German Constitutional Court Rules ECB’s Bond Buying Program Partly Breaches German Law

Germany's Constitutional Court determined on Tuesday that the European Central Bank's stimulus program, through purchases of government bonds since 2015, partly violates German law since neither the German government nor its parliament approved such spending.

The bond-buying program was designed to upgrade the euro zone economy and push inflation towards the ECB’s target of just below 2%. On the whole, between 2015 and 2018, the program purchased government bonds and other securities valued at approximately $2.9 trillion. (The program was restarted in late 2019)

“The ECB fails to conduct the necessary balancing of the monetary policy objective against the economic policy effects arising from the program. Therefore, the decisions at issue...exceed the monetary policy mandate of the ECB,” the court in Karlsruhe said in a statement.

(The court ruling did not include the ECB’s current 750 billion euro -- $813 billion -- Pandemic Emergency Purchase Program which was launched in response to the coronavirus crisis.)

The German judges had voiced concerns about the bond-buying scheme as far back as 2017 when they noted that one particular segment of the endeavor -- the Public Sector Purchase Program, or PSPP – was allowed to directly engage in economic policy and direct government financing; two activities the ECB is banned from doing.

PSPP accounted for about $2.3 trillion of asset purchases over the aforementioned 2015-2018 period.

Although the German court admitted it found no evidence of direct government financing by the ECB, it nonetheless indicated that the German government and politicians failed to properly assess the objectives and mechanisms of the ECB's bond buying program. The judges also determined that the adequacy of the ECB's PSPP scheme was never thoroughly analyzed.

As a result of the ruling, the ECB must now explain to the German court’s satisfaction why the PSPP is necessary otherwise the Bundesbank central bank will be prohibited from participating in the asset purchase program in three months’ time. The court declared “unless the ECB Governing Council adopts a new decision that demonstrates in a comprehensible and substantiated manner that the monetary policy objectives pursued by the ECB are not disproportionate,” Bundesbank will have to pull out.

In its ruling, the German court supported the contentions of various plaintiffs -- including Bernd Lucke, an economist and former leader of the far-right Alternative for Germany party; and Peter Gauweiler, a former senior member of the conservative Christian Social Union in Bavaria – who asserted that the ECB’s bond buying program did not fall under the central bank’s mandate of ensuring price stability. Essentially, the plaintiffs said EU laws bans one member country from the subsidizing the debts of another.

The German court ruling partly rejects the December 2018 decision by the European Court of Justice ruled that the ECB's plan to buy government bonds was valid and fell within the central bank's mandate.

Uwe Burkert, an economist at Landesbank Baden-Wurttemberg in Stuttgart, described the German court’s verdict as “a very explosive thing."

"The Bundesbank will -- after a transitional period of three months -- be barred from taking part in the ECB's PSPP program," he said.

However, Jorg Kramer, the chief economist at Commerzbank, thinks the bond buying scheme will continue.

"The ECB will have to prove now that the program is really proportionate so as to win approval by the German government and lawmakers -- given the large group of experts at the ECB, that shouldn't be much of a problem," he said.

But others worry the ruling will raise doubts about the bond buying scheme and perhaps put pressure on the current Pandemic Emergency Program bond-buying scheme. Italy, due to its enormous external debt and now lockdown-inflicted economic damage, has been heavily dependent on the bond purchase program.

Michael Hewson, chief market analyst at CMC Markets U.K. in London, commented that the German court’s criticism of the ECB will likely “prompt enhanced scrutiny of current and future programs going forward, with all of the problems that might entail in terms of fast effective delivery of monetary policy. While the time frame being allotted is a tight one for the ECB to ensure they are compliant, the bigger concern is the scope of the new Pandemic Emergency Program, which has a much wider remit than the one just ruled on by the court.”

Claus Vistesen, chief euro zone economist at Pantheon Macroeconomics, said: “Our gut tells us that this will blow over, eventually, though we sympathize deeply with the ECB’s legal experts at this point in time. They’ll need to muster all their creativity to come up with a response to satisfy the German Constitutional Court, and they need to work fast.”

Carsten Brzeski, chief economist at ING Germany said: “It will take some time to fully understand the implications of the German Constitutional court’s ruling on the ECB’s quantitative easing program today ... But this could certainly become a real problem for the ECB in the recovery phase of the crisis,”