Have borrowing costs in the eurozone periphery come down too far, too fast?

Over on his Forbes blog, Open Europe’s Raoul Ruparel asks: is there a bond bubble in peripheral Europe? The thurst of his answer is that, while there are good explanations for why costs have come down so far and so fast, they could certaintly have side effects, not least because people misinterpret the reasons for the move. The full post is here, but below are the key points:

What is driving this and is it a bubble?
There are three key factors at work here:

1. ECB President Mario Draghi’s promise to do “whatever it takes” to protect the euro combined with the unlimited bond buying policy of Outright Monetary Transactions (OMT) has driven borrowing costs down since mid-2012. This effect has been amplified by the expectations of further ECB easing, particularly some form of Quantitative Easing (QE), which would bring yields down even more.
2. There has been some success in terms of eurozone reform, particularly with the successful end to the Irish and Portuguese bailouts as well as these countries’ return to the markets, along with Greece. The eventual agreement on banking union and other aspects of trying to correct the structural flaws in the euro (although I believe it is far short of what is needed) has also contributed to the positive sentiment.
3. Possibly the most important factor though is the very low inflation in the eurozone (and even deflation in some countries). Over the past six months this has pulled the borrowing costs across the eurozone down.

This final point is driven home by looking at the rough and ready version of the ‘real yield’ on ten year debt in Europe (10yr yield minus HICP inflation). As the graph below highlights*, when this is done the UK actually borrows at a real rate which is 2% below Ireland’s.

Could this present a problem? (Hint: Yes)
While the process of collapsing bond yields in peripheral Europe is explainable it does still present some serious causes for concern.

• The huge demand for peripheral bonds does seem to have gone too far with respect to the economic fundamentals of these countries. Debt levels have continued to rise – exacerbated by low inflation – while many countries are barely posting any economic growth.
• More concerning though is that this creates very perverse incentives. Many governments can already be seen professing the success of their policies, citing falling borrowing costs and buoyant financial markets. In reality, these are much more down to the ECB and inflation effects mentioned above.
• The risk is that complacency seeps in (some of which can already be seen) and that the reform process in these countries stalls. Italy and France are prime examples of this. While the European Commission does have additional powers now to encourage further reform, when push comes to shove there is little it can do to force reform on an unwilling political class and population, particularly one with low borrowing costs.
• As detailed here, the banking union looks insufficient to break the sovereign banking loop in the eurozone. The efforts to improve the structure of the eurozone have slowed, the risk is they will grind to a halt until the threat of a crisis returns.
• The performance also looks strange relative to countries such as the US and UK which have always borrowed in their own currency for which they are solely responsible and have clear fiscal and central bank backing. Even with the changes to the euro structure and the ECB promises it’s hard to say that, in another crisis, the same issue wouldn’t arise with regards to a comprehensive lender of last resort (let’s not forget, the OMT comes with plenty of conditions and is limited in scope). Even though accounting for the inflation impact, the difference in risk between peripheral eurozone countries and the likes of the US and UK does seem to be being underestimated.

Ultimately, the crisis highlighted that too much price convergence without economic convergence and reform in the eurozone can actually be a bad thing, with resulting perverse incentives and negative outcomes. While the price action in peripheral bonds might not yet count as a ‘bubble’, investors and politicians would do well to remember these lessons when interpreting the record low borrowing costs.

Can the real Super Mario please stand up?

Former Italian Prime Minister Mario Monti may be out of Italian politics, but it's fair to say he still likes to talk - especially when travelling abroad.

In an interview with Belgian daily De Morgen and Dutch daily De Volkskrant, Monti seems to hint at what many Bundesbank-fearing Germans already suspected: that the ECB's pledge to do "whatever it takes" (i.e. the OMT, the new bond-buying scheme) was de facto grounded in a political decision - contrary to what the ECB's mandate dictates.

Here is what Monti said in the interview:

[At the June 2012 European Council], I have used my full negotiating position in order to get a line approved that looks boring at first glance. At 4 am, the signatures of all leaders had been provided, including the ones of [German Chancellor Angela] Merkel, of my good friend the Dutch Prime Minister Mark Rutte, and of Finnish Prime Minister Jyrki Katainen, you can say the monetary firepower from the North [...] The line established, in short, that eurozone countries who did their homework, like Italy, were guaranteed ECB support. That statement – at the highest political level – didn’t impress the markets, because the leaders did have the authority, but no money. One month later, ECB President Mario Draghi came out with his famous statement: the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough. That did calm the markets, because Draghi did have the money. 

Monti is clearly trying to claim some credit - and the headline of the interview in De Volkskrant is actually "Mario Monti: the man who saved Europe". However, if Monti is right, it clearly means that the ECB's political independence was seriously compromised, since, strictly speaking, there should be no link whatsoever between a political agreement and ECB action..

Draghi's statement is one of the main reasons behind the fall in borrowing costs for countries in the eurozone periphery - some of which have yet to deliver on real economic reform. Monti may have given Draghi some of the credit - but he has also given fuel to those Germans who fear the ECB's independence is a thing of the past.

Has the ECB actually moved closer to QE?

There has been a cacophony of comments from ECB members and ECB watchers over the past few days. However, the overriding view since ECB President Mario Draghi’s press conference last week is that the ECB has now moved a step closer to unconventional action such as Quantitative Easing (QE).

This is mostly down to two factors. First the following statement from Draghi’s presser:

“The Governing Council is unanimous in its commitment to using also unconventional instruments within its mandate in order to cope effectively with risks of a too prolonged period of low inflation…this statement says that all instruments that fall within the mandate, including QE [Quantitative Easing], are intended to be part of this statement. During the discussion we had today, there was indeed a discussion of QE. It was not neglected in the course of what was actually a very rich and ample discussion.”

Second, the FAZ report over the weekend that the ECB has been modelling the impact of a €1 trillion per year (€80bn per month) QE programme. While it suggested that such a programme would only raise inflation by between 0.2% and 0.8% (not a significant amount given the cost), the simple fact it is being modelled has been enough to give markets hope.

We believe QE or similar measures have become a bit more likely, but mostly because the market now seems to expect action and if the ECB is to maintain its credibility it will need to do more than simply talk.

That said, while there may be ‘unanimous commitment’ to using such measures when needed, it’s still not clear what the criteria are for such action and it is even less clear that all members of the GC agree on when such action would be needed. Draghi was pushed on this on the first question during the Q&A session, however, he never provided a direct answer.

Furthermore, much of the coverage has suggested that QE is in fact closer because the ideological opposition to such a measure at the Governing Council (GC) level has crumbled - although we're not sure that such a clear unified opposition ever really existed.

With this in mind then, it’s worth once again pushing the point that, in fact many of the issues with further easing are practical, political and/or legal rather than ideological at the ECB. We have previously analysed each measure in detail, below is a summary and links to all those posts:

Quantitative Easing (purchasing government debt)
We have detailed the issues extensively here (but also here and here). Draghi has hinted of these practical issues before, highlighting that they need time to design the programme and gather more information. Beyond political opposition in Germany and the legal limits to ECB financing governments, there is a clear problem in that the purchases would need to split according to the ECB capital key, meaning little would flow to the periphery where the deflationary forces are strongest. Add onto this the fact that QE in other countries has not been proven to boost the real economy or even bank lending as well as that it may exacerbate the squeeze on safe assets and it becomes clear that practically and technically this would be a very difficult step for the ECB to take and is not well suited to tackling the problem of low inflation.

