June 27, 2023 - 1:00pm

The German central bank, the Bundesbank, is the latest institution to suffer the consequences of rising interest rates. This week it was reported by the Bundesrechnungshof, the auditing office, that the bank might need recapitalisation from budgetary funds. This may prove very awkward for the European Central Bank (ECB), considering that the Bundesbank is a longstanding opponent of the very quantitative easing (QE) programmes that are leading to the current problems.

The Bundesbank has long been known as the most hawkish economic institution in Europe. Before the Eurozone debt crisis that started in 2009 and reached its nadir in 2011, the Bundesbank was also the most powerful of the European economic institutions. Thanks to its influence, the ECB was regarded as one of the most prudent central banks in the world.

This arrangement grew out of the founding of the European Union. The implicit deal between the two largest powers — France and Germany — was that France would be the leader in the diplomatic sphere of diplomacy and Germany the leader in the economic sphere. All of that changed during and after the European sovereign debt crisis.

To save the single currency, the ECB’s hand was effectively forced, and the institution stepped into the market for sovereign debt, something that it was not technically allowed to do. The Germans were opposed to this at the time, but their objections were steamrolled by necessity. After this, the Bundesbank largely lost its influence in the European monetary system — which went from championing a conservative approach to engaging in some of the most experimental monetary policies in the world.

Shortly after the Eurozone crisis, the ECB started to ramp up its QE programmes. The Bundesbank opposed this move in 2015, with many German bankers and economists fearing that the monetary system was on a slippery slope. Perhaps the government bailouts were necessary to save the single currency, but this seemed to open the floodgates to any and all monetary experiments. By 2022, the monetary powers had been completely politicised, with the bank committing to buy “green bonds” in an effort to realise climate goals — something that was totally outside its remit.

Now it looks like the Bundesbank can claim vindication. Not only have these monetary experiments failed spectacularly — they did not lift the Eurozone economy out of stagnation and now they are leading to serious problems in the banking system — but this failure could cost a lot of money. Right now, the Bundesbank maintains that it can avoid having to tap the taxpayer for cash, but this could easily change in the near future. And the bankers are pointing out that the QE programme has already cost the German government around €22bn in lost dividends.

This is a humiliation for the monetary doves responsible for running the ECB for the past decade and a half, and it seems probable that the Bundesbank will leverage this disaster to regain control over the EU’s monetary system. The Germans, with their rivals discredited, will soon be back in the financial saddle.

Philip Pilkington is a macroeconomist and investment professional, and the author of The Reformation in Economics