German Court Challenges OMT -What Does That Mean for the Euro?

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Market Drivers for February 7, 2014
GE Constitutional Court Challenges OMT – refers to EU Court
UK Trade Better buy IP/MP miss
Nikkei 2.17% Europe -0.05%
Oil $97/bbl
Gold $1260/oz.

Europe and Asia:
AU AIG Construction 48.2 vs. 50.8
EUR GE Trade Balance 18.5B vs. 17.3B
GBP UK Trade -7.7B vs. -9.3B
GBP UK MP 0.3% vs. 0.6%
GBP UK IP 0.4% vs. 0.7%

North America:
CAD Employment 8:30 AM

The German Constitutional court challenged the constitutionality of ECBs OMT program but did not rule it illegal, passing the final judgement on to the European Court of Justice in Brussels. The news sent the euro briefly tumbling more than 50 points and injected some volatility in what otherwise would have been a typically quiet pre- NFP session.

In its ruling the German court took issue with OMT program which is designed to allow ECB to buy sovereign bonds in order to stabilize financial markets in times of deep turmoil. However, the court noted that , “In the view of the Federal Constitutional Court, the objective mentioned by the European Central Bank to justify the OMT Decision, namely to correct a disruption to the monetary policy transmission mechanism, cannot change this assessment. The fact that the purchase of government bonds can, under certain conditions, also help to support the monetary policy objectives of the European System of Central Banks does not turn the OMT Decision itself into an act of monetary policy. If purchasing government bonds were admissible every time the monetary policy transmission mechanism is disrupted, it would amount to granting the European Central Bank the power to remedy any deterioration of the credit rating of a euro Member State through the purchase of that state’s government bonds. This would largely suspend the prohibition of monetary financing of the budget.”

Nevertheless the German justice refrained from issuing an outright ban on the program and referred the final decision to Brussels. Several German justices issued their separate opinions noting that the court had no business even considering the matter as it was an executive rather than a judicial concern and given approval of the deal by Germany’s Senate was already arbitrated legislatively. For its part the ECB disagreed with the ruling, stating that it believes that the OMT program is within its charter and mandate.

The EUR/USD initially tumbled on the news dropping to a low of 1.3550, but quickly found its feet and settled down in morning London dealing. Many analysts pointed out that the OMT has never been used and is unlikely to go into effect anytime soon. By referring the matter to ECJ the German court implicitly acknowledged the superiority of Brussels to Berlin and ceded sovereignty on the matter. The ECJ is expected to take a more liberal view of the matter and will likely rule in favor of the program.

Although tonight’s ruling has no immediate impact on ECB policy it does highlight the tensions within the EU monetary system and forces the central bank to walk a very fine line. At very least it removes some of the macroprudential tools at its disposal and making it rely on indirect methods of stimulus such as LTRO. Therefore it should come as no surprise that at yesterday’s meeting the ECB chose to remain passive despite very lackluster demand in the region as it continues to be very careful in its policy choices. Whether such political pressure on economic policy prohibits the ECB from effectively doing its job remains to be seen, but tonight’s ruling certainly limits the choices for policymakers for the time being.

In economic news tonight the calendar only carried UK data which was mixed. UK Trade balance improved markedly as the deficit shrank to -7.7B from -9.3B eyed. However both MP and IP missed their mark printing at 0.3% vs. 0.6% eyed and 0.4% vs. 0.7% forecast. Although the data showed continued expansion in the sector, it comports with the thesis that UK growth may have peaked in Q4 of last year. Cable was slightly lower post the release and remains near weekly lows as it struggles to stay above the 1.6300 level. The pair has seen profit taking for the past several week and remain under pressure to test support at 1.6200 in the near future.

Turning to today’s main event, the NFP report is due at 13:30 GMT and market consensus is for 185K. Anything above 150K will likely be seen as a relief for dollar bulls as it will suggest that the Fed will stay the course in light of relatively steady US growth. However, if the market sees another sub 100K report the dollar could see some massive turbulence with USD/JPY possibly diving to 100.50 in reaction to the news. Although some analysts have made the point that the inclement weather in the US could have skewed the job numbers for the past two months, the markets are unlikely to shrug off two straight months of sub-par performance. However given the data in the leading indicators such as ADP and ISM Services report the NFP is likely to meet expectations and provide further support for USD/JPY rally.

Boris Schlossberg
Managing Director

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