MNI SOURCES: Fears Over German Ruling As ECB To Reinvest PEPP

--ECB Seen Committing To PEPP Reinvestment, Junk Purchases

--Concern Over Longer-Term Effect Of German Court Ruling

     LONDON (MNI) - The European Central Bank will soon announce reinvestment of

principal payments on bonds bought under its pandemic emergency purchasing

programme, and commit to buying junk debt, MNI was told by sources who see no

immediate policy impact from the German Constitutional Court's ruling but fear

potential repercussions down the line.

     An increase in the EUR750 billion PEPP is likely, but not until harder data

on the effects of the Covid-19 crisis on the eurozone economy is available, the

sources said. Some expressed concern also that newly-announced cheap PELTRO

loans could tempt banks to buy more government bonds instead of providing credit

to the real economy.

     One high-level source said it would be "business as usual for the ECB"

after the German Constitutional Court's May 5 ruling called on the ECB to

demonstrate its public sector purchases programme was proportionate. Another

official said the court would be unable to stop the Bundesbank buying bonds even

if the ECB failed to provide an explanation, maintaining that German's central

bank was obliged to act in line with eurosystem peers.

     "The ruling places no limits on what we can do," the official said. "We

will do what is proportionate and what makes sense. But it's not our aim to have

our biggest single NCB out of the game. Politically it's not good, technically

it's not good."

     --SHADOW OVER INDEPENDENCE

     Others MNI spoke to were even less sanguine.

     The ruling "casts a shadow over ECB independence," a senior Eurosystem

official said, adding that while short-term work arounds are possible, it

creates tension within the EU's legal framework: "If it doesn't explode in three

months, it will eventually."

     Even if the ECB navigates this ruling, others may follow, with further

implications for monetary policy, another ECB source said. If the Bundesbank is

forced to stop purchases, having other central banks step in to compensate would

be an unsatisfactory stopgap.

     Were "the Bundesbank to exit PSPP, even if only for a limited period, it

would still be liable to participate in the risk sharing of other banks," the

official remarked. "This is definitely only possible as a temporary solution, a

temporary situation leading to the next step of disintegration, probably."

     The PEPP "maybe crosses the line or goes very close to the borderlines of

what is achievable in Europe and what is not," the official continued. "The

space of possible actions becomes narrower after such a decision."

     --REINVESTMENT

     The ECB could publish a response to the court but avoid giving the

impression that it was following its instructions, the source said.

     A decision to reinvest PEPP principal payments "can be expected", while the

inclusion of junk bonds is "not just a possibility, it's ingrained in the legal

set-up," the official said. An Italian debt downgrade would not affect purchases

of that country's bonds.

     An increase in the PEPP requires more economic data, and would probably

follow a reinvestment announcement, another well-placed central banker said.

     "If the situation changes then of course we can expect some decisions in

between. But under 'normal' Covid circumstances I think we will wait until

June."

     --"POPULIST"

     A former Governing Council member told MNI he was "extremely disappointed

and nervous" about the ruling, which showed the court had "given into a kind of

populist feeling", providing an "invitation for the next group of German

professors" to launch further objections to ECB actions.

     "In some way this is perhaps the most dangerous part of the ruling, because

this is something that would severely limit the chances to overcome the crisis

we have now."

     "What the court demands is something the ECB can easily provide," he said,

adding: "I am not relaxed about the formal side of it. It is a huge infringement

on the independence of a central bank if a national court can demand something

from the ECB."

     While reinvesting PEPP principal payments was "implicit", the former

official said there was "no necessity" for the ECB to act for the next two

months. "It might be that in September or October we really have to have a

strong review," he added, but for the time being, let's give some time for those

instruments to work."

     Another concern for the ECB is that PELTRO loans to banks, which lack

conditionality, could reignite the carry trade in sovereign debt, an ECB

official said.

     "It's only a question to what extent it will happen," he said. "This is

definitely a step back in terms of the discussion about the government-bank

nexus."

     An ECB spokesperson declined to comment on the matters in this article.

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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