The European Central Bank is brushing aside fresh legal action against its emergency bond purchase programme, promising more bond market support to withstand yield increases stemming mainly from US forecasts of higher inflation.
Christine Lagarde, ECB president, signalled an uneasy truce between factions on its decision-making council, with members favouring continued monetary accommodation at least temporarily regaining the upper hand. The ECB declared on 11 March it would ‘significantly’ increase the pace of bond-buying under its €1.85tn pandemic programme (PEPP) during the next three months, following a sharp reduction in purchases in recent weeks.
As with previous court cases, the ECB is reacting with frosty hauteur to the latest shot across its bows – a 150-page lawsuit delivered to the Karlsruhe constitutional court by a group led by Professor Markus Kerber, a Berlin-based lawyer. The legal action, which will take at least a year to get to the first stage of litigation, is Kerber’s eighth lawsuit over two decades contesting European monetary and fiscal policies shoring up the euro.
The effect is likely to be as much psychological and political as economic. Announcement of the new lawsuit was timed to coincide with Lagarde’s regular press conference announcing ECB policy moves. It will increase underlying vexation in German public opinion at central bank policies seen as unfairly disadvantaging savers and privileging debtors in the euro area.
The complaint goes beyond previous cases in deploying specific arguments laid out in the constitutional court’s landmark judgment of May 2020, setting down clear criteria on what constitutes illegal monetary financing under the European treaties.
One specific aspect of the lawsuit – innovatively supported by five German individuals with financial market backgrounds among Kerber’s 10-strong plaintiff group – takes aim at easing collateral conditions under the March 2020 PEPP rules. The lawsuit claims this is illegal under article 18 of the ECB’s governing statutes calling for ‘adequate’ levels of collateral.
The plaintiffs believe that the ECB was hampered in announcing the PEPP in March when the Karlsruhe judgment in the 2015-20 previous landmark asset purchase case had already been made but had not been announced, because of a delay in procedures caused by Covid-19. Had the ECB known about the judgment published eventually on 5 May, it might have framed the legal language for the PEPP more carefully.
Divisions over the PEPP on the ECB council appear to be rising as recovery gains momentum, although at an uneven pace around the world. More hawkish members see rising bond yields as a healthy sign of predictions of higher inflation, indicating central bank policies are starting to work. Doves – including Lagarde and other high-profile ECB board members – regard this as an undesirable indication of worsening financial conditions at a time when many European countries are struggling to return to economic and social normality.
On 11 March, Lagarde declared that the ECB was not practising ‘yield curve control’ to depress euro member states’ bond yields with massive asset purchases. She was contradicted by Mervyn King, former governor of the Bank of England, and Otmar Issing, former ECB board member for economics, at an OMFIF meeting two hours after Lagarde’s press conference.
A desire to maintain loose financial conditions was forcing the ECB into de facto yield curve control, Issing professed, which is a grave threat to central bank independence. It was the abandonment of this same policy, King asserted, that allowed the US Federal Reserve to become a truly independent central bank in the post-war period, when it liberated itself from an obligation to cap government bond yields as part of the 1951 Fed-Treasury Accord.
On the issue of central bank independence, King underlined there is ‘no immediate challenge to central bank independence in a formal sense’, pointing to the legally tortuous nature of treaty changes required to alter the ECB’s status.
However, both expressed concern over the indirect pressure that governments might exert on monetary policy. Issing worried that central banks might find themselves in a trap of ‘fiscal and financial dominance’. Recent upturns in long-term interest rates, spreading from the US into the euro area and rattling financial markets, accentuated the view that highly indebted governments had become dependent on central bank action.
Central banks have developed a hubristic instinct to loosen policy at the slightest sign of bad news, Issing warned, a trend which would only bring future problems. Both King and Issing made a plea for policy humility: central banks should rethink their role in contemporary macroeconomic management, especially considering their paltry record in macroeconomic forecasting and modelling.
The pandemic-induced economic upset, both concurred, is a deeply complex, sector-specific shock, striking at a time of profound systemic change in the global economy. Given the circumstances, markets will be ‘sceptical’ of central banks’ ‘ability to fine-tune an economy so precisely’, King warned, raising profound questions about the efficacy of monetary policy.
In view of this, while ‘the pandemic is not a time for change,’ central banks ‘need an exit strategy,’ Issing said. The long sought ‘moment of truth’, he added, would come not abruptly but in stages –‘slowly but not smoothly’.
Pierre Ortlieb is Economist and David Marsh is Chairman of OMFIF.