A ruling on Tuesday by Germany’s top court on the legality of an emergency ECB bond-buying scheme looks set to test bond investor confidence in the bank’s crisis-fighting powers just two days before Britain’s vote on membership of the European Union.
The German 10-year bond yield, the benchmark for borrowing costs in the euro area, fell 1 basis point to 0.05 percent, drifting back towards last week’s record lows below zero percent as a note of caution returned to markets and lifted demand for safe-haven German debt.
Germany’s constitutional court is due to gives its final ruling on the European Central Bank’s outright monetary purchases (OMT), launched as part of ECB President Mario Draghi’s vow during the 2012 debt crisis to do “whatever it takes” to preserve the euro but has never been used.
Limiting OMT would not have immediate consequences for the ECB but it may dent confidence in its ability to tackle crises, raise doubts about the use of any future unconventional tools, and strengthen a separate legal challenge over the bank’s 1.74 trillion euro asset-buying scheme.
The decision comes as investors are braced for the fallout from Thursday’s British referendum on whether to remain in the EU.
Investors expect the ECB to stem any broader market volatility in the event of Brexit and a sign that the central bank’s hands are tied could undermine that confidence.
“Markets are already in a shaky environment and if the German court ruling is against OMT and the ECB faces restrictions that could apply to QE (quantitative easing), that would not be favourable for the EU project or sentiment,” said ING rates strategist Benjamin Schroder.
The ruling also has the potential to weigh on already strained ties between the ECB and Berlin, which has many times criticised the bank’s stimulus programmes, arguing that it is doing more damage than good.
Orlando Green, European fixed income strategist at Credit Agricole said the ruling could stoke uncertainty in bond markets if there was a negative outcome for the ECB.
Polls in recent days showing those campaigning in favour of Britain remaining in the EU taking a lead have helped boost risk appetite in global markets and dent the appeal of safe-havens such as German bonds and the Japanese yen.
But with the vote still too close to call, analysts said German bond yields were unlikely to rise too sharply.
Bond yields across the euro zone were broadly steady, with focus turning to a testimony later in the day by Draghi to the European parliament.
US Federal Reserve Chair Janet Yellen meanwhile will deliver her semi-annual report on monetary policy to Congress later in the day.