Quantitative Easing (purchasing private assets)
See our detailed analysis here. The thrust would be to target purchases of assets which would help promote bank lending – the main one discussed is Asset Backed Securities (ABS), particularly ones made up of loans to the real economy. However, these markets in Europe are small and underdeveloped meaning the level of assets available and suitable for purchase would be minimal. The ECB has suggested it wants this market to grow but it’s tough to force such a move, especially in the short term.

Negative deposit rate
We analysed this option here. Since then the ECB seems to have made progress on the technical implementation of such a move. That said, the impact remains very uncertain. It could further reduce excess liquidity, force money market funds to shutter and force banks to pass costs onto consumers. On the plus side it could help weaken the euro.

A targeted LTRO (similar the Bank of England’s Funding for Lending Scheme)
Discussed, with other measures, here. A fairly simply option to take, however, given that there is already full allotment (unlimited liquidity at low rates) and banks have already repaid a lot of the previous LTROs there is no guarantee there would be any significant take up or that it would filter through to the full economy.

Ending sterilisation of the Securities Markets Programme (SMP)
A smaller measure, discussed in this post. While it would stop liquidity being drawn out of the system on a weekly basis, it’s not clear that this liquidity would flow to the real economy.

Further standard measures such as rate cuts and changing collateral rules
We rounded up such options a while ago here. Given that rates are already so low and that the transmission mechanism remains broken, the impact of such moves is likely to be limited to signalling intent rather than hoping for any significant return.

Overall, nearly all of these measures face quite serious practical, technical and/or legal obstacles.

Furthermore, it is unlikely that there is any consensus at the ECB GC level of when each measure is needed or what the triggers for such action are. The obstacles are also probably viewed to be different sizes by each national central bank. All that is to say, while it may have moved slightly closer, don't yet count on QE being much more than a last resort.

German Constitutional Court believes ECB bond buying is illegal, but asks ECJ to rule first

Hanging up their robes? Ball is now in ECJ's court

As has been widely reported this morning there has been some surprising news out of Karlsruhe with regards to the ECB's bond  buying programme and its legality.

Our full take is here, with the summary below:

Summary: The German Constitutional Court (GCC) – Bundesverfassungsgericht – has referred several questions surrounding the ECB’s Outright Monetary Transactions (OMT) programme to the European Court of Justice (ECJ). It is evident that the Court believes the OMT is illegal and incompatible with EU and, therefore, German law. However, the Court only has jurisdiction to rule on matters of German domestic law. It therefore argues that it must refer the key questions to the ECJ – the body which interprets EU law – given that the ECB’s mandate and any overstepping of EU treaties is obviously a question about EU law.

The ECJ is likely to side with the EU institutions and rule that the OMT is compatible with EU law, with the GCC likely to therefore say its hands are tied. Still, the decision throws new uncertainty into the fragile eurozone economy and could hamper the recovery. The GCC may also, in its interpretation of the OMT’s compatibility with German law, insist in new red lines - potentially limiting the level of purchases. This itself would severely restrict the role of the ECB. 

Markets, while briefly spooked, seem to have broadly recovered, whilee the euro remains slightly weaker. This doesn't seem to have had much impact, with many coming round to the view that the OMT will remain practically usable until the ECJ almost inevitably fully approves it.

The broader fallout is interesting, as this case has often been cited as one of the remaining risks in the eurozone. Despite the GCC's strong objections to the OMT, this could end up actually bolstering the ECB's position.

More generally as well, it does raise questions about Germany's role in monetary policy and the GCC's role. On EU related issues it is ultimately bound by the ECJ's interpretation of EU law. Furthermore, we can't help but feel that the Court has tried to somewhat dodge this very difficult and politically sensitive decision. It also suggests Germany may be struggling to fulling impose its will over monetary policy - although it clearly remains very powerful and many would argue continues to hold action such as asset purchases at bay.

Nonetheless, plenty of food for thought and an interesting shift in the dynamic of the eurozone.

Italian PM Letta survives key confidence vote: What's next for Italy?

What looked like an imminent political crisis has just been defused in Italy. As we anticipated in our previous posts (see here and here), Italian Prime Minister Enrico Letta has managed to survive a vote of confidence in the Senate - the upper chamber of the Italian parliament where his Democratic Party doesn't hold a majority.

In a last-minute U-turn, Silvio Berlusconi has decided that his party would support the government after all - turning a potential showdown into a mere formality. Nonetheless, what just happened in the Italian Senate does have consequences for the future of Italian politics. Here are a couple of thoughts.

1. Letta stays on, but uncertainty remains over what his government can deliver

The first, and most obvious, immediate consequence of today's vote is that Enrico Letta can stay on as Italian Prime Minister and maintains, at least on paper, his overwhelming parliamentary majority. However, it remains to be seen what Letta and his cabinet can deliver in terms of bold, concrete measures to get Italy going again - not least because some fundamental differences between the parties forming Italy's ruling coalition will remain.

One may argue that, faced with a party mutiny ahead of today's vote, Berlusconi would have finally learnt his lesson and would think twice before triggering new crises in future. But we wouldn't rule out new coalition rows. Berlusconi is famous for his CEO-style handling of his party, and he tends to take all the big decisions on his own - which makes him a very unpredictable coalition partner.    

Another important issue is: how long will Letta stay in office for? It's no secret that both him and Italian President Giorgio Napolitano would like the current government to continue at least until after Italy's rotating EU Presidency (July-December 2014) - and then perhaps go to early elections at the beginning of 2015. This would still be much earlier than 2018, when the current parliamentary term is supposed to end.

Questions will also remain over whether, if the crisis deepened once again, Italy would really be able to gain access to the ECB’s bond-buying programme, the OMT. As we mentioned above, Letta has clearly won the day - but uncertainty remains over his government's ability to push through unpopular measures.

Crucially, the ECB has made it clear that any country accessing the OMT must have a credible government in place to enforce the necessary conditionality attached to bond purchases (very likely to involve significant structural reform and budget cuts).

2. This is not the end for Berlusconi, but he's just been dealt a hard blow 

There's another reason why today's confidence vote is significant. Looking beyond the appearances (and the last-minute coup de théâtre) Silvio Berlusconi has, in substance, seen his plan to bring Letta's government down disrupted by a rebellion from within his own party. Last weekend's decision to pull his ministers out of cabinet has therefore proved a miscalculation, and will have at least two consequences:

• Berlusconi's threats to bring the government down if he's voted out of parliament as a result of his recent tax fraud conviction are no longer credible; 

• 25 senators from Berlusconi's party have this morning announced the creation of a breakaway group in the Italian Senate, irrespective of how the rest of the party would have voted. Though far from certain at this stage, today's defectors may well decide to follow up and quit Berlusconi's party - which in turn may reduce Il Cavaliere's electoral strength.

