EUR has been slammed in recent trade, following an unfavourable ruling from a German Court on the legality of current ECB asset purchases under the German Constitution. EURUSD was trading just above 1.09 prior to the ruling, but has now slipped to the below 1.0850.
Risk appetite more generally did not react too well to the ruling. Risk FX (AUD, NZD, CAD, NOK and SEK) all slipped in tandem with EUR, European stocks fell (all though at the time of writing, are still in the green on the day), while the yield on Italian debt rose sharply (reflecting a greater risk that ECB bond-buying will be unable to keep Italian debt servicing costs in check).
In summary, the German Supreme Court was unable to find the ECB’s PSPP (QE) programme as a violation of monetary financing (which is illegal under the German law), however, it did find that some of the actions taken by the ECB are not valid in Germany. As such, the ECB now has a three-month deadline to clarify that the PSPP programme is 'proportionate' or the Bundesbank (the German Central Bank, that forms part of the ECB) will no longer be allowed to partake in the QE programme. The ruling does not apply to COVID-19 related matters (i.e. the EUR 750bln Pandemic Emergency Purchase Programme).
In simpler terms (cause that's how we do it at Freak Network!); the ECB is made up of al the national central bank’s of the countries of the Eurozone, including Germany’s Bundesbank. The German Court has pretty much ruled that unless the ECB can demonstrate that the purchases made under the PSPP (a QE programme) are “proportional”, the Bundesbank will be prohibited from partaking in the programme and will be forced to sell back all the bonds that it bought. “Proportional” is a term open for interpretation, but given that 40% of all assets purchased under the PSPP programme have been Italian debt, it may be difficult for the ECB to argue such.
Attention now turns to how the ECB demonstrated proportionality, whether or not the Court needs to rule again to prevent the Bundesbank from partaking in ECB QE. Moreover, if the Bundesbank if forced to exit the ECB’s QE programme, could the other European national central banks just buy all of its assets and continue the ECB’s QE programme as normal?
Why all of this matters?
The Eurozone is fraught with division that is threatening the continued existence of the EUR.
Generally speaking, there is a cultural divide in the EU on key economic and monetary policy issues that comes down to this;
Northern countries (Germany, Netherlands, Finland, Austria etc) have low debt levels due to years of tightly controlled government spending. These countries typically have higher saving rates and export to the rest of the continent. They are generally considered to have the best economies. Due to their higher saving rates, they prefer more hawkish central bank policy (to reward savers with higher interest rates).
Southern countries (Italy, Greece, Spain, Portugal, even France) have much higher debt levels, following years of more wasteful government fiscal policy. These countries have a low saving rate and are generally net importers of goods from the northern states. Due to their high debt levels, these countries prefer more dovish ECB policy, to keep their debt servicing costs lower.
ECB policy has been very dovish over the last decade because if it wasn't, borrowing costs for many of the southern states would become too high (like in the debt crisis in 2010-12) and they might need to exit the Eurozone - ending the whole project.
However, this dovish ECB policy comes to the great annoyance of many of the northern states.
This “annoyance” is the motivation behind the whole of today’s case that went before the German Supreme Court.
Now that the supreme court has ruled that there is a chance that the Bundesbank might be forced out of the ECB’s QE programme, the risk that the ECB will not be able to hold together the Eurozone is growing.
Hence why EUR fell off a cliff and Italian bond yields have shot through the roof.
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