On Wednesday, the German Constitutional Court will hold a public hearing on the legality of the European Central Bank's "outright monetary transactions" (OMT) program.
The OMT is a program announced last summer that gives the ECB the ability to backstop government bonds, provided said country agrees to oversight and reforms.
Remarkably, the ECB has yet to actually engage in any outright monetary transactions.
However, as ECB President Mario Draghi put it in a press conference on Thursday following the central bank's latest decision on monetary policy, "OMT has brought stability, not only to the markets in Europe but also to the markets worldwide."
As such, people are talking about this week's court hearing.
Société Générale interest rate strategist Ciaran O'Hagan asserts that there is " much concern over what damage talk at the German constitutional court might do."
"In the 29-page Buba report leaked last April, there was some choice criticism of the ECB’s powers by the Bundesbank," writes O'Hagan in a note to clients . " A speech along the same lines by Mr Weidmann would hurt peripherals, and that is the key near-term threat. "
Arguably, the biggest issue on the table is whether OMT impinges on the German constitution.
Deutsche Bank's Europe economists provide a pretty good overview of the subject in their latest note to clients:
- The first requirement is that the budgetary prerogative and the budgetary competences of the Bundestag are not endangered. Against this background, the Court will certainly assess whether the unconventional measures of monetary policy are subject to sufficient control by the German parliament and the legislative and how this could be reconciled with the ECB’s independence. As there is a parliamentary prerogative on any ESM programme (simple majority) as a precondition for any OMT intervention, parliamentary control might be regarded as given – although it cannot be ruled out that initiating OMT in the end leaves the Bundesbank’s balance sheet and thus indirectly the German taxpayer with higher liabilities than formally decided under the ESM. However, as the OMT was explicitly limited to bonds with a maturity from 1 to 3 years, it should be possible for the Bundestag to assess the upper limit of potential ECB interventions (given member states’ current refinancing structures).
- The second requirement refers to the question whether the ESCB’s secondary market interventions will influence the identity of the German constitution. According to Art. 88 of the Basic Law the competences of the Bundesbank can be transferred to the ECB provided it is independent and adheres to the prior goal of price stability. In this context, the assessment whether OMT will put price stability at risk could become an issue. The Court faces the difficulty of having to rule (1) on the constitutionality of the ESCB’s unconventional monetary policy while fully respecting (2) the Bundesbank’s independence in order to comply with the constitution. One option to address this conflict: The Court could demand that the Bundestag has to take note of the Bundesbank’s opinion before OMT-related ESM decisions are taken that affect German liabilities.
- The Bundesverfassungsgericht has stated in previous judgments that it will not make any economic assessments of euro area support measures. So this view is going to limit its bite over the coming months. Instead, the court will analyse more the legal consistencies between the German Constitution, the ECB’s actions and European treaties. Talk that the court will set constraints on ECB market interventions is over the top; the court is unlikely to comment on such matters.
This week's events only entail a hearing. The actual court rulings will likely come later in the year.
"We are fearful of what Mr Weidmann will say now, but we do not expect the German court to rock many boats over the coming months," says O'Hagan. "Indeed, by Europeanising the ECB’s interventions, the court could end up strengthening the ECB’s powers."
And, once again, one of the remarkable aspects of this story is the fact that OMT has not even been activated yet.
"The more serious issues for investors are whether the ECB is at all serious about OMT and whether it will ever act on all its talk," says O'Hagan. "For now investors have blindly accepted the ECB’s talk at face value. But what if they think that the emperor doesn’t have enough clothes? That is a more real threat to [euro area] peripherals."
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