Berlusconi has shown his resilience several times, so we are unlikely to be witnessing the end of his political career just yet - even after he's ousted from parliament. Let's not forget that polls suggest he maintains quite large public support, with the help of his control over a large swathe of the media. We wouldn't expect him to take this challenge lying down. That said, his leadership of Italy's centre-right forces has today unequivocally been put into question.

These are our preliminary thoughts. We'll continue monitoring the situation in Italy very closely, so keep following us on Twitter @OpenEurope and @LondonerVince for all the updates.

Ireland prepares to exit financial assistance…with further assistance…

Talk surrounding the Irish exit from its bailout programme has been picking up in recent days and weeks given that it is supposed to get off its current bailout programme at the end of this year (the final disbursement of funds is expected sometime in November).

The last few days in particular has seen increased interest with Eurogroup head Jeroen Dijsselbloem telling the European Parliament yesterday that there would be “measures to support [Ireland’s] gradual exit” from its programme. Irish Finance Minister elaborated on this suggesting that Ireland will seek a €10bn credit line to help aid its transition back to fully funding itself.

All this means that it is looking increasingly likely that Ireland will request some form of ESM credit line towards the end of the year. This could take two forms:

Precautionary credit line (PCCL): open to eurozone states that have sound economic and financial situation including: sustainable public debt, access to capital markets, sustainable external position and solvent banking system (amongst others).

Enhanced credit line (ECCL): essentially for member states who do not meet the criteria for PCCL but do not require a full bailout programme. Conditions will involve improving shortcomings that prevent PCCL access.

Looking at the above criteria Ireland is likely only to be eligible for the ECCL, given the on-going banking sector issues and the questions over debt sustainability after the bank bailout. The procedure is pretty similar to any other bailout request and given Ireland's relative success in implementing reforms, approval seems likely. Importantly, “enhanced surveillance” (read strict conditions) will apply in either case, so Noonan’s hope that this can be done without further austerity and/or reforms seems unlikely to be fulfilled.

The key aim of such a loan is to gain access to the ECB’s OMT, its bond buying programme. Under a credit line Ireland would be eligible for the OMT as the programme applies the much needed conditionality. The combination of the loan (the size is not particularly important) and the OMT means it may not have to be tapped.

All that said and despite the many resounding endorsements for Ireland’s progress, many problems remain. In particular, toxic loans at Irish banks continue to increase while households struggle under the burden of such loans. The issue of how to deal with the public debt created by the previous round of bank bailouts remains unsettled and leaves a cloud hanging over the Irish economy.

Deliberations begin as hearings draw to a close in Karlsruhe

The hearing at the German Constitutional Court into claims against the ECB's crisis policies is now over. Day one saw verbal jousting between the two men to the left (Bundesbank President Jens Weidmann and ECB Executive Board Member Jörg Asmussen) which we covered on our live blog. Day two of the hearing was a bit more cagey and less political but possibly more revealing in terms of the Court's thinking.

Constitutional Court Judge Peter Müller kicked off by reiterating the strict rules of the game:

“it is clearly defined in which china shop the elephant of monetary policy is not allowed – monetary state financing.” 

Clemens Fuest, Research Director at the Oxford University Centre for Business Taxation, shrugged his shoulders and replied:

“If OMT is ECB’s commitment to buy state bonds to a non-defined extent, than I wouldn’t know how to prevent the contact with the china shop”  

Being slightly more direct (as might be expected), Head of the Ifo Institute Hans-Werner Sinn said that the ECB engages in “regional fiscal policy” and that the Central Bank’s OMT programme is basically “a free insurance for investors when a state goes bankrupt”.

It's clear the Court remains concerned that the ECB could overstep its mandate. President of the Court Andreas Vosskuhle suggested that the current conditions attached to the OMT, the ECB’s bond-buying programme, are on a “very abstract level” but if correctly applied “could be a good middle way…of distinguishing between monetary and fiscal policy”.

A rather diplomatic construction but conditionality is a key issue here, as we’ve pointed out. The fundamental problem is that since there is no legal documentation and the OMT has never been tapped, it is very challenging for the court to judge how strictly the conditions will be applied. They could make a value judgement over whether they trust the ESM and eurozone politicians to fully implement the conditions but this could well be beyond the scope of the legal judgements the Court is allowed to make.

As Süddeutsche Zeitung's Markus Zydra points out, there is significant ambiguity around one of Asmussen's key points - that the OMT is practically limited since it can only purchase short term bonds. This is especially true given ECB President Mario Draghi's (and other's) previous remarks that there are no ex-ante limits to the OMT. Chief economists of DZ Bank Stefan Bielmeier put it nicely saying, “there is a dual rhetoric of the ECB…[they] tell everybody what they want to hear” - exactly as we noted here.

A running theme of the coverage following day two has been the signfiicant time given to those arguing against the ECB. ECB proponents reportedly told Handelsblatt “we feel like at an away game”, given the level of opposition support. The paper even goes so far as to question the neutrality of the court's referees given the line-up of known ECB critics it had called to provide evidence at the hearing (e.g. Hans-Werner Sinn, Kai Konrad, Harald Uhlig, Franz-Christoph Zeitler, Clemens Fuest).

How the Court will rule remains to be seen. It's clear they have some serious concerns about the policies but are struggling given the hypothetical nature of the case - the OMT remains undefined and unused, so any claims against it rely on second-guessing its implementation. Ultimately, it could be a question of whether they take the ECB at its word or not. Approval of policies but with some extra constraints remains the most likely outcome.

A final ruling is due for September although many involved expect a delay until after the German Federal Elections on 22 September. In the meantime, there are already those calling for a re-match in Luxembourg.

German Constitutional Court live blog: One of the most important cases in the Court's history?

The German Constitutional Court in Karlsruhe

The German Constitutional Court’s (GCC) hearings into the legality of the ECB’s actions to combat the eurozone crisis – and specifically the OMT bond buying programme – kicked off this morning. (See here for the background). In a front page leader, FAZ describes the case as one of the “most important” in the court’s history.

Public opinion in Germany is mixed, with a Forsa poll for Handelsblatt finding that 48% of Germans hope that the Court will put a stop to the OMT, while 31% believe that the complaint against the ECB is unjustified. As we noted in our flash anaylsis on the topic yesterday, the GCC can't actually stop the ECB. At worst, it could remove Germany from the ECB's bond buying programme and probably, therefore, from the eurozone itself. (A poorly phrased poll question, then, but a very telling result nonetheless).

With Schäuble, the German Finance Minister, and the ECB's positions already well known (that OMT is within the Central bank's mandate), we can safely say that the highlight of the day will come  from the opposing side, in testimony of Bundesbank President Jens Weidmann. In terms of their specific grievances, it will be the first time we will hear a detailed, public explanation of where the Bundesbank stands on this issue, while the tone of Weidmann's comments will also be interesting. Will there be any more Faust references we wonder?

Check our twitter feed for live updates from Karlsruhe throughout the day. We will also continue to update this blog as things develop.

17:45

Bundesbank President Jens Weidmann has now had his say - and again his points were very much as expected (his full statement is here but only in German for now).

