German angst

ECB asset purchase program goes on trial in European court

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Change of venue. Source: Reuters

The European Court of Justice is finally poised to hear a challenge to the European Central Bank’s ongoing asset purchase program Tuesday, nearly a year after Germany’s highest court referred the case to it with prejudice. And it’s actually too late: The hearing comes just weeks after the Mario Draghi-run central bank declared the program would be stopped at the end of the year.

It is a case that has divided Germany, which has long been skeptical of the ECB’s crisis-era policies, and where conservative hardliners have spearheaded a series of legal challenges. In what was perceived at the time as deliberate waffling, the Constitutional Court in Karlsruhe opined that the ECB purchases — a “quantitative easing” designed to loosen monetary policy after interest rates were already at zero — may violate EU rules against central banks financing government debt.

The ECB’s asset purchase program, similar to that pursued by the US Federal Reserve, calls for the central bank to purchase bonds on the secondary market as a way of injecting money into the banking system. Because there is a dearth of government bonds to purchase, the ECB, unlike the Fed, includes corporate bonds in its program.

German support is restrained

For the case in Luxembourg this week, the Berlin government is largely supporting the ECB position. Wolfgang Schäuble, the former finance minister, defended the ECB’s position against the Karlsruhe court. The case was originally brought by hardline politicians in Germany — namely, Bernd Lucke, a cofounder of the far-right Alternative for Germany (AfD) who has since left the party, and Peter Gauweiler, a former deputy leader of the Bavarian wing of Angela Merkel’s Christian Democrats. In a statement on Tuesday, Mr. Gauweiler said it was “scandalous” that Berlin supported a program that posed such “gigantic” risks to Germany.

Germany’s central bank has had more of a mixed history before the court. It fiercely opposed a different, more controversial crisis-era program known as OMT, but sees the new current “QE” program of asset purchases as legal. The Bundesbank did however note, like the Karlsruhe court, that it is suspiciously close to government financing. The European Court of Justice meanwhile is widely expected to rubber stamp the ECB’s latest program, considering it backed the ECB’s more controversial version two years ago.

But there is a fight brewing in the background. The German government makes one critical exception to its support: The risks taken by the European Central Bank should stay with individual member states.

The ECB maintains that if actions taken as part of normal monetary policy result in losses, then these must be borne by all members. The German government disagrees. It stipulates that all losses should be borne by the individual central bank. Berlin is at pains to dispel the notion widespread in Germany that the Bundesbank will have to shoulder the brunt of losses on foreign bonds.

The point is largely moot for the current asset purchase program. The ECB specifically exempted government bonds from its rule, saying each central bank is responsible for any losses on its own purchases. Losses on corporate bonds, on the other hand, will continue to be mutualized — a fact that actually worked in Germany’s favor recently. But if the Luxembourg court decides to weigh in on this dispute, its ruling will have an impact on any future programs launched by the ECB.

Impact on Target2 balances

From Germany’s perspective, it doesn’t help that the asset purchase program adds to the sum of what other central banks owe the Bundesbank. This is due to the complex bookkeeping system of the 19 national central banks belonging to the euro. The so-called Target2 balances reflect the net positions of the banks vis-à-vis each other.

The Bundesbank currently has a positive balance of €976 billion – the amount other central banks owe it because of transactions conducted in Germany. Some 30 percent of each bond purchased in the ECB program ends up in a Target2 balance — 20 percent in the Bundesbank alone. At the current pace of €30 billion a month, the program adds a substantial sum to the Bundesbank balance. (The ECB plans to reduce the monthly amount to €15 billion in October and end the purchases altogether at the end of the year.)

The concern is that if a country leaves the euro, or if the entire system unravels, the Bundesbank will be left holding the bag for those Target2 liabilities. Leaving the common currency is technically impossible, and in any case the ECB maintains that any liabilities would have to be paid back. But the Greek crisis and now the uncertain outlook in Italy worries the German public — however the Luxembourg court rules after Tuesday’s hearing.

Frank Wiebe covers monetary policy for Handelsblatt. Darrell Delamaide adapted this article into English for Handelsblatt Global. To contact the author: wiebe@handelsblatt.com.

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