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Germany’s ESM ruling: Doves versus Hawks

Germany's constitutional court ruling on Wednesday ratifying the European Stability Mechanism (ESM) provided a welcome fillip to European and global markets, but issues surrounding the European Central Bank's (ECB) involvement remain politically sensitive.

In a note from JPMorgan’s European rates strategists, they argue that the German constitutional court’s summary ruling – a final ruling is anticipated later this year – was predominantly dovish in tone, ultimately giving the green light to the use of the ESM without the burden of new restrictions:

 “On balance, we view the constitutional court’s ruling as dovish. The court has essentially rubber-stamped the ESM and imposed no further major conditions on German parliamentary procedure when it comes to approving aid packages.”

This is because of four simple reasons:

 “First, the ESM is allowed to be ratified, almost as-is.

Second, the court made a summary review of overall ESM constitutionality before deciding on whether to issue the injunction. No major issues were flagged during the court’s three-month review, which indicates a high probability that the ESM will be found constitutional in the court’s final decision.

Third, the two conditions that the court imposed on ESM ratification are relatively minor, and don’t limit maximum ESM size or cost much in terms of ESM flexibility.

Finally, and perhaps most importantly for the future, the court also found that Germany’s ratification of the fiscal compact was constitutional.”

To a great extent, it is as if Germany was resigned to the fact it was destined to be Europe’s saviour. Indeed, the ruling allows for a lot of flexibility on Germany’s part:

 “It sounds to us like the German court has been convinced that no way out of the current crisis is costless, and that the legislature must be allowed to decide on the best of the bad options available to it. This makes it easier, in our opinion, for Germany to make bailout contributions or upsize its ESM commitment in the future if needed, than otherwise might have been possible.”

However, there is one area where Germany will allow less room for manoeuvre. The court appeared much more hawkish on the point of ECB/ESM interaction and ECB secondary-market purchases:

The main area where the constitutional court sounded hawkish was on ECB issues, which remain politically sensitive in Germany. First, the court appears to rule out ECB financing of the ESM (via both debt issuance and repo operations), stating that this would violate the prohibition on monetary financing. Second, the court stated that ECB bond purchases should not be aimed at sovereign monetary financing /capital market access. The German court cannot consider whether the Maastricht Treaty is violated (this is up to the European Court of Justice), but it can consider whether the framework upon which Germany joined the EU has been violated.”  

On Wednesday, the court did not elaborate much on the reservations it has against the ECB, but expect further disputes to come out of this.

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