Draghi Faces Legal Test on Bond Buys as ECB Readies QE Plan

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ECB President Mario Draghi
The Frankfurt-based ECB in September 2012 announced details of the OMT plan as bets multiplied that the euro area would break apart and after President Mario Draghi’s promise to do “whatever it takes” to save the currency. Photographer: Martin Leissl/Bloomberg

European Central Bank President Mario Draghi will get a legal readout tomorrow on a predecessor to the quantitative easing plan that he’s set to reveal later this month.

An adviser to the EU Court of Justice will say whether the European Central Bank’s Outright Monetary Transactions program overstepped the law in a non-binding opinion that may signal whether QE must also be reined in.

A negative opinion “would make the ECB’s life much tougher,” Carsten Brzeski, chief economist at ING-DiBa in Frankfurt, wrote in a note to clients yesterday. “It would be welcome grist to the mills of Germans’ opposition against QE. In our view, given the political and economic sensitivity of the Court’s verdict, an outright condemnation of the legality of OMT is highly unlikely.”

The Frankfurt-based ECB in September 2012 announced details of the OMT plan as bets multiplied that the euro area would break apart and after Draghi’s promise to do “whatever it takes” to save the currency. The calming of financial markets that the still-untapped OMT program produced helped the euro area emerge from its longest-ever recession.

Germany’s top court expressed doubts last year about the legality of the OMT program, when it referred the case to the EU tribunal in Luxembourg for guidance.

The national court said OMT may violate EU rules because it amounts to economic policy that is outside the ECB’s mandate. German judges said the plan may also be seen as monetary financing of governments, which the EU treaties ban.

Deflationary Spiral

Pedro Cruz Villalon, an advocate general at the EU Court of Justice, will issue his opinion at about 9:30 a.m. local time tomorrow.

The ECB is now fighting to stave off a deflationary spiral in the euro area after consumer prices fell in December for the first time in more than five years. Policy makers remain divided on the need for quantitative easing, with German-led opposition claiming it increases taxpayer risk and undermines the incentive for governments to push through economic reforms.

Government bond buying under QE would be part of fresh stimulus to be considered at the Governing Council’s Jan. 22 meeting. While Draghi says the deflation threat warrants action, the final decision is further complicated by Greek elections on Jan. 25, which could bring to power a party seeking to restructure the nation’s debt.

Final Decision

A 15-judge panel at the Luxembourg-based EU court is expected to give its final decision on the OMT case about four to six months after tomorrow’s opinion.

While the EU court usually follows such opinions, the court has been at odds with its advocates general in some high-profile cases. These include a landmark ruling in May concerning Google Inc. that gave citizens the right to be forgotten online. The U.K. lost a fight last January over EU short-selling rules even after an advocate general at the court had partly backed Britain’s stance.

“If the opinion is favorable and the conditions attached are not too restrictive, it would open the way to QE by the ECB right now,” said Pierre-Henri Conac, a professor of financial-markets law at the University of Luxembourg.

“The real question is the extent of the conditions the EU court will impose to allow for such a program,” said Conac.

The OMT program could pass the test if it were limited and placed under certain conditions, like banning debt writedowns and unlimited purchases of bonds of selected member states, the German court said.

“We do not think that these legal proceedings will unduly delay an ECB government bond purchase program,” said Antonio Garcia Pascual, chief euro-area economist at Barclays Capital in London. “Without a final ruling by the ECJ, however, the ECB might avoid certain language such as that interventions could be unlimited.”

The EU court case is: C-62/14, Peter Gauweiler and Others.

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