• Warned that ECB OMT blurs the line between monetary and fiscal policy - this makes it more difficult to achieve price stability and spreads solvency risks amongst eurozone countries, but does so without any parliamentary or democratic approval.
• Pushed for a narrow interpretation of a central bank's primary mandate, with a complete focus on price stability.
• Suggested that the OMT does represent potential losses for taxpayers, arguing that if the ECB took on significant amounts of risky debt, it may face large a loss which it cannot absorb and may require aid from member states.
• Argued that even secondary market purchases can overturn the force of market discipline and undermine fiscal autonomy.
• Issued a warning over the interpretation of the real-risk premiums for bonds, which he suggested was very subjective and dependent on future policies.
• Accepted that the inflation outlook in the eurozone fits with price stability at the moment, but still expressed serious concern about comprising the ECB’s focus on this.

It seems to us that, of the two sides, Weidmann had the tougher case to make. Ultimately, as much of the above shows, he is forced to consider hypothetical scenarios and potential worst cases. These are undoubtedly risks that should be highlighted, but it does leave one feeling that his argument is slightly less clear cut than Asmussen’s.

Having heard the key testimony of both sides, we still expect the court to side with the ECB, but with some caveats (although how strict they will be is very much up in the air). Of course, this could still develop more tomorrow. 

16:20

Asmussen has now concluded his testimony and subsequent Q&A, and the ECB has also helpfully put a transcript on their website. Here are the key points he made:

• the OMT will have the ability to sell bonds as well as buy them, and it will not take them off the market permanently, unlike its forerunner the SMP (in fact Asmussen repeatedly highlighted the differences between the two);
• the OMT is pari passu (equal to) other creditors,
• the OMT seeks only to reduce unwarranted interest rate spikes and is not aimed at harmonising financing conditions of member states,
• the ECB would react if a country were to try to game the system by converting all its bond issues to a short maturity (of up to three years), but that in any case markets themselves would "see through and deny" such attempts,
• the only risks associated with the programme stem from countries operating "un-sound" policies, but that those states that fail to comply with the OMT's conditionality could be faced with the prospect of having to leave the eurozone.

The comments were more or less as expected. However, there are a couple of interesting points. First, the fact that the bonds purchased under the OMT will be judged at market value suggests that, if they are purchased and then decline in value, the ECB could be facing losses on its balance sheet. A tricky technical and political issue. Second, the point about 'un-sound' policies leaves us feeling slightly uneasy. Its clear that even with an ESM bailout programme, implementation may not be up-to-scratch. Meanwhile, it also highlights the clear link that would be established between ECB policies and the fiscal (and other) policy of national governments. This surely raises questions about the ECB's independence.

Asmussen also admitted that the policy did have de-facto practical limits given that it will only purchase short term debt, as reported over the weekend.

15:10

Handeslblatt reports that Philip Rösler, the German Minister for Trade and Vice Chancellor is coming under increasing pressure from his own FDP party to take a stand against the ECB, following the Handelsblatt/Forsa poll showing that almost 50% of Germans hope that Karlsruhe will stop the ECB’s OMT programme (despite this actual course of action not being possible, see blog intro above on this).

Frank Schäffler, the financial expert of the FDP parliamentary group, told Handelsblatt Online that "Working towards a market-economy is widespread among the followers of the FDP. Liberals know that prosperity cannot be printed from the ECB.”

The irony of clinging on to central bank independence, while using political pressure to change the course of the ECB is not lost on us - nor on Rösler it seems, who said: “We must not allow this course toward stability to be broken up through the the attempt to exert influence on the European Central Bank.”

13:55

These comments from ECB Executive Board member Yves Mersch seem to confirm our feelings that the ECB is trying to have it both ways over its refusal to publish the OMT documentation (see 13:30):

Mersch: "controlled uncertainty on the OMT is necessary"
— zerohedge (@zerohedge) June 11, 2013

13:40

Germany's new anti-euro party Alternative für Deutschland has just put out a press release citing Professor Joachim Starbatty - one of the original plaintiffs in the case and now one of AfD's top candidates in September's elections - warning that under the OMT, German taxpayers will be responsible for liabilities that are "no longer the responsibility of any government or parliament". The party is clearly hoping the publicity around the hearings will boost its poll ratings.

13:30

Asmussen is clearly channelling Draghi in his comments below. The ECB's continuing refusal to simply publish the legal documents relating to the OMT is at best strange and at worst downright obstructive. It does beg the question: what are they trying to hide? Maybe nothing, but at the very least it seems they are trying to have the best of both worlds. By refusing to reveal the exact terms and conditions, the ECB can try to address German concerns over the extent of the OMT (as we have seen them doing in the run up to this case) while also being able to continuously reassure markets that the scheme is in fact "unlimited".

Such a balancing act is tough to pull off and may add to confusion if it breaks down. Some transparency would be welcomed. It needs to happen at some point, who's to say it would be better revealing the legal documentation just when the OMT is being tapped, surely by definition that would be a period of crisis?

13:05

The ECB's Jörg Asmussen is up now making the point that the ECB would actually adopt a legal ordinance before any bonds were purchased:

#ECB's Asmussen: #OMT Documentation Ready For Publication When Needed. OMT Documentation Can Be Published Within Days
— Holger Zschaepitz (@Schuldensuehner) June 11, 2013

#ECB's Asmussen: #OMT Cannot Be Activated Before Publication Of Guidelines
— Holger Zschaepitz (@Schuldensuehner) June 11, 2013

11:15

German Finance Minister Wolfgang Schäuble has spoken, and as expected, he backed the ECB:

German FinMin Schäuble: #ECB Independence Gives It Wide Scope For Decision-Making
— Holger Zschaepitz (@Schuldensuehner) June 11, 2013

Schäuble tells court government sees no evidence that the ECB has overstepped the bounds of its mandate. #karlsruhe
— Michael Steen (@michaelsteen) June 11, 2013

German finance minister Schaeuble argues the court shouldn't even be considering the OMT case, as they've no jurisdiction there. #karlsruhe
— Jeff Black (@Jeffrey_Black) June 11, 2013

The future of the eurozone: Will it be the lawyers who have the last laugh?

Update 18:00 The new German anti euro party Alternative für Deutschland have put out a press release claiming that di Fabio's report is a "body blow for the euro rescuers" and that he is corroborating AfD's stance that the ECB's bond buying constituting illegal state financing.

******************************************

We have frequently pointed out the significant role played by the German Constitutional Court in the eurozone crisis, including before it came to be in vogue. The Court is due to hold hearings next week into the ECB’s handling of the eurozone crisis, specifically whether the legality of the new OMT bond-buying programme. In an interesting development ahead of the hearings, Udo Di Fabio – a prominent legal scholar and former German Constitutional Court judge has warned that if the Court rules that the ECB has violated its ban on state financing, in the most extreme case, the Court could then commit the German Parliament and Government to withdrawing from the euro.

This is the key quote from his report:

"If the rulings of the Constitutional Court were unsuccessful in influencing the federal acting bodies, it [the GCC] would have to make an extreme-case ruling that the further participation of Germany in such a system would be constitutionally untenable."

This is admittedly an unlikely scenario – we expect the Court to approve the measure albeit with some additional conditionality and carefully expressed warnings for the ECB not to go too far – this has been standard procedure in the big EU/eurozone cases recently. Ultimately, despite the legal ambiguity surrounding the ECB and the wider handling of the eurozone crisis, the Court is mindful of the fact that it does not operate in a political vacuum. Di Fabio’s warning does however highlight that compliance of the German legal establishment cannot be taken for granted indefinitely.

