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Week Ahead (5 May)

w/c Tuesday, 5 May – Markets digest German Constitutional Court partial ruling against ECBs’ QE programme

In our preview piece of 29 April, we highlighted the potential for the German Federal Constitutional Court (FCC) to impose limitations on the European Central Bank’s Expanded Asset Purchase Programme (QE). Strengthening our view was the fact that FCC President Andreas Vosskuhle, who had fired several warning shots at the ECB over the years, retires tomorrow.

The FCC ruled today that QE was an ultra vires act which “is not to be applied in Germany, and has no binding effect in relation to German constitutional organs, administrative authorities and courts.” It therefore ruled that after a “transitional period of no more than three months” the Bundesbank would no longer be able to participate in QE unless and until the ECB adopts a new decision showing that “the monetary policy objectives pursued by the ECB are not disproportionate to the economic and fiscal policy effects resulting from the programme.”

Our preview piece outlined our expectation that the FCC would not reject QE out of hand (and it rejected the constitutional complaints by 7 votes to 1) but could rule that German participation in the QE programme would only be legal provided some conditions were met, similar to its OMT ruling. As anticipated, the FCC ruled that QE would only be legal provided:

- the purchase limit of 33% per international securities identification number (ISIN) is observed;

- purchases are carried out according to the ECB’s capital key;

While this ruling did not pertain to the ECB’s pandemic emergency purchase programme (PEPP) per se, it renders the PEPP’s legality questionable, at least in the eyes of the FCC and we would anticipate that legal challenges will be quickly submitted at the FCC. As outlined in our preview piece, the PEPP significantly deviates from the ECB’s capital key and has bought over 60% of new Italian debt issuances. While the GC is likely to be able to adopt a new decision to enable the Bundesbank’s continued participation in the ‘ordinary’ QE programme, today’s decision unleashes a wave of uncertainty as regards the PEPP and the ECB’s ability to fight future crises. This is reflected in a spike in Italian ten year debt at the time of writing.

Today’s decision also shakes the EU’s legal foundation. Although the Czech Constitutional Court also rejected a ruling by the ECJ in 2012, this is the first time a national court of a large EU Member State has stated that it would not honour the decision of an EU court. The fact that it relates to the ECB’s ability to protect the single currency – the main factor saving it from collapse – is all the more significant.

Wednesday, 6 May - EU Anti-Money Laundering plan to be launched

The European Commission will unveil plans for a new anti-money laundering body on Wednesday. A draft Commission action plan showed that initiatives are afoot that are scheduled to come into being in 2021, while a new AML monitoring body might be almost three years away.

While there had been some division on the eventual shape of the new body, it seems the Commission has come down in favour of a brand-new entity, with the draft specifying, "Establishing an EU central supervisory mechanism will increase compliance with the rules. This will ensure that adequate action is taken in order to prevent money laundering from occurring in the first place and that, when this cannot be achieved, effective sanctions are imposed."

Thursday, 7 May - Tackling the economic crisis - Commission draft of MFF due; ECB announces new round of lending

With last week's confirmation that the Eurozone economy has shrunk at the fastest rate on record in the first quarter of 2020, attention once again turns to the response of the European institutions. The European Commission is expected to publish a draft of the new Multiannual Financial Framework on Thursday, which also aims to unlock as much as €2 trillion in financing for a recovery fund for member states. We find the €2 trillion figure highly unrealistic.

The prevailing view within the EU is that the provision of credit, rather than grants, should form the centrepiece of efforts to tackle Covid-19. This was well demonstrated at the ECB last week where it expanded its lending to banks at record low rates - as low as -1% - via a new round of Targeted Long-Term Refinancing Operations lending, as well as the establishment of a new Pandemic Emergency Long-term Refinancing Operation, PELTRO, which will allow banks to borrow at 0.25%. While it did not increase purchases under the Pandemic Emergency Purchasing Programme (PEPP), it said the possibility remained open to it and that it could be considered in future.

Friday, 8 May - Italy and Greece credit ratings to be reviewed (Moody's and DBRS respectively)

Italy will this week have its credit rating reviewed by Moody's, while Greece will be assessed by DBRS. The reviews come after Fitch made an unscheduled review of Italy's credit rating on Wednesday, downgrading it to BBB-, or one level above junk rating. Fitch cited the economic impact of Covid-19 as the reason for the downgrade and forecast that the Italian economy will contract by 8% this year, which is in line with the government’s own projection made last week, and said Italy’s public debt will climb to 156% of gross domestic product from 134.8% in 2019.

Greece maintained its BB- rating from S&P last week, three ranks below investment grade, but revised its outlook downward from positive to stable given the economic damage caused by the health crisis.

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