The headquarters of the European Central Bank in Frankfurt, Germany. Picture: EPA
The headquarters of the European Central Bank in Frankfurt, Germany. Picture: EPA

Frankfurt — 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 asset-purchase programme, and will do what is needed to carry the eurozone through the coronavirus crisis.

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

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

“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,” Bloomberg economist David Powell said.

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

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

In the meantime though, 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 and €1.5-trillion of extra debt. If the ECB does not 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 programme will be increased by about €500bn later this year.

How soon more support is needed 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 have not yet said if they will reinvest the cash, as they do for the older asset-purchase programme.

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 policymakers will tread more carefully now. The ECB was given three months to justify the 2015 programme, or Germany’s central bank will have to drop out. That would be a huge 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 programme is the obvious vehicle as it was not covered by last week’s ruling. That does not mean it is 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 are said to have investigated whether the plan is proportionate to the economic environment — applying the kind of oversight that the court deemed missing.

Bloomberg