German court ruling casts doubt on European monetary policy

A bombshell ruling by Germany’s constitutional court questioning the legality of European monetary policy impinges on central bank independence and imperils the EU legal system, former policymakers and legal experts have warned.

The court on Tuesday ordered the German government to ensure the European Central Bank carried out a “proportionality assessment” of its vast purchases of government bonds to ensure their “economic and fiscal policy effects” did not outweigh other policy objectives. It threatened to prevent the Bundesbank, Germany’s central bank, from making further asset purchases if the ECB failed to comply within three months.

“It is a very dangerous argument,” said Lorenzo Bini Smaghi, former member of the executive board of the European Central Bank. “The next time the ECB raises interest rates it would have to look at all the negative effects it would have on debtors, the unemployed or on governments whose borrowing costs would rise. It is a very delicate argument that would lead to infringement of independence and of the price stability mandate.”

“It would be really peculiar if the Germans were now challenging the independence of the ECB,” Mr Bini Smaghi added.

The German court, which is based in Karlsruhe, also stunned lawyers and legal scholars by casting aside a 2018 ruling by the European Court of Justice that ECB bond-buying was legal. It is the first time a national court has declared an ECJ judgment as invalid and could undermine the uniform application of EU law, one of the bloc’s most important achievements.

“There are so many constitutional issues in this case,” said Catherine Barnard, professor of EU law at the University of Cambridge. “The most dramatic is that it is so overtly critical of the ECJ. They really get stuck in.”

The ECJ’s review of ECB’s €2.2tn of public debt purchases was deemed by the Karlsruhe judges to be “not comprehensible”, “manifestly fails” to consider the issue of proportionality and “is simply untenable from a methodological perspective”.

The court ruling followed many years of legal skirmishes with the ECJ over eurozone monetary policy — including an earlier German challenge to the Outright Monetary Transactions policy at the heart of former ECB president Mario Draghi’s pledge to do “whatever it takes” to keep the eurozone from breaking apart.

“It is not totally surprising that they have come out against the ECJ eventually: there have been enough warnings [from the court] and a growing dissatisfaction that the ECJ would never say anything against the ECB, whatever it did,” said Manuel Lorenz, head of German financial services regulation at US law firm Baker McKenzie.

The Karlsruhe court had also “holed below the waterline” the ECJ’s efforts to uphold democratic standards and the rule of law in Poland and Hungary, whose authoritarian governments may now be encouraged to defy European judgments, said Prof Barnard.

Poland’s government has repeatedly accused the EU of exceeding its competences during a five-year battle over reform of the Polish judiciary, and it seized on the German case as a sign that other countries shared its concern over the creeping expansion of the EU’s powers.

“It is a groundbreaking ruling in terms of the effects it may have on . . . the competence of national authorities and national courts to review whether EU institutions are acting within the competences assigned to them within the treaties,” said Pawel Jablonski, deputy foreign minister. “From Poland’s perspective, there was a growing problem with observance of this principle for quite some time, so it is very good that we will now start this debate.”

Economists said the ruling might force the ECB to think twice before expanding its monetary stimulus efforts for fear it could provoke a response from the German constitutional court.

“It is creating a lot of uncertainty with the ECB, saying to them that they cannot be sure that the next time the court may say ‘no, the Bundesbank cannot buy any more Bunds’, so they should be careful what they do in the future,” said Marcel Fratzscher, a former ECB official who now runs the German Institute for Economic Research in Berlin.

The ruling comes at a particularly sensitive time for the ECB, which last week signalled it was soon likely to consider increasing the size and timeframe of its new €750bn pandemic emergency purchase programme — its flagship policy response to the coronavirus crisis.

Tuesday’s court ruling exposes the deep mistrust with which the ECB is viewed in many parts of Germany, where it is often accused of bailing out profligate southern European countries at the expense of prudent savers in the north. Mr Fratzscher said this mistrust had two dimensions: opposition to risk-sharing across Europe, and “moral hazard” objections that the ECB’s actions support zombie companies and take pressure off governments to reform.

Vitor Constâncio, former vice-president of the ECB, said it would be “easy” for the central bank to provide the proportionality assessment requested by the German court. But he said the court’s attempt to draw a line between the ECB’s monetary policy mandate and the economic policy domain of national governments “makes no sense”.

Lawyers said the decision on whether to accept the ECB’s assessment was likely to fall to the Bundesbank, which has long opposed the bond-buying programme.

“There is no mechanism for this to go back to the court right away, so the hot potato is set to land in the lap of the Bundesbank,” said Mr Lorenz. “But with a proper reasoning it would be very difficult for them not to accept it.”

Additional reporting by James Shotter in Warsaw

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