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ECB's OMT program not against the law

June 21, 2016

Germany's Constitutional Court in Karlsruhe has issued a closely watched ruling on the legality of the ECB's program of Outright Monetary Transactions (OMT). It said the bond-buying instrument did not violate the law.

Germany's supreme court
Image: picture-alliance/dpa/U. Deck

The judges on Tuesday reacted to a class-action lawsuit brought by thousands of German plaintiffs against a superpower the European Central Bank had claimed since 2012. They argued the lender's OMT program was not within the ECB's mandate and stripped the German parliament of the right to agree to or reject burden-sharing financial guarantees among eurozone member states.

While Karlsruhe did not come up with an outright objection to OMT, the court raised some objections, asking for the scope of any participation in the scheme by the German central bank, the Bundesbank, to be monitored closely by parliament and also asking for OMT to be more strictly dependent on reform pledges from ailing economies of the eurozone.

Limiting OMT would have been unlikely to have had immediate consequences for the ECB, but it might have dented confidence in its ability to tackle crises, and it may also have raised doubts about the use of any future unconventional tools.

Although never used, the ECB's controversial Outright Monetary Transactions program in principle allowed the bank to stop eurozone governments from teetering on the edge of bankruptcy by buying sovereign bonds in whatever quantities needed to keep those nations financially afloat.

The program came into being as a result of ECB President Mario Draghi's remarks back in July 2016 when he said that within the bank's mandate, the ECB would "be ready to do whatever it takes" to preserve the euro.

The very announcement of the OMT bond-buying program had a calming effect on markets to such an extent that southern European governments quickly saw their interest rates on bonds lower dramatically, enabling them to borrow fresh money under much better conditions as private bond markets no longer doubted the solvency of countries like Italy or Spain.

Huge impact

It's worth noting that no such transactions have ever been made under the OMT program as the sheer announcement of it was enough to achieve the desired impact.
Under the European Union's founding treaty, the ECB is not allowed to buy government bonds from eurozone governments directly. To get around this limitation, the central bank had made it clear right from the start that it would buy OMT-related bonds only from secondary bond markets, that is from private institutional investors such as pension funds or commercial banks, which had previously bought those bonds from the governments that issued them.

The European Court of Justice had already ruled in June 2015 that the OMT scheme was legal, but it transferred the matter to Karlsruhe to revisit the issue.

Had Germany's supreme court ruled against OMT as such, it could have thrown several European governments into a tailspin in the long term by making it impossible for the ECB, as a lender of last resort, to guarantee eurozone countries' solvency.

hg, nz/cjc (dpa, Reuters)