ECB Heads for More Stimulus Even as Courts Spar Over Limits

(Bloomberg) -- In the middle of a spat between Europe’s top courts over the limits of European Central Bank monetary stimulus, President Christine Lagarde is probably preparing to do even more.

A lawyer herself, Lagarde says her institution is “undeterred” by a legal tussle over its 2.7 trillion-euro ($2.9 trillion) asset-purchase program, and will do what’s needed to carry the euro zone through the coronavirus crisis.

For many economists and investors, that almost certainly means ramping up a separate bond-buying plan -- the 750 billion-euro pandemic purchase program -- which was created in March specifically to combat the fallout from the pandemic.

The ECB could decide to increase that program, extend it into 2021, or promise to reinvest the proceeds of bonds as they mature. The only question is when.

What Bloomberg’s Economists Say

“The decision opens up a route for the Governing Council to avoid falling afoul of the justices, and likely allows asset purchases to continue unhindered. However, it raises more questions than it answers and creates considerable uncertainty.”

-David Powell. Read his ECB INSIGHT

The shock ruling by Germany’s constitutional judges last week that the ECB may have stepped outside its remit came at an extraordinary time. The continent’s worst postwar recession and the struggle by governments to agree on a joint fiscal response has led to warnings that the currency union is at risk.

The verdict sparked an immediate backlash from the European Union’s highest tribunal. The European Court of Justice in Luxembourg, which had cleared the policy in 2018, issued a rare press release saying it “alone” can rule that an act of an EU institution is contrary to EU law.

The European Commission threatened twice over the weekend to sue Germany, with Commission President Ursula von der Leyen saying in a statement that “the final word on EU law is always spoken in Luxembourg. Nowhere else.”

German Chancellor Angela Merkel told the leadership of her party that the ruling has far-reaching consequences. According to a person familiar with the discussion, she said one solution could be for the ECB to explain its asset-purchase program to the Bundesbank, which would serve as an intermediary to the German parliament.

Merkel’s spokesman Steffen Seibert said Monday the government doesn’t see the constitutional court’s decision as questioning the ECJ’s role in guarding European law.

Investors seem to maintain faith in the ECB’s ability to push ahead with its measures despite the ruling, with yields on benchmark debt in Italy and Spain relatively stable on Monday.

The ECB is predicting the economy will shrink by 5%-12% this year and might not recover to pre-virus levels before the end of 2022.

Lagarde said on Friday that governments could have to issue between 1 trillion euros and 1.5 trillion euros of extra debt. If the ECB doesn’t help mop that up, markets could push borrowing costs higher and undermine the recovery.

Some ECB officials have openly highlighted the likely need for more action. Most economists surveyed before the ruling predicted the crisis program will be increased by around 500 billion euros later this year.

Executive Board member Isabel Schnabel sought to reinforce the message in her interview with an Italian newspaper on Monday. The ECB will continue to conduct bond purchases in line with its mandate despite the ruling, she told La Repubblica, adding that the resolve “seems to have been well-understood by market participants.”

“We are using this flexibility to make sure that our monetary policy is transmitted to all euro area countries,” Schnabel, who runs market operations at the ECB. “And we stand ready to adjust the size and duration of the programme if needed.”

How soon more support is required depends partly on how the easing of lockdown measures proceeds, but some decisions are becoming pressing. The shortest-term debt that the ECB holds could start maturing next month and officials haven’t yet said if they’ll reinvest the cash, as they do for the older asset-purchase program.

Not doing so would mean withdrawing monetary support with one hand while adding it with another, even if the initial sums are small.

“Our working assumption is that it’s reinvested,” said Danske Bank’s Piet Christiansen. “But we can’t verify it.”

Legal Jeopardy

Some economists do see a chance policy makers tread more carefully now. The ECB was given three months to justify the 2015 program, or Germany’s central bank will have to drop out. That would be a massive blow -- Germany is the bloc’s biggest economy and its Bundesbank accounts for the largest share of bond purchases.

“The case for additional monetary policy support is clearly strong; the timing of any announcement has however become harder to gauge,” said JPMorgan economist Greg Fuzesi. “It is hard to know if the ECB will respond to the German Federal Constitutional Court’s statement by moving more cautiously” or “whether it will more aggressively to demonstrate its independence.”

Should the ECB decide that more stimulus is needed, the emergency program is the obvious vehicle as it wasn’t covered by last week’s ruling. That doesn’t mean it’s out of danger though -- the plaintiffs in the latest case are now preparing to target that as well.

In a sign of how the legal ruling has jangled nerves, Germany’s Der Spiegel magazine reported that finance ministry officials are already trying to head off that threat. They’re said to have investigated whether the plan is proportionate to the economic environment -- applying the kind of oversight that the court deemed missing.

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