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EUR Rallies as ECB Prepares for Life Without Bundesbank




EUR was buoyed midway through today’s European session on the news that the ECB is drafting contingency plans to carry out its multi-trillion bond-buying programme without the Bundesbank, in case Germany’s Constitutional Court forces the German Central Bank to quit, according to Reuters citing four sources.


EURUSD shot higher to around the 1.0975 mark from around 1.0950 prior to the news. It is worth noting that EUR had already been trading on the front foot, mainly as a function of USD weakness.


The article continued that in this worst-case scenario (where the Bundesbank is pulled from the ECB’s PSPP), the ECB would launch “unprecedented” legal action against the German central bank, to bring it back into the programme.


For context, Germany’s Constitutional Court has given the ECB until early August to justify its massive buying of government bonds and if it cannot demonstrate “proportionality” then the Bundesbank, who carries out roughly one-quarter of the bond purchases, will be forced to quit the programme.





Most of the sources interviewed by Reuters expect the legal challenge from the court in Karlsruhe to be resolved by the Bundesbank itself by demonstrating that the policy was appropriate and addressing concerns about its side effects.


Therefore, one source described the above scenario as “unbelievable”. Nonetheless, the ECB is taking a “hope for the best, prepare for the worst” attitude.


Why was EUR boosted by this news?


By signalling that it will press ahead with the PSPP (its pre-Covid-19 QE programme) regardless of what happens with the German Constitutional Court and Bundesbank, the ECB is again, in a way, signaling that it will do “whatever it takes” to save the Eurozone.


The ECB’s QE programme is seen as very important to the survival of the Eurozone. Without the ECB buying the debt of the more heavily indebted/economically weaker southern nations, their debt servicing costs would likely spiral out of control (as we saw the beginnings of in the Eurozone debt crisis of 2010-12).


Was this to be allowed to happen unchecked, these countries might end up defaulting on their existing debt (which is issued in EUR) and might be forced to exit the EUR and revert back to their old currencies - i.e. the end of the Euro.  


By coming across as resolute in face of the threat from the German Court, this increases confidence in EUR, and is hence EUR positive.


Note: EUR carries something of a “Eurozone break-up risk premia” at the moment. Given rising intercountry divisions and populism in the Eurozone, investors have had to revise higher their risk probability that the EU (and Eurozone) will break up in the coming years - with Covid-19 crisis and its uneven effects on the continent serving only to worsen the problem. 

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