- ECB's job at supporting Eurozone economy made harder
- Functioning of Eurozone now questioned
- Euro absorbed fresh anxieties
- But Sterling will struggle to break solid resistance line
Above: Lady Justice statue, Frankfurt © Adobe Images
- Spot GBP/EUR exchange rate at time of writing: 1.1472
- Bank transfer rates (indicative guide): 1.1170-1.1250
- FX specialist rates (indicative guide): 1.13-1.1350 >> more information
A ruling by a German court that says the European Central Bank's flagship quantitative easing policy is unconstitutionally sound has allowed the Pound-to-Euro exchange rate to move higher and test a formidable resistance level once more, which if broken could open the gate to fresh multi-week highs.
The Euro fell against the British Pound and other major currencies after Germany's Constitutional Court (GCC) said that the purchase of government bonds by the Bundesbank under the ECB's Public Sector Purchase Programme (PSPP) had a questionable foundation in European Union law.
Unless European authorities are able to make the necessary changes to satisfy the German court there is the potential for further anxieties concerning the Euro to build, which should allow Pound Sterling to extend higher.
"The Euro has been bruised by a ruling from Germany's Constitutional Court on Tuesday, and it may take time for those bruises to heal. The German court ruled that the Bundesbank must stop buying government bonds under the European Central Bank's long-running stimulus scheme within three months unless the ECB can prove those purchases are needed," says Robert Howard, a Reuters market analyst.
The Pound-Euro exchange rate has rallied back to resistance in the late 1.14s and early 1.15s area; an area that Sterling has been unable to crack since April 13. If the pair fails to transcend this level we would expect further sideways movement, or even a capitulation lower.
However, a break could open the door to notably higher levels, with the mid-February highs at 1.20 becoming an obvious multi-day target.
Court Ruling Strikes at the Heart of the Eurozone
The GCC has granted the ECB and European lawmakers three months in which to amend how it conducts its quantitative easing programme.
While the court did not find the ECB had carried out "a violation of the prohibition of monetary financing of Member State budgets", it did cast doubt on an earlier European Court of Justice’s judgement that the PSPP satisfied "the principle of proportionality".
The ECJ's judgement that the programme was proportional was "not comprehensible" according to the German court.
Therefore, it was ruled that German authorities acted unconstitutionally by not challenging the €2.7 trillion plan when it was launched by the ECB in 2015.
Above: A breakdown of the ECB's quantitative easing programme shows the PSPP is by far the dominant force
In order to remedy the problem, the German court ordered that:
"Following a transitional period of no more than three months allowing for the necessary coordination with the Eurosystem, the Bundesbank may thus no longer participate in the implementation and execution of the ECB decisions at issue, unless the ECB Governing Council adopts a new decision that demonstrates in a comprehensible and substantiated manner that the monetary policy objectives pursued by the PSPP are not disproportionate to the economic and fiscal policy effects resulting from the programme.
Unless changes are made, Germany's central bank (Bundesbank) must also ensure that the bonds already purchased and held in its portfolio under the PSPP programme are sold off.
Such sales would cause a sizeable and potentially economically destabilising rise in the yield on German bonds, which would impact borrowing costs right across the Eurozone.
In short, years of effort by the ECB to keep the Eurozone glued together will unravel and it is little wonder the Euro came under pressure.
"The euro was more than a half percent weaker on the day, a slide inspired by a German court ruling that the ECB had to demonstrate that a key stimulus program was both necessary and appropriate. The euro tumbled as the court ruling stoked uncertainty over ECB policy and suggested limits to what the central bank could to bolster the bloc’s sputtering economy," says Joe Manimbo, Senior Market Analyst at Western Union.
Press release: ECB takes note of German Federal Constitutional Court ruling and remains fully committed to its mandate https://t.co/n5vi0Wg911— European Central Bank (@ecb) May 5, 2020
However, Dr. Andreas Rees, Chief German Economist at UniCredit Bank, says he is confident authorities will do enough to satisfy the courts and therefore allow the Bundesbank to continue participating in the ECB's quantitative easing programme.
"In our view the GCC verdict makes the ECB's life more complicated with a lot of paper work to be done. However, and importantly, the GCC did not shoot down the PSPP itself but demanded an "improvement" in the process of the PSPP which might be delivered by the ECB soon," said Rees. "In other words, the likelihood of the Bundesbank participating in the PSPP further beyond the three months is significantly higher than the Bundesbank being forced to leave the programme abruptly."
Therefore, the Euro's newfound anxieties could ultimately be short-lived, something to keep in mind for those readers looking to buy discounted euros.
"The German ruling is a big negative for the Euro," says Marshall Gittler, an analyst at BD Swiss, "taken to extreme, the German court’s ruling could mean that the court forces the Bundesbank out of the ECB Target 2 payment system and in effect pushes Germany out of the euro, although I sincerely doubt if it would go that far."
Responding to the ruling, the ECB said while it "takes note" of the judgment by the GCC it remains "fully committed" to its price stability mandate, adding:
"The Court of Justice of the European Union ruled in December 2018 that the ECB is acting within its price stability mandate."
"Quite clearly the German court cannot overrule the ECJ – that's the whole point, it’s why we wanted out. Italy’s PM Conte agrees, noting that ECB independence is at the heart of European treaties," says Neil Wilson, Chief Analyst at Markets.com.