By Jack Duffy

PARIS (MNI) – The European Central Bank’s one-size-fits-all
monetary policy is not fitting the Eurozone too well these days.

In Germany, rising house prices, booming equities and sharp wage
gains for public-sector employees have put the ECB, and the Bundesbank
in particular, on inflation alert. Warnings about “upside risks” for
prices have returned and the drumbeat for removing emergency liquidity
measures has grown louder.

Outside the Eurozone core — which by some measures is now just
Germany, Finland and Luxembourg — economies are stagnant or shrinking.
Bank lending and the money supply are contracting, asset prices are
falling and unemployment is soaring.

And it is not just the periphery. Countries like France and the
Netherlands, traditionally part of the core, are struggling with
economies today that bear little resemblance to Germany’s. Leaders in
both countries face challenges from left-wing opposition parties opposed
to more fiscal tightening.

This week’s unemployment data was the starkest evidence of the
Eurozone split. Germany’s 5.7% unemployment rate is at its lowest level
since 1991 while the average EMU jobless rate, at 10.8%, is a record
high for the euro era. National jobless rates range from 9.3% in Italy,
to 10% in France, to 15% in Portugal, to 23.6% in Spain.

And borrowing rates — at 0.19% in Germany and 2.8% in Spain for
2-year government paper — seem far too low in the core and much too
high in the periphery.

So where does the ECB toss its anchor? Does it tighten because of
the core, which accounts for about a third of Eurozone output, or does
it ease because of woes in the remaining 70%?

ECB President Mario Draghi on Wednesday essentially voted for the
status quo, saying that talk of unwinding liquidity measures was
premature but that the ECB wouldn’t hesitate to act to counter price
risks.

He also served notice that a one-size-fits-all policy can never
accommodate so many vastly different countries.

“Single monetary policy naturally focuses on maintaining
medium-term price stability for the euro area as a whole,” Draghi said.
“It is up to national policy makers to foster domestic developments
which support the competitiveness of their economies.”

The ECB’s chief hawk, Bundesbank President Jens Weidmann,
recognized the difficulties facing monetary policymakers in a recent
speech in London.

“We will see more heterogeneity, more diverse developments in the
euro area in the years ahead, with Germany being at one end of the
spectrum and other countries being at the other,” Weidmann said.
“Meaning,” he added, “you will see inflation pressures rise in Germany.”

Holger Schmieding, chief economist at Berenberg Bank, argues that
the Eurozone is not splintering but merely going through an adjustment
process that will in the end make it more balanced.

“After all, the periphery is largely implementing the same kind of
reforms that turned Germany from the ‘sick man of Europe’ into the star
performer now,” Schmieding said in an e-mail. “In a way, the situation
today is a mirror image of that of 2004-2005: While Germany was
reforming itself, German growth lagged far behind that of Spain.”

Schmieding said a key part of the adjustment is that unit labor
costs are converging, since above-average wage gains in Germany come at
the same time that wages are stagnating or falling elsewhere in the
Eurozone.

The question is whether the Eurozone hang together in the years it
will take for the economic adjustment to take place. Will financial
markets give Spain, Italy and Portugal time for economic reforms to take
root before resuming the attack?

The point of the ECB’s E1 trillion in LTRO money was to buy the
time required for this adjustment. But with Spain’s 10-year bond
yielding around 5.8% now and CDS on those bonds flashing warnings signs
not seen since November, it is not certain that the time bought by the
ECB will be enough.

(EuroView is an occasional column written by Market News
International editorial staff. Any views expressed are solely those of
the writer)

–Paris newsroom, +33142715540; jduffy@marketnews.com

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