* Ruling on stimulus scheme sparks doubts over ECB policy
* Southern European bond yields jump, spreads widen
* Euro set for biggest 1-day drop in over a month
(Updates with price action in southern Europe, adds comment,
chart, bullets)
By Dhara Ranasinghe and Thyagaraju Adinarayan
LONDON, May 5 (Reuters) - The euro, southern government
bonds and European stocks lost ground on Tuesday after Germany's
top court ruled that the Bundesbank must stop buying bonds under
the European Central Bank's stimulus scheme if the ECB cannot
justify the purchases.
The ruling that Germany's central bank must end the
government bond purchases within three months unless the ECB can
prove they are needed clouds the bloc's monetary policy outlook
at a time when the coronavirus is hammering economic growth.
The decision did not apply to the ECB's PEPP coronavirus
pandemic-fighting programme, a 750 billion euro ($812 billion)
scheme unveiled in March at the height of a coronavirus-induced
financial market rout.
But the ruling raised concern about further expansions in
ECB asset purchases. That manifested in a sharp selloff in
Italian government bonds, while the euro tumbled more than 0.5%.
"The good news is that the ruling does not seem to apply to
the PEPP, but there is a bigger concern that it limits the
ability of the ECB to "do whatever it takes," said Sarah Hewin,
chief Europe economist at Standard Chartered.
Amassing nearly 3 trillion euros of bonds since 2015, the
ECB has long relied on asset purchases to support the euro zone
economy through crises and the threat of deflation.
The euro was down 0.65% at $1.0836 EUR=EBS and was set for
its biggest daily drop in more than a month. It earlier fell to
as low as $1.0826, its lowest in almost a week.
In bond markets, southern Europe bore the brunt of the
selling pressure. Italian 10-year bond yields were around 18
basis points higher at 1.94% IT10YT=RR - pushing the gap over
safe-haven German Bund yields to 250 bps, the widest in around
1-1/2 weeks DE10IT10=RR .
Spain's 10-year bond yield gap over Germany widened to
almost 145 bps DE10ES10=RR , up around 8 bps from late Monday
levels. Portuguese 10-year yields jumped 7.5 bps to 0.95%
PT10YT=RR .
As the selling pressure in peripheral bonds gathered pace,
investors moved back into German bonds, allowing that market to
recover from a post court-ruling selloff. The 10-year Bund yield
was last down around 2 bps at -0.57% DE10YT=RR .
"The court ruling highlights that core countries not only
face political hurdles to any form of liability sharing but also
legal hurdles," said Richard McGuire, head of rates strategy at
Rabobank, explaining the weakness in peripheral bond markets.
ECB policymakers will discuss the ruling at a Governing
Council meeting starting at 1600 GMT, a spokesman for the bank
said.
Among stocks, the pan-European index .STOXX cut some of
its gains following the ruling and was up 1.5%. Germany's shares
.GDAXI briefly touched day lows, while euro zone banks .SX7E
halved their gains and were up 1.2%.
The Italian banking index .FTIT8300 cut most of its gains
and was up 0.3%.
"The PSPP (long-term bond purchase programme) violates
German law but I think the three-month deadline is important to
clarify proportionality and the ECB can move on after that. In
the meantime PEPP carries on as normal," said Societe Generale
strategist Kenneth Broux.
"It illustrates the difficulties versus the Fed for example;
the Fed has no such constraints of U.S. states challenging QE
(quantitative easing) there."
($1 = 0.9234 euros)
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