Weak growth and negative inflation will keep the pressure on the ECB to ease policy. We forecast November Euro area industrial production to grow only 0.1% m/m, in line with the bleak momentum in both the European Commission and PMI surveys. The EUR is trading at 1.178, the lowest level since 2005.
Will the court’s verdict hamper the effectiveness of any potential OMT or QE programme?
Although ECB President Draghi refused to be drawn into a discussion on the technical features of a government bond purchase programme in the ECB December press conference, he readily conceded that the imposition of ECB seniority over private holders of government debt could be counterproductive.
An exclusion of ECB held debt from any debt restructuring would likely increase the haircut imposed on privately-held bonds. In the OMT announcement, the ECB promised the same (pari passu) treatment as private creditors with respect to bonds issued by euro area countries and purchased by the Eurosystem, in accordance with the terms of such bonds; however, the ECB never followed up, as announced, with a legal act that would have clarified this issue.
When Greece restructured some of its government bonds in 2012, the ECB did not take part and received new bonds shortly before the debt restructuring which were then excluded/exempt from this event. At the time, many argued that the ECB could not legally participate in any such debt restructuring where nominal debt relief is granted.
Reportedly, the decision to exchange the bonds held by the ECB and to exclude them from the restructuring was made at the level of government heads. Official (public) debt relief and/or public debt restructuring is inherently a political decision and the German constitutional court made it clear that it considers a haircut on euro area government debt held by the ECB as an illegal act of monetary financing prohibited by the EU Treaties.
In contrast, the ECB’s Legal Council has argued that the acceptance by the ECB of the pari passu treatment simply reflects the legal position enjoyed by the Eurosystem in any open market operation (see, The ECB’s OMT in the Courts, IMFS Frankfurt). He further noted that as of 1 January 2013, collective action clauses (CACs) must be included in all new euro area government securities with maturity above one year and, against this background, the ECB would be subject to a resolution adopted by the relevant majority of bondholders outweighing the ECB’s vote (assuming the ECB would not be the majority holder of that bond itself). However, a debt restructuring (and bond holder vote) would only be triggered if a eurozone member state is seeking debt relief and one could argue that a member state cannot do that if it involves the ECB without violating the EU Treaty and the “no bail-out” clause.
The EU court (in its ruling about the ESM forwarded by the Irish constitutional court in the ’Pringle’ case) highlighted that the ”no bail-out” clause in Article 125 TFEU states that neither the Union nor a Member State are to ”be liable for … the commitments” of another Member State or ”assume [those commitments]”. Moreover, the court stated that Article 123 TFEU, which prohibits the ECB and the central banks of the Member States from granting ”overdraft facilities or any other type of credit facility”, employs wording which is stricter than that used in the ”no bail-out clause” in Article 125 TFEU.
All in all, it therefore cannot be ruled out that the ECJ (and the Advocate General may state this already in his opinion), sides with the German court and insists that all member states always have to fully repay any credit they owe to other member states or Union institutions including the ECB at least in nominal terms (this is the key issue for us but other questions forwarded by the German Court are listed in the Appendix below).
Such a view, which entails the imposition of (absolute) seniority for EU institutions and member states would render the discussion of risk sharing across the Eurosystem for potential government bond purchases largely irrelevant since haircuts on ECB held debt of a member state would be effectively ruled out. The (Bundesbank) proposal to have national central banks (NCBs) take the risk of any government purchases on their own (and only buy the debt of their own sovereign), amounts to the economic equivalent of imposing seniority because a national central bank is part of the broader government and therefore cannot effectively grant debt relief to its own sovereign, at least in net present value terms.
In case of a fully-fledged default and exit from EMU of a member state, the remaining Eurosystem members would have to share eventual losses in any case.
Next to OMT itself, the ruling could therefore have an adverse impact on the effectiveness and design of broad-based ECB government bond purchases (QE), which we consider likely to be announced next week.