Germany’s shock court ruling against the ECB challenges the stability of the euro zone

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A euro currency symbol sits on display in the visitor centre at the European Central Bank (ECB) building in Frankfurt, Germany.

Alex Kraus | Bloomberg | Getty Images

The stability of the euro zone is once again under scrutiny after the German Constitutional Court issued a decision last week that surprised financial markets and policymakers in Europe.

The highest court in Germany said last Tuesday that parts of the European Central Bank’s (ECB) actions were illegal under German law. The court said one of the ECB’s tools — its quantitative easing program — did not respect “the principle of proportionality” and that the German central bank and government should have challenged the central bank in this regard.

The ECB was quick to react, arguing that it follows decisions taken by the European Court of Justice — not national courts. However, the German ruling has sparked an unprecedented legal minefield and has led to new questions about the future of the euro zone.

“People will ask: ‘Will this increase the risk of a (euro zone) breakup?’” Marchel Alexandrovich, senior European economist at Jefferies, told CNBC Monday during a phone call.

He said the German court decision was unlikely to directly drive the 19 countries which use the euro apart, but argued it will support more hawkish views when it comes to monetary policy.

“It does strengthen the ammunition of more hawkish countries,” Alexandrovich said, referring to nations such as Austria and Finland, where policymakers generally have a more aggressive stance and are in favor of higher interest rates. This contrasts with the ECB over the last decade, where the governing council has learned towards looser monetary policy.

The euro zone has a unique set up, where the 19 member governments oversee their own fiscal policy, but the ECB decides monetary policy across the region. The German Constitutional Court ruling is the latest incident showcasing differences between national and European institutions.

Stephen Gallo, head of forex strategy at the Bank of Montreal, told CNBC Monday that the court’s decision “could ultimately reinforce the extent of legal, economic and financial fragmentation within the bloc.”

QE at risk

 “Unless there are major changes to German and/or EU law, the ECB may not be able to absorb as many risks onto its own balance sheet through QE (quantitative easing), which should mean that those risks remain parked within the financial systems of individual member states,” Gallo said.

This would become particularly problematic for countries such as Italy, which has very high levels of government debt. Their borrowing costs would rise if the ECB was prevented from buying Italian bonds, as investors would assign a greater risk to the the possibility of the Italian government defaulting on its debt.

The image is essentially one in which individual member states have a wide range of different priorities, relative to a number of the EU’s institutions.

Stephen Gallo

Head of forex strategy at the Bank of Montreal

The ECB, led by Christine Lagarde, started purchasing governments bonds in 2015 in an effort to prop up moribund prices and economic growth in the euro area. This stimulus program ended in 2018, but was restarted in late 2019 as economic indicators remained weak.

The highest court in Germany said the ECB needed to explain why these government purchases are needed.

“Taking a much bigger picture of the bloc, the image is essentially one in which individual member states have a wide range of different priorities, relative to a number of the EU’s institutions, which seem intent on trying to centralise the whole thing,” Gallo added via email.

In a statement issued Sunday, European Commission President Ursula von der Leyen said: “The recent ruling of the German Constitutional Court put under the spotlight two issues of the European Union: the Euro system and the European legal system.”

She added that European law has primacy over national law and that rulings of the European Court of Justice are binding on all national courts.

Political challenges too

Nonetheless, there are concerns that the court ruling will be used by member states which are at odds with European institutions.

“The risk that this sets a precedent looms large. It may even be more relevant in political than in economic and financial terms — think Hungary and Poland, for example, whose leaders have their own disputes with European institutions,” Holger Schmieding, European economist at Berenberg, said in an email last week.

Both Hungary and Poland have been under investigation by the European Commission, the executive arm of the EU, for appearing to disregard some of the union’s values. There are concerns that the German ruling would encourage these two countries to challenge any decision taken in Brussels.

Erik Nielsen, chief economist at UniCredit, said the embarrassment of the ruling for the Bundestag (the German parliament) was notable.

“As illustrated when Bundestag President, and long-time ECB critic, Wolfgang Schäuble said … that ‘it may well be that the existence of the euro is now being questioned in other EU member states — because every national constitutional court can judge for itself’,” he said in a note Sunday.

Silvia Amaro

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