Eurozone leaders breathed a sigh of relief Wednesday as the European Union’s top court indicated that ECB President Mario Draghi’s promise to do “whatever it takes” to save the euro is on solid legal ground.
Cruz Villalon, an advisor to the European Court of Justice, said that the European Central Bank hasn’t exceeded its powers in giving itself the right to buy the bonds of struggling governments in order to stop the Eurozone breaking up.
In doing so, he effectively nixed a complaint brought by disaffected German scholars and investors and backed by many in Germany, including the Deutsche Bundesbank (though not, importantly, by the government in Berlin). Germany’s Constitutional Court had supported the plaintiffs last year, but had referred the case to the ECJ in Luxembourg because of its Europe-wide dimensions.
Villalon’s opinion isn’t binding, but the ECJ generally tends to follow the thinking of its advocate-general. A final ruling is expected around the middle of this year.
It was the ECB’s “Outright Monetary Transactions” program, outlined by Draghi in 2012, that turned Eurozone bond markets out of a destructive spiral that threatened to push countries as big as Spain and Italy out of the currency union in 2012.
Italy’s 10-year borrowing costs had soared to over 7% as investors feared that they would be repaid in a reintroduced and sharply-devalued lira rather than in euros. The measure of how much the markets trusted Draghi’s promise is that, as of today, Italy’s 10-year bonds yield only 1.72%–despite the fact that its debt burden has risen after another two years of virtually no growth.
Villalon added only a couple of minor provisos to his opinion, saying that the ECB mustn’t take any part in devising bailout programs for Eurozone nations in future, and adding that the program must still leave room for the market to set a representative price for a government’s bonds.
But he rejected conditions that the German Constitutional Court had said it wanted to be attached to the ECB’s actions, such as imposing “ex ante” limits on the amount it could buy, and insuring that the ECB got repaid ahead of other investors if a country subsequently defaulted.
“The Eurozone’s rescue shield stays strong, making it unlikely that it will ever actually have to be used,” Berenberg Bank analyst Christian Schulz wrote in a note to clients.
The most immediate consequence of the court’s opinion, Schulz said, is “bad news for Greece’s radical left opposition,” as the ECB will be able to use OMTs to limit the fallout if a new Greek government rips up its existing bailout deal and leaves the Eurozone.
Just as importantly, the opinion is a big boost for the ECB as it prepares to embark on another radical program that is also fiercely disliked in Germany. Draghi told the German weekly Die Zeit that the ECB is now “ready” to start a ‘quantitative easing’ program of buying government bonds, aiming to stop the Eurozone from falling into a deflationary spiral. The annual rate of inflation dipped to -0.2% in December, its lowest since the financial crisis.
“The risk of deflation is still low, but it is certainly bigger than a year ago,” Draghi said.