Tuesday 20 August 2019

European Court of Justice rules ECB bond-buying programme legal

We need Euro area recovery for real growth; European Central Bank (ECB) headquarters in Frankfurt, Germany. Photo: Bloomberg
We need Euro area recovery for real growth; European Central Bank (ECB) headquarters in Frankfurt, Germany. Photo: Bloomberg

Ailish O'Hora

The European Court of Justice (ECJ) has ruled that the European Central Bank's bond-buying programme is legal, once certain conditions are met.

The conditions identified by the court’s advocate general include an assurance that the ECB does not provide “direct” financial assistance when it buys the debt issued by a euro zone member state.

The ruling states that “direct involvement in the financial assistance programme that applies to the State concerned”.

Essentially that means that OMT can be used to drive down the borrowing costs of a country by buying bonds but the bank can't fund a bailout.

Pedro Cruz Villalon, advocate general at the court, said while the ECB was entitled to buy bonds and that the scheme outlined was "necessary" and "proportionate", it would first have to spell out its justification and remove itself from any direct aid programme to a euro zone member state.

That would make it difficult for the ECB to continue as a member of the troika of inspectors that supervises Greece and Cyprus with an emergency aid programme if they were also to benefit from bond-buying.

"The Advocate General ... considers that the OMT programme is necessary as well as proportionate in the strict sense, since the ECB does not assume a risk that will necessarily make it vulnerable to insolvency," the court said in a statement.

Although Wednesday's opinion looks at a bond-buying blueprint from 2012, designed at the height of the crisis to avert a break-up of the euro, it could shape future QE (quantitative easing) to buy state bonds in order to avert deflation.

The adviser's opinion is another milestone in a long-running dispute about printing money between the ECB and Germany, the largest member of the 19-country bloc.

The ECB is on the verge of announcing a scheme as soon as next week to buoy falling prices and put the struggling economy back on a steady footing.

The adviser fired a shot across the bows of the German Constitutional Court, which had referred the question to Europe's top court, saying it was hard for courts to call the ECB into question as they had little expertise to do so.

“The ECB must have a broad discretion when framing and implementing the EU’s monetary policy, and the courts must exercise a considerable degree of caution when reviewing the ECB’s activity, since they lack the expertise and experience which the ECB has in this area,” the statement said.

However, it may limit ECB President Mario Draghi's room for manouevre as he tries to make good a promise to do 'whatever it takes' to save the euro.

The pressure for OMT policy action has been intense as falling oil prices pulled consumer prices into negative territory across the euro zone last month.

The impact was also clear in the UK this week where inflation halved to just 0.5pc in December, the lowest in over 14 years. That only reinforced market expectations the Bank of England would not be able to hike rates until 2016 at the earliest

Likewise, investors are wagering the Federal Reserve will find it hard to start tightening in the middle of the year, as some policy members have suggested.

In just the past three weeks, Fed fund futures have priced out 25 basis points of hikes for this year and now see just one move to 0.5 percent by Christmas.

The risk of low inflation for longer has in turn pulled down bond yields globally, with five-year debt in Germany and Japan now paying nothing at all.

One side effect of plunging bond yields is to make gold more attractive as an alternative investment.

Since gold does not pay a return, an opportunity cost for holding it is the yield forgone on safe-haven bonds. Now, that cost has diminished to the point where buying gold offers the same return as lending money to Germany for five years.

The yellow metal was steady around $1,231.60 an ounce after touching a three-month peak.

(Additional reporting Reuters)

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