On Tuesday, the German constitutional court delivered a withering verdict on the governance around decisions of the European Central Bank (ECB) and the Eurosystem of national central banks over the public sector purchase programme (PSPP).
This programme was established in 2015, with ECB policy rates then already at the zero bound, to buy eurozone sovereign bonds and so provide further monetary stimulus to ward off dreaded deflation.
The programme kicked off modestly enough on March 9, 2015, with the initial purchase of €3.2 billion of bonds and a monthly target of around €60 billion.
Allegations that this constituted outright financing of sovereigns by the ECB – even though it buys bonds in the secondary market – were immediate and have rumbled through the courts ever since, with a finding from the European Court of Justice in 2018 that the PSPP was actually perfectly fine, thank you.
One of the hardest things we had to fight was to get central banks out of the vicious cycle of financing governments- Former Bundesbanker
By the time the German constitutional court delivered its recent judgment, the PSPP had grown to holdings of €2.189 trillion of government bonds.
This, the German court thinks, is really not fine at all. It focuses its attack on inadequate consideration given to issues of proportionality.
The German court points out that the PSPP clearly allows member states to obtain financing in the capital markets at considerably better conditions than would otherwise be the case.
It further points out that the PSPP transfers large quantities of high-risk government bonds off the balance sheets of commercial banks and onto the balance sheets of the Eurosystem central banks, and so notably improves the commercial banks’ credit ratings.
It judges that: “A programme for the purchase of government bonds, such as the PSPP, that has significant economic policy effects requires that the programme’s monetary policy objective and economic policy effects be identified, weighed and balanced against one another.”
It claims to find no evidence that the ECB has done any of this identifying weighing and balancing and declares that “by unconditionally pursuing the PSPP’s monetary policy objective – to achieve inflation rates below, but close to, 2% – while ignoring its economic policy effects, the ECB manifestly disregards the principle of proportionality”.
With that, and a withering slap to the European Court of Justice that its favourable rulings over the PSPP have been incomprehensible and ultra vires, the German constitutional court gives the ECB three months to conduct such an assessment, without which the Bundesbank may no longer participate.
This is not quite the inconsequential fudge that market participants had expected.
The accusation that central banks are directly financing governments is as old as quantitative easing itself.
Euromoney thinks back to the last eurozone sovereign debt crisis in 2011.
The ECB had set up its securities markets programme (SMP) in May 2010 to buy government bonds at a time when the bills were falling due for bailouts during the global financial crisis amid collapsing tax revenues that had swollen annual deficits and stretched public debt-to-GDP ratios.
At the SMP’s launch, the ECB had said that it would be temporary and limited, but insisted that it was needed because extraordinary variations in government bond spreads in thinly traded and dysfunctional secondary markets were preventing the even transmission of monetary policy.
In December 2011, Euromoney attended a heated public debate in Frankfurt between Antonio Sáinz de Vicuña, general counsel of the ECB, and professor Markus Kerber, of Technical University of Berlin, who accused the ECB of over-stepping the treaty limits imposed on it to prevent bailouts of sovereign states.
Just how could the ECB claim the programme was limited and temporary, Kerber wanted to know, when it had already been running for 18 months and had grown to a hefty sounding €200 billion.
That day, Euromoney sat next to the only person in the over-heated hall not becoming over-excited, an elegantly dressed and composed older gentleman. We smiled at each other, shook hands and chatted, he in better English than my own.
He was a former Bundesbanker, a veteran of negotiations with Latin American sovereigns over the debt crises of the 1970s and early 1980s. He wanted to share some lessons from a quarter of a century and more earlier.
He recounted: “One of the hardest things we had to fight was to get central banks out of the vicious cycle of financing governments.”
When we talked, Mario Draghi was still the new president of the ECB. This was more than six months before his famous “whatever it takes” speech. But it was already obvious that, rather than scaling back purchases of government bonds as Kerber and his backers demanded, the ECB would have to buy far, far more.
With private sector investors already bailed in on Greek debt, Italian sovereign bonds being quoted at 85 cents on the euro, and Spanish government bonds in the low 90s, risk aversion was already spreading to France as well.
The European government bond markets had reached a cliff edge with talk turning to various forms of debt restructuring, if not outright default. The yield on 10-year Italian government bonds hit 7.3%.
Return to the cliff edge
That’s where it looks as if we are headed once more. Calls for jointly guaranteed sovereign bonds have once again been rejected in 2020 as they were in 2011.
By the start of this month, economists were starting to project falls in eurozone GDP of above 6% in 2020, even with further support from governments and the ECB to offset the only gradual re-opening of economies. Recoveries will, sadly, not be as rapid or as sharp as the shutdowns.
UBS suggests eurozone budget deficits for this year will come in at between 8% and 11% of GDP, with Germany at the low end and France and Spain at the high.
It sees debt-to-GDP ratios rising by between 12 and 22 percentage points this year, to 71% in Germany, 116% in France, 114% in Spain and 156% in Italy.
As a result, the eurozone will remain, for years to come, dependent on the ECB keeping interest rates and sovereign bond yields low. Today, 10-year Italian government bonds yield 1.9%, but the key risk is that sovereign debt markets will experience greater tensions.
The debate about mutualization of eurozone sovereign debt is set to continue.
We hope our old friend from the tussle at the Haus am Dom in 2011 is still following it.
I’m sure the lesson he would take is that, in sovereign debt terms, we are all emerging markets now and we are very close to the precipice once more.