We shouldn't over-state the risk of deposit-led contagion,but the Cypriot bailout deal is political dynamite

Over on his Telegraph blog, Mats Persson argues that,

There are two ways to look at the hugely controversial bailout agreed for Cyprus in the early hours of Saturday morning, in which the small island nation – accounting for only 0.2 per cent of eurozone GDP but whose troubles will have an impact far beyond its size (including on some 25,000 Brits in Cyprus) – received a €10bn rescue package in return for a series of unusually harsh conditions. In a shock to everyone, including admittedly Open Europe, the deal included a “tax” on depositors: 6.75 per cent for anyone with less than €100,000 in a Cypriot bank account, 9.9 per cent for anyone with more than that.

The first way to look at the deal: lessons have been learned. Unlike in the case of Greece, Cypriot debt will come down to around 100 per cent of its GDP, following this deal. While not great, it’s not the type of maddening cocktail of continued austerity and increasing debt that Greece has been forced to swallow (the country’s debt is at 160 per cent of GDP this year). At least the combination of the deposit tax and privatisations in Cyprus will give the country some breathing space. And the alternative, letting Cyprus sink and leaving the euro, showing the world that the single currency is no longer "irreversible", would have been far worse.

The second way: All bailouts are unfair – the people who screwed up almost never pay – but this is in a league of its own. Seventeen Eurozone finance ministers locked themselves in a room and decided that every Cypriot depositor – whether super-wealthy or dirt-poor – will, out of the blue, see part of their hard-earned money seized. Remember, Cypriot President Nicos Anastasiades explicitly promised in his election campaign, only a few weeks ago, that depositors were safe. The Cypriot electorate now faces losses on deposits as well as years of austerity (under the bailout loan). What’s worse, deposits under €100,000 are supposed to be protected by EU law, not raided by EU leaders. And Cypriot banks have frozen close to €5.8bn, i.e. imposed capital controls which is meant to be illegal under EU single market rules. This is political dynamite.

Regardless of one’s interpretation, in the entrenched eurozone North-South stand-off, this clearly represents a victory for the German government and German taxpayers over their southern counterparts, as it was Berlin that drew a line in the sand. In many ways, Cypriot depositors fell victim to the forthcoming German elections in September.

What happens next? Well, the Cypriot parliament will vote on the deal tomorrow (conveniently, a bank holiday in Cyprus). This will be a nail-biter. The parties which supported Cypriot president Nicos Anastasiades only hold 28 out of 56 MP, so not a majority. Yesterday, Anastasiades issued a stark warning: accept the bailout deal or face “a complete collapse with a possible exit from the euro”. Given the huge stakes, I reckon that MPs will approve the deal, but it could be close – current voting arithmetic suggests 30 in favour and 26 against, but this is incredibly fluid. Even if the parliament does reject the package, there could still be room for further negotiation.

The bailout format is therefore a gamble on several levels. Most importantly, massive questions still linger over the precedent this sets. If Cypriot depositors are forced to pay today, why not Spanish ones tomorrow? People queuing up in massive numbers outside ATM machines is always an incredibly scary sight wherever you are and given the anger in Cyprus, we just don’t know how people will react when banks open again (unclear when, the Cypriot government may declare both Tuesday and Wednesday bank holidays as well).

But fears of deposit-led contagion to other parts of the eurozone should definitely not be be overstated. EU leaders have gone out of their way to say that the depositor tax won’t be repeated in other countries. And viewed with a depositor's eyes from Barcelona or Bilbao, Spain may have very little in common with Cyprus.

The eurozone also now has a contagion-fighting instrument in the ECB’s bond-buying programme (the OMT), which can be used should panic spread to Spain and Italy. There’s a problem here of course. If the Cyprus deal represents a more assertive German approach, it will be far more difficult to actually trigger the OMT as that, in turn, depends on whether the debtor country will agree to be put on a bailout programme, with tough conditions (a prerequisite for it to tap the OMT). Cyprus is small enough to boss around, but Italy or Spain?

Some more signs of financial market fragmentation in the eurozone?

The European Repo Council of the International Capital Market Association (ICMA) released its bi-annual assessment of the European repo markets today. Admittedly, not the most exciting of intros but the survey does contain some interesting points regarding financial markets in the eurozone. As a reminder, repo markets are the main source of short term funding for banks (or at least they should be if markets are functioning normally).

The report highlights that repo funding fell by 11.9% during 2012 (based on a standard sample size). Interestingly, the fall slowed significantly in the second half of the year – there was only a 0.9% drop in the market from June to December. This is likely to have been down to the creation of the ECB bond buying programme, OMT.

There are a few other interesting points and conclusions which can be drawn from the report:

• As of the start of this year, European banks remain heavily reliant on ECB funding. The LTRO repayment has shown this has decreased somewhat. However, as we previously noted, if the repo market does not pick up the slack then we could see a de-facto tightening of monetary policy (the opposite of what the ECB is trying to achieve).
•  There is some evidence of an increase in cross border repos up from 48.1% to 50.5%. However, importantly, cross border repos between eurozone only countries remained steady – suggesting significant market fragmentation remains in the eurozone.
• The share of transactions which we were for a maturity of a year or more dropped from 13.3% in June to 5.9% in December, suggesting banks filled much of their long term financing needs at the ECB LTRO. This will be an interesting indicator to watch in the next survey to judge the impact of LTRO repayments.
• The ICMA also go to lengths to highlight the threat of the financial transaction tax (FTT) to the repo markets.
• Government bonds, especially from core eurozone countries, remained a key source of collateral for repo transactions. In fact, the use of German government bonds as collateral increased sharply. Usually, this would be seen as a sign of risk aversion and a flight to safety (i.e. negative for the prospect of recovery), however, ICMA suggests this is actually a positive sign since previously these bonds were being hoarded to improve balance sheet safety. Still, the over-reliance on core government bond highlights the shortage of safe assets in the eurozone and should be taken into account when considering why borrowing costs have remain low despite increased tensions in the eurozone once again.

Overall the survey seems to confirm fears that fragmentation remains in the eurozone financial markets, as does over-reliance on the ECB - at least up to the end of 2012. The real question is whether this has been reversed at all at the start of this year. Unfortunately, we’ll have to wait until the September survey for a conclusive answer on that point.

The inbuilt political stand-off in the ECB's bond-buying programme

One of the many sub-stories of the Italian election is how it calls into question the ECB's bond-buying programme - the Outright Monetary Transactions (OMT). Not so much because of the ECB's ability to expand its balance sheet and stand behind Italy and Spain (though there's a clear cost to that). The reason is another one: unpredictable politics.

This is something we highlighted immediately following Mario Draghi's announcement to launch the OMT, in September 2012. We said:

"It will also be virtually impossible for the ECB to impose effective conditionality on debtor countries, meaning that the ECB can only hope that a series of unpredictable political decisions in member states will go in its favour."

