A German court ruling could jeopardize the continuity of one of the European Union's bond-buying programs and result in higher borrowing costs for Southern European countries at a time when their debt levels are increasing due to the COVID-19 crisis. On May 5, Germany's constitutional court ruled that the European Central Bank (ECB) must provide additional clarifications about the Public Sector Purchase Programme (PSPP), which buys sovereign debt from eurozone countries in secondary markets, within three months. Otherwise, the Bundesbank, Germany’s central bank, will not be allowed to continue participating in the program. This would probably mean the end of the PSPP, given that the Bundesbank is the ECB’s largest shareholder.

The ECB must now prove by early August that its quantitative easing program is justified and does not constitute a case of fiscal financing, which is illegal under EU law. The ruling will require the ECB to show that the bond-buying program was a “proportional” reaction to the eurozone’s financial problems. If the ECB fails to convince the German court, the end of the PSPP would lead to higher borrowing costs for countries such as Italy, Spain, Portugal and Greece, which rely on cheap debt to pay for the stimulus measures they implemented since the start of the COVID-19 pandemic. As a result, these Southern European countries would have to scale back their spending measures, which would further slow their economic recoveries. Higher borrowing costs could precipitate a financial crisis in Italy if markets believe Rome is no longer capable of honoring its debt, which according to the International Monetary Fund, will rise from 135 percent to 160 percent of GDP by the end of 2020.

The ruling opens the door to eventual legal challenges to the Pandemic Emergency Purchase Program (PEPP), the 750 billion euro ($816 billion) stimulus package that the ECB launched in March. Should the PEPP end abruptly, the recession in the eurozone would probably worsen and several countries in Southern Europe could face debt crises. Since the mid-2010s, ECB intervention in debt markets has kept borrowing costs in Southern Europe within tolerable margins by creating liquidity and a market for these bonds. With the debt-to-GDP ratios of these countries set to increase in 2020 due to their worsening deficits and shrinking economies, a spike in borrowing costs could make their debt pile unsustainable.