Eurozone: The Judges Have Spoken, But the Jury is Still Out
On 5 May, Germany’s Federal Constitutional Court decreed that the European Central Bank (ECB) had exceeded its mandate in the implementation of its quantitative easing (QE) program of purchasing government bonds. The main argument suggested that the ECB measures were “not proportional” to the monetary policy objectives and therefore veered into economic and fiscal policy areas. In addition to the dangerous precedent of contradicting the European Court of Justice, this has raised market concerns about the ability of the ECB to sufficiently conduct future QE to maintain financial stability and help engineer an economic recovery.
While peripheral spreads rose and the euro weakened after the court ruling, existential worries are misplaced. The economic crisis resulting from the pandemic is massive and though the eurozone’s architecture has not been reformed enough to fix the monetary union’s deficiencies, the tail risk of an Italian exit is lower than consensus estimates.
Specifically, there are three major developments in 2020 that support the prospect of a sustainable European solution for Italy and other peripheral public debt challenges. First, the crisis has worsened the fiscal profile of all European sovereigns. Even relatively optimistic forecasts by the European Commission predict Germany and the Netherlands will experience a 12%-15% rise in their debt-to-GDP ratios this year. But more importantly, France is forecast to end the year with a ratio of 116%. The political ramification is that public debt management moves from a peripheral issue to a core eurozone problem. Thus, any policy approach will need to help France cope, and by extension, such measures are likely to support Italy and others as well.