EU’s bond buying plan hits a tricky legal curve

Luxembourg: The EU’s top court begins a potentially explosive legal review of the European Central Bank’s bond-buying plan, which may ultimately determine whether the scheme credited with ending the Eurozone’s sovereign debt crisis could ever be used.

The European Court of Justice is not expected to give a final ruling on the legality of the bond-buying programme - known as Outright Monetary Transactions (OMT) - until summer 2015. But Tuesday’s hearing could give an early sense of how the judges will handle the arguments in the case. It is also a reminder of the increasingly hostile sentiment in Germany towards the ECB’s exceptional measures for tackling the Eurozone crisis.

Ultimately the ruling could impinge on future asset purchases by the ECB under a wider quantitative easing programme designed to save the Eurozone from the threat of deflation. At a time the Eurozone crisis threatened to spin out of control in mid-2012 amid fears of Greece being ejected from the euro, instability in Spanish banks, and rising Italian borrowing costs, the announcement by EBC chief Mario Draghi that he would do “whatever it takes” - followed by the unveiling of the OMT programme - helped bring relative stability to the common currency that has held ever since.

The case has been closely watched because any court ruling that the ECB cannot use its printing presses to churn out cash that then, in turn, can be used to buy sovereign bonds of struggling countries, could raise questions about the bank’s ability to be a lender of last resort - potentially calling the currency’s survivability into question again.

According to court files, the ECJ will examine whether Draghi’s programme violates EU treaties’ “prohibition on monetary financing” - using central bank money to lend to governments - a policy that is not only illegal, but anathema in German economic circles.

The case has already made history. It follows the first ever referral to the Luxembourg court by Germany’s constitutional court earlier this year. The German case was originally brought by 37,000 people protesting against the legality of ECB bond-buying, announced in 2012 to calm markets but never used, and of the Eurozone’s bailout fund.

When referring the case, Germany’s constitutional court in Karlsruhe took the unusual step of outlining the ways in which it thought the OMT scheme would be illegal and breach the ECB’s mandate unless certain restrictions were imposed. The fear is that any caveats imposed by the ECJ could make the OMT, and future asset-purchases, less effective.

The German court also reserved the right to review the ECJ’s decision although most experts think such a constitutional clash - which would have grave consequences for the EU’s legal system - is unlikely.

The Karlsruhe judges asked the Strasbourg court to rule whether the bond-buying scheme exceeded the ECB’s mandate because it was tied to a programme of reforms and budgets cuts and targeted at selected Eurozone members. It also asked for a ruling on whether it breached EU law because bond purchases could be unlimited, take no account of default risk and treat private creditors in the same was as public ones.

Even if the generally pro-integration European Court rejects the Karlsruhe objections and these are respected by the German court, it could rebound politically in Germany.

“The risk is that with Karlsruhe potentially caving in, two of Germany’s most-trusted non-political institutions - the court and the Bundesbank - would subordinate themselves further to European law,” said Carsten Nickel of Teneo Intelligence, in a note. “In turn, this might increase pressures on the political system to better represent concerns regarding Europe.”

— Financial Times