To inject such conditionality, the OMT was linked to the European Stability Mechanism - the eurozone's permanent bailout fund - which comes with strict conditions (or at least is supposed to). To tap the OMT, a country has to be on an ESM programme. But, in effect, this made the OMT - despite it being run by an independent central bank - hostage to parliamentary and electoral politics.

As we argued in our analysis on the German Constitutional Court ruling on the ESM - a few days after the OMT announcement in September last year:

"...the ruling and the role of the Bundestag highlights that activating the OMT will be challenging, since in order to qualify for ECB bond-buying, a country must first get funding from the ESM – and be subject to conditions. If the Bundestag agrees to activate more bailouts, it will most certainly push for harsher conditions than what debtor countries – most importantly Spain – are willing to accept. In the long-term, under current arrangements of linking ESM and OMT, the latter is also effectively capped and subject to a Bundestag veto."

Well, enter the Italian elections (and Beppe). Discussing the election results, we told the Telegraph on Monday that:

“People have forgotten that the OMT cannot be triggered without a vote in the German Bundestag. This is going to be a huge problem, and we may be back to the political stand-off between the North and South of Europe,”

And in our flash analysis yesterday, looking at the Italian election results, we noted:

“A fragmented, anti-austerity Italian parliament could also make it far more difficult for the country to tap the ECB’s OMT. This is because it would need to access the European Stability Mechanism simultaneously, meaning a series of strict conditions – which Berlusconi and others could resist – and approval from several Northern Eurozone parliaments, including from the Bundestag.”

Other analysts are now waking up to this issue as well.

Then again, if it ever came to a point where Italy actually needed to tap the OMT, things might be so bad that politicians on both sides (probably during a panic-stricken weekend) could be scared into accepting whatever ESM-deal that could be struck.

But it all goes to show that in the eurozone, there's no escaping the politics.

Celebrating the end of the eurozone affair ignores the heart of the matter

In today's Telegraph, Mats Persson seeks to answer this simple - and yet brutally complex - question: is the eurozone crisis over?

'We are in the middle of the beginning of the end. The crisis has really hit its peak”, former French economy minister and current IMF chief Christine Lagarde told a broadcaster when asked about the eurozone crisis. The only problem: that was in July 2010. Time and again, EU leaders have declared the crisis over – and been proven wrong. So with markets remaining cautiously optimistic about the euro, is the worst finally behind us?

There are well-rehearsed reasons to be cheerful. Borrowing costs are down for all crisis-stricken countries, exports are picking up in some and EU leaders have actually agreed on a forward-looking measure by turning the ECB into a single supervisor for eurozone banks. Just as eurozone leaders have celebrated prematurely, Anglo-Saxon analysts have consistently tended to overstate the immediate risk of a eurozone break-up. Famously, one major US bank last year assigned an 80pc-90pc risk of Greece leaving the euro – an assessment that Open Europe cautioned strongly against. In Europe, the safest money is always on another fudge. Germany and the ECB were likely to take a political decision to keep Greece inside the eurozone for now, given the fragile situation elsewhere.

But the news last week that the eurozone economy shrunk by 0.6pc in the last quarter of 2012 illustrated what was always the bloc’s greatest challenge: reversing chronic economic malaise. Most fundamentally, reconciling a supranational currency with 17 national democracies remains a challenge. The eurozone’s basic austerity-for-cash prescription continues to fuel tension within individual countries and between the hawkish north and the austerity-fatigued south, testing voters’ patience. The forthcoming Italian elections are turning into a bit of a referendum on EU-mandated austerity, just like the Greek elections last year. Five of the seven main political parties – together polling at around 50pc – have vowed to end cuts. Two parties, Lega Nord and the Five Star Movement, the latter led by comedian-cum-politician Beppe Grillo, even want a referendum on whether the country should remain in the eurozone. The everlasting Silvio Berlusconi is making last-minute gains, in part thanks to a promise to kill what he calls “austerity imposed by Europe”. Against all known principles of common sense, the man still could win. Thankfully, a broadly pro-reform, centre-left coalition led by Pier Luigi Bersani is the most likely outcome, but even then the hope of sweeping economic reforms will be tempered, not least due to those parties’ strong links to the unions.

The Italian elections show how the north and Club Med in many ways are locked into a Catch-22: one wants cash (“solidarity”) first, supervision or discipline second, the other the exact opposite. That dynamic is again evident in the ongoing difficulties in agreeing a bail-out for Cyprus: Germany is unwilling to put in cash for fear of rewarding the bloated Cypriot financial sector. Cyprus resists far-reaching privatisations or significant write-downs of its banking or sovereign debt. This north-south stalemate could become further entrenched if French president Francois Hollande continues to slide towards the Mediterranean bloc, both in terms of political temperament and growth rates (France registered zero growth in 2012). This would weaken the Franco-German axis.

And beyond politics, has the eurozone’s triple crisis – fiscal, banking and competitiveness – really been addressed in any fundamental way? Many eurozone countries are on the path to running a primary surplus – meaning income exceeds outgoings, excluding the cost of servicing a country’s debt. But the eurozone’s overall debt still stands at 90pc of GDP, compared to 70pc in early 2010. Greece, Italy, Portugal and soon probably Cyprus, have debt levels exceeding 120pc of GDP – double what is meant to be allowed under eurozone rules.

The banking sector, too, remains fragile. Thankfully, ECB action helped avoid a massive bank funding crisis last year, but there is a price: eurozone banks have become alarmingly reliant on artificial life support. Liquidity from the ECB to banks now tops €1 trillion (£860bn) – up €140bn on 2009. Even though some banks have started to pay back the cash they owed the ECB early, the eurozone is a long way off a back-stop to allow for wind-downs of bust banks or disentangling of bank and government debt. Overnight interbank lending – a key indicator of banks confidence in the system – remains only half of what it was in 2009 and a third of its peak in 2007. If the crisis were solved, this would surely not be the case.

Finally, by almost every indicator, the single currency is absolutely riddled with economic imbalances, but with no fiscal facility to compensate for them. Encouragingly, Spain, Portugal and in particular Ireland have cut unit labour costs relative to Germany – a key measure of competitiveness - but Italy and France are actually becoming less competitive in relative terms. And imbalances go far beyond labour cost. This year, Greece is expected to contract by over 4pc, Spain by 1.5pc and Cyprus by almost 2pc – while Germany, Finland and others are set for growth. Then there is unemployment. Shockingly, Greek unemployment hit 27pc towards the end of last year, with youth unemployment close to 62pc. Spain is not much better at 26pc and 55pc respectively – and all the scheduled reforms and cuts haven’t even been implemented yet. In Germany, meanwhile, unemployment is at record lows.

In a best-case scenario, the Mediterranean countries will follow the Irish example and continue to squeeze wages and cut costs at home. But in light of domestic political resistance, these imbalances could well continue to test the eurozone’s one-size-fits-all model for a very long time.

So, we have an election fought over EU austerity, political stalemate, a bail-out which no one wants to pay for, abysmal growth forecasts and massive unemployment. There may come a day when the eurozone bounces back and puts us all to shame. But to celebrate now the “end of the crisis” seems to be setting the bar exceptionally low.

Spain back under the spotlight soon?

