The euro has depreciated relative to the US dollar to its lowest level in almost a decade. In the meantime, time is running out for the European Central Bank (ECB) to implement a massive purchase of sovereign bonds aimed at quelling the threat of deflation. This much-anticipated operation, called Quantitative Easing (QE), will most likely be officially announced by ECB president Mario Draghi at the upcoming meeting on 22 January.
The European currency has plummeted this year under the 1.1747 dollar threshold, the exchange rate at which it was first introduced in 11 European countries on 1 January 1999. The euro continues to weaken after losing 12% of its value relative to the US dollar in 2014 – the sharpest annual fall since 2005. Last week, Goldman Sachs said the euro would reach parity with the dollar in 2016, one year earlier than it had originally forecasted. The last time there was euro-dollar parity was in December 2002.
Reactions in the foreign exchange market have been mostly due to the opposite monetary measures implemented in the euro area and in the United States. The Federal Reserve is ready to increase interest rates for the first time since 2006, whereas the ECB is about to implement the same kind of stimulus from which the US central bank has just moved away.
The European Court of Justice backs OMT program
An additional downward pressure on the euro’s value has been made by the European Court of Justice. The Advocate General considers that the bond-buying plan designed by Draghi in 2012 to save the euro – known as OMT or Outright Monetary Transactions, similar to the QE – is “in principle in line with EU law”.
“The ECB must have a broad discretion when framing and implementing the EU’s monetary policy, and the courts must exercise a considerable degree of caution when reviewing the ECB’s activity,” Pedro Cruz Villalón said in a non-binding opinion. The final decision follows the Advocate General’s advice in a majority of cases and will be adopted by the Court in the next few months.
The legality of the OMT program was first questioned by the German Constitutional Court and the case was referred to the EU tribunal thereafter. Not implemented to this day, the program consists on purchases of government bonds with a maturity of one to three years in the market of the countries asking for a bailout.
Draghi has won a legal endorsement from the EU’s highest body of justice, although with some red lines. In case of activation of this mechanism, the ECB will not be allowed to provide ‘direct’ financial assistance in purchases of debt issued by a country of the euro area. It will be obliged to explain the reasons for the purchase and will have to proceed proportionally and cautiously so as to avoid speculative movements in the markets.
Moreover, if the ECB decides to activate the OMT program in a bailout country such as Cyprus or Greece it would be forced to leave the Troika, which it shares now with the European Commission and the International Monetary Fund.
Setback for the German hawks
The opinion from the European Court of Justice comes as a setback for the German hawks and clears the way for the fulfillment of Draghi’s promise to “do whatever it takes” to save the euro. “All the members of the ECB Governing Council are determined to fulfill our mandate,” said the ECB president. “There are of course some discrepancies on how this should be done, but there’s not an unlimited number of possibilities,” he remarked.
Germany is the main opponent of QE. According to the Bundesbank, it would go against taxpayers, and would delay the structural reforms that are necessary in the more economically troubled countries. The ECB is indeed under mounting pressure to take action on the threat of a deflationary spiral in the euro area. The consumer price index suffered in 2014 the first annual fall in five years, and is increasingly far from the 2% goal.
