transactions (OMT) programme was legal. The European Court of Justice (ECJ) just released its ruling on the OMT, calling it compatible with EU law. Even if widely expected, this ruling still brings a relief at the ECB and in financial markets. However, at least the press release still leaves the door open for new lawsuits against QE. Remember that OMT was the programme the ECB announced back in 2012 when the risk of a Eurozone break-up had increased significantly. It was the incarnation of Mario Draghi’s famous ”whatever-it-takes” speech in July 2012. Back then, the speech and the subsequent announcement of OMT calmed financial markets and spreads on government bond yields narrowed again, assuming that the ECB had finally accepted a role as the lender of last resort. The ECB, however, has never referred to the role of lender of last resort but has always argued that OMT was a sheer monetary policy instrument, targeted at a proper functioning of the monetary transmission mechanism. While markets were cheerful, some Germans were not and started a law suit against the ECB, putting the OMT’s legality into question. With OMT, this was the argumentation, the ECB had crossed the Rubicon, entered the arena of monetary financing and had put German taxpayers (without any accountability) at risk. The lawsuit was filed at the German Constitutional Court. Then, in early 2014, the German Constitutional Court has basically said that it was unable to assess the legality of the ECB’s OMT but if it could, it would deem it illegal. This is why the German judges had referred the case to the ECJ. The ruling The ECJ just released a first four-pager press release with the main argumentation of the ruling. The entire verdict will be released later today. Judging from the press release, the ECJ gives the clear backing to the ECB. According to the ruling, the OMT programme “falls within monetary policy and therefore within the powers of the ESCB”. OMT contributes to the singleness of monetary policy. The ECB’s role in the Troika Today’s positive ruling does not come as a surprise. In fact, the ECJ broadly followed the advice of its Advocate-General Cruz Villalon. This advice was given back in January this year. However, the Advocate-General had pointed out another issue, which is of great interest. In the event of the OMT programme being implemented, the “ECB must refrain from any direct involvement in the financial assistance programme that applies to the State concerned”. Back then a clear sign that the ECB’s role in the Troika should be revisited. Today’s official ECJ ruling – at least in the press release – does not comment on this aspect anymore. Impact on QE There is no doubt that OMT paved the way for QE, even if there are some substantial differences between the two. While OMT has a built-in conditionality and only focusses on the countries applying for OMT, QE is unconditional and purchases are spread across Eurozone countries. Today’s ruling should clearly discourage new lawsuits against QE, though not entirely. The ECJ states that ECB bond purchases could in practice have an effect “equivalent to that of a direct purchase”, particularly when potential purchasers of government bonds in the primary market new for sure that the ECB was buying in the secondary market. In our view, the ECJ kept the door to new QE lawsuits slightly open. Who has the last word? Anyone familiar with lawsuits knows that there is almost always the possibility to continue. This is why even the discussion on OMT might now be entirely over and solved. After today’s ruling, the crucial question is whether the German Constitutional Court will simply embrace the ECJ’s ruling or not. In 2014, the German Constitutional Court clearly signaled its own judgement, namely that the OMT may well exceed the mandate given to the ECB and would be inconsistent with the prohibition of monetary financing of member states. Even if the European Court would rule favorably towards the ECB, the German Constitutional Court made it clear that it reserves its own judgement and that it would not automatically follow the ECJ’s opinion. In its own view, the German Constitutional Court claims to have the last word in extreme cases. However, even if in theory the German Court could still come with a different ruling, it is hard to see that this would really happen in reality. It would lead to a legal conflict between two strong Courts with reputational damage for all. In sum All in all, today’s ECJ ruling should bring some relief to markets. In these times, when Eurozone policymakers are realizing that a Grexit would lead to contagion on financial markets, at least in the short run, confirming and strengthening the ECB’s OMT is almost existential. Up to now, OMT has been the ECB’s most powerful tool, and actually the most powerful tool which did not cost a single euro. The ECJ gave a strong backing to the ECB’s independence and sent a sad message to some Germans: there is European life outside the German borders.

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