We haven't blogged on Spain for a bit, but a couple of interesting developments have caught our attention today. Spain will presumably disclose its final deficit figure for 2012 shortly, and everything seems to suggest that Madrid will let its eurozone partners down once again.

Spanish Industry Minister José Manuel Soria (pictured) told a conference this morning that Spain's public deficit for 2012 will be somewhere around 7% of GDP - higher than the target of 6.3% of GDP agreed with the European Commission.

It is also probably not just a coincidence that Soria's words came just before the European Commission put out its latest update on Spain's compliance with the conditions attached to its bank bailout. The content of the report was not entirely new to us (and the readers of our daily press summary), given that a draft was leaked to El País last week. The document reads,  

Fiscal consolidation advanced in the third quarter, but the 2012 deficit target will likely be missed.

Most importantly, it adds,

The 2012 deficit target for the regions of 1.5% of GDP can...still be within reach for the regional level as a whole, but risks are substantial and a number of regions will most likely exceed their target.

You won't hear us say this very often, but well done to the European Commission for making the right prediction. Of course, we (and others) warned of the risk of several Comunidades Autónomas overshooting their deficit target as early as last July.

Anyway, Catalonia (Spain's wealthiest region) has just announced that its deficit at the end of 2012 stood at 2.3% of GDP - with the overall target for Spanish regions fixed at 1.5% of GDP. With the wealthiest region missing its targets, and few others likely to undershoot theirs to pick up the slack, it seems unlikely that the overall target will be met.

A day of bad news for Spanish Prime Minister Mariano Rajoy and his government - not least because Spain had already obtained a relaxation of its deficit target for this year. The risk is that, once the official deficit figures come out, Spain could face fresh pressure from the markets. Before complaining about being "underrepresented" in the EU institutions (see Spanish Economy Minister Luis de Guindos remarks from this morning), the Spanish government should probably do more to regain its credibility vis-à-vis its eurozone partners. Top EU/eurozone jobs would surely follow.

A virtual Spanish bailout?

In case you’re wondering, we not talking about a bailout on Facebook or the like.

No, we’re referring to the quite strange comments by a Spanish finance ministry official reported in the press this morning. The official reportedly stated that Spain does not see a bailout request as imminent or immediately necessary but would be comfortable making the request for a precautionary credit line in order to potentially access the ECB’s new Outright Monetary Transaction (OMT) programme. All par for the course you would say, but the comments that really caught our eye were the following, via the FT and the WSJ:

"The credit line is not fundamental, it is circumstantial…One could say it's a virtual credit line,” adding that Spain will likely not access any of the money from the ESM, while the ECB may not even have to buy any bonds. 

Let us elaborate, because this seems to amount to a bailout without any money. Essentially, the suggestion is that Spain would sign a new Memorandum of Understanding (MoU), which wouldn’t include any new reforms or conditions, allowing it access to ESM money if it ever became necessary. This would supposedly satisfy the OMT requirements allowing the ECB to intervene in the secondary market for Spanish bonds if borrowing costs for Spain once more reach unsustainable levels.

A very neat idea in theory, as with most eurozone proposals, but we have a few concerns:

• We can’t imagine the ECB or Germany would go for it. Both would likely request stricter reforms and conditions (probably rightly, as we noted recently Spanish labour market reform has some way to go), particulary since it would need approval from the Bundestag. 
• More importantly, this may fail the ECB’s conditionality requirement. Although, details on the OMT are thin on the ground, the conditionality needs to be enforceable. The conditionality comes from a MoU which is tied to the ESM financial aid. Therefore if the ESM aid is not actually being accessed the conditionality is instantly voided since it cannot be enforced by withdrawing funding (since the funding is non-existent). 
• A strange situation could arise where the ECB is then buying bonds without the ESM lending money, while no new conditions have been enforced. We’ve warned of the moral hazard and other negative impacts of this at length before. 
• If the ESM is not lending to Spain but the ECB is buying its bonds surely the MoU and conditions essentially become a direct agreement between the ECB and Spain, putting pay to the view that these actions relate to monetary policy and maintain the independence of the ECB. 
• As the ESM guidelines on precautionary loans note, they are only available to countries where there are no “bank solvency problems that would pose systemic threats to the stability of the euro area banking system.” We’re sure this will be fudged, with the eurozone suggesting the bank bailout solves any remaining provlems, although we’d maintain that €40bn is far from enough to solve the problem.
• This is not to mention that Spain has huge funding needs and will in fact need real cash injections at some point, meaning the threat of intervention will surely not be enough to hold Spain over. 

We’ll end with an interesting, if somewhat mixed, analogy from the Spanish official:

“One does not just normally drop an atomic bomb. It has to be co-ordinated and discussed. But we [Europe] are all in the same boat.” 

Quite. As we’ve previously warned the OMT and Spanish bailout needs to be carefully structured, unfortunately a 'virtual bailout' is unlikely to do the trick.

Germans vs Inflation: the battle continues

In our daily review of UK and continental press, we spotted an interesting consumer analysis survey referenced on the front page of Bild yesterday. The survey - conducted by Axel Springer AG and the Bauer Media Group - found that Germans were conservative and prudent in terms of their finances with 67.9% of respondents possessing a savings book, 57.2% setting aside a specific sum every month, with only 33.8% having a credit card.

In contrast, in 2010, 64% of the UK’s adult population had a credit card – almost double that of Germany’s. This could possibly help to explain how the German and UK debates on the eurozone pass each other by so often, especially when it comes to the role of the ECB. The view from Berlin is that the ECB ought to remain as the guardian of price stability and not engage in activist monetary policies such as bond-buying, while the view from London, Washington and indeed other European capitals is that Draghi’s recent actions mark a decisive turning point in the crisis, and that it is good that he has been able to overcome German resistance – as argued by David Laws at an Open Europe fringe event at the Lib Dem conference.

Incidentally, former ECB chief economist Otmar Issing has an interview in yesterday’s Die Welt in which he warns against the social and economic damage of unchecked inflation:

“Many people come up to me on the street. Savers are deeply insecure and they have every reason to be. [The ECB’s] monetary policy has reached its limits [it] risks losing its credibility.” 

"There is no immediate risk of inflation. However I have my doubts that the ECB will stop its immense liquidity at the correct time. If this fails, prices will rise. I do not anticipate hyperinflation. However, even an inflation rate of 4 to 5% disposes savers and creates social problems… The social partnership between employers and unions, everything depends on a reliable monetary policy. Inflation is the most anti-social policy.” 

“[Pumping more liquidity into the system] is a dangerous argument. In putting out a fire, it is also the case that more water is not always better per se. Ultimately it could turn out that the damage caused by the water exceeds the actual fire damage.” 

Speaking to the German Industry Federation (BDI) yesterday, ECB President Mario Draghi defended the ECB’s new bond-buying programme, and in an apparent swipe at German fears of inflation, that in times of crisis “we cannot always look to the past for answers”. While Bundesbank chief Jens Weidmann may have been isolated in voting against the OMT programme, he retains the backing of a huge swathe of German public opinion which is deeply rooted in the country’s culture of savings and financial prudence.

This battle is not over by any stretch of the imagination.

ECB's own budgetary discipline not inspiring confidence

With budgetary discipline the only game in town in the eurozone, it must have been a bit of an awkward moment at the ECB when they realised that the bank's new Frankfurt headquarters (pictured), currently under construction and due to be completed in 2014, will come in significantly over budget.

Executive board member Jörg Asmussen let the cat out of the bag in his welcome address at today's 'topping-out' ceremony, revealing in his welcome address that:

We are monitoring the construction progress, costs and price developments very closely, adjusting and adapting where necessary. As a public institution, we are committed to using our resources responsibly. This is essential. So far the ECB has spent approximately €530 million in construction and other costs, including the purchase of the site. In 2005 the overall investment cost was estimated at €850 million at 2005 constant prices. It is anticipated that increases in the price of construction materials and construction activities from 2005 until the completion of the project in 2014 will lead to a €200 million increase in the overall investment cost. 

In addition, there have been a number of unforeseen challenges that needed to be dealt with. The two major challenges unforeseen in 2005 were, first, that the original tender for a general contractor did not yield a satisfactory result and the ECB had to change to a different contractor model, and second, that the Grossmarkthalle – a large industrial heritage building from 1928 – presented a number of challenges that were not detected in the initial examination conducted prior to the acquisition:

• the foundations turned out to be insufficient and required additional support; 

• the roof coverage was found to be contaminated and therefore could not be disposed of as envisaged; 

• and parts of the concrete construction had insufficient steel support.

These factors are likely to account for additional costs of about €100-150 million, or a 10-14% increase in the overall investment cost. The resulting delay in the construction works on the Grossmarkthalle, as well as the entrance building, has been incorporated into the existing time schedule.

So overall the total cost is likely to come in at around €1.2bn, a tidy sum of money, even at a time of multi-billion euro bailout funds. We estimate that the cost of the new building amounts to around half of the outstanding cuts the Greek coalition still has to make in its latest austerity package.

DPA notes that the new building will hold 2,300 personnel, seemingly large enough for a central bank. Although when you consider that the ECB is currently looking to take over the supervision of 6000 financial institutions - a job which national supervisors currently employ tens of thousands of people to do - one does wonder whether another new building could be needed in the near future. 

We can't say the ECB is setting a great example for austerity, especially given that is now a precondition for accessing its new bond-buying programme.

Merkel caught in the middle between the Bundesbank and the ECB

In her traditional news conference following the summer recess, German Chancellor Angela Merkel walked a fine line in questions about the eurozone crisis, having to maintain a delicate balancing act with regards to different elements within her governing coalition.

For starters, she has to contend with the increasingly fractious rhetoric from the CSU – the Bavarian sister party of her own CDU – on the eurozone (see here and here for examples). The latest example being Bavarian Prime Minister Horst Seehofer’s argument that the €190bn cap on German liability imposed by the German Constitutional Court in its ruling on the ESM and fiscal treaty last week should apply to the euro-rescue effort as whole, including the ECB’s new OMT bond purchasing programme. However Merkel has rejected this interpretation on the basis the two are not linked. Speaking earlier today, she told reporters that:

“If the ECB determines that monetary transmission has become difficult, then it must take measures to ensure price stability - it is not up to us to set it limits.” 

Seehofer later confirmed that “this is the only issue which we interpret somewhat differently than in Berlin”, adding that it was nonsensical for the Court to cap Germany’s liability at €190bn only for “it to be suddenly increased by many multiples through other means”.

On the other hand however, Merkel did not issue a statement of blanket support for the ECB’s actions, adding that Bundesbank President Jens Weidmann’s recent interventions – in which he has been fiercely critical of renewed ECB bond-buying were “understandable and always welcome”, a statement widely interpreted in Germany as a subtle rebuke of Finance Minister Wolfgang Schäuble’s comments in an interview with Frankfurter Allgemeinen Sonntagszeitung yesterday in which he criticised Weidmann for his public dissent, arguing that “I'm not sure that making this debate semi-public helps to build confidence in the [European] central bank.”

Merkel is in a tough position because, having invested so much in the euro-rescue, she cannot afford to oppose the ECB’s ‘big-bazooka’ strategy. At the same time however she cannot allow Weidmann – whose views are widely respected and shared by the German public – to become completely isolated for fear this would provoke a substantial domestic backlash.

How long Merkel will be able to keep her fractious coalition together on one hand while also keeping the German public – whose support for the EU and euro has hit an all-time low – onside remains to be seen, especially in the event of unforeseen developments such as Germany actually suffering direct losses on its loans to Greece and/or losses on ECB holdings of Greek debt.

Yesterday's Karlsruhe ruling: Good news for Germany and Europe?

Following yesterday’s ruling by the German Constitutional Court in which it gave the go-ahead to both the ESM and fiscal treaty, German politicians from all the main parties were tripping over-themselves to praise the Court and its ruling. Speaking in the Bundestag, Chancellor Merkel declared it “a good day for Germany and a good day for Europe” while Foreign Minister Guido Westerwelle praised “the [Court’s] wise decision in the pro-European spirit of our Constitution.” The SPD’s parliamentary leader Frank-Walter Steinmeier also welcomed ruling, in particular the additional participation rights for the Bundestag.

While some politicians - including those who had themselves lodged legal challenges - said they were disappointed, even politicians who have been among the fiercest critics of the euro-zone bailouts declared their satisfaction, with, for example, the FDP’s Frank Schäffler describing the verdict as a “victory for democracy”, claiming that with the imposition of the cap on German liability, “The ESM has lost its sharpest tooth”.

However, interestingly the German media has adopted a more sceptical tone altogether. For example, today’s Süddeutsche comments that:

“In their ruling, the judges clearly called out the risks of the euro-rescue but drew few consequences. Their reservations do not change the fact that Europe is moving together under great financial and political risks.” 

In a front page op-ed, Die Welt editor Thomas Schmidt draws in the ECB OMT bond-buying angle – something that we also cover in our analysis of the ruling - arguing that:

“The Court watches over German money and the issue of democratic legitimacy. It is clear that the ECB decision has opened the way into the bottomless transfer union in principle. It is equally clear that the legitimacy of the path towards the further deepening of European integration is poorly grounded. This must and will result in yet more legal challenges.” 

FAZ's economics editor Joachim Jahn describes the verdict as “a slap in the face of financial policymakers”, but warns that:

"With the requirement to secure a liability cap binding under international law, the judges have at least curbed the potential harm to the taxpayer… It is however questionable how much exactly the Karlsruhe order would be worth in an emergency. A protocol to the effect that Germany does not feel itself bound by alternative interpretations of the agreement is would be easy to obtain. Whether this would be considered material by the ECJ in the event Italy and Germany were to argue over reserve liabilities is by no means certain."

Last but not least to Bild Zeitung, whose chief editor Nikolas Blome argues that:

“The ECB’s [OMT] programme is perhaps well intended but not well executed. It is highly dangerous – and here the Court’s ruling changes nothing. The double whammy of the ESM and ECB is essentially so strong so as to be able to save every eurozone member. However, exactly this will lead all eurozone states into temptation: why enact painful reforms and brutal savings when it could be supposedly easier at the expense of the others, and Germany in particular?” 

The relief of Germany’s politicians is palpable, but the battle for the future of the euro – and the role of the ECB in particular – is still far from over.