FRANKFURT (MNI) – France’s public support for Bank of Italy
Governor Mario Draghi to succeed Jean-Claude Trichet as European Central
Bank president later this year is confirmation of Draghi’s position as
lead candidate, but it has not significantly altered his chances.

“France will be very happy to support an Italian for the presidency
of the ECB,” French president Nicolas Sarkozy said Tuesday. “I know
Draghi well. We support him not because he is an Italian but because he
is a man of quality.”

While German leaders have voiced their support in principle for
Draghi behind the scenes, Berlin continued to insist on Wednesday, even
after Sarkozy’s comments, that it will communicate its choice closer to
the time a decision is needed, by end-June.

Chancellor Angela Merkel clearly wants to keep her options open to
react to any potential domestic political backlash against an Italian at
the helm of the ECB. And she leaves little doubt about who will call the
shots: “Without German support no one will become head of the ECB,” a
German government spokesman said Wednesday.

France’s endorsement of Draghi likely comes down to political
calculation. On the one hand, it helps Germany test how its increasingly
concerned populace will react at the prospect of a southern European at
the helm of the ECB. On the other hand, it gives France some bargaining
power should Merkel push for a German candidate after all.

In the latter case, the French likely would ultimately support the
German position. Sarkozy’s support for Draghi has thus far been
lukewarm, and he is said to view Draghi’s Goldman Sachs history with
some dismay. According news reports, Sarkozy agreed to back Draghi with
the understanding that the current Italian on the Executive Board,
Lorenzo Bini Smaghi, would step aside, allowing France to name its own
person for the Board.

But if Merkel were to float a German candidate, France could cut a
similar deal — in this case, involving the resignation of German
national Board member Juergen Stark — and still get a Frenchman on the
board. Seen in this light, Sarkozy would seem to have no particular
vested interest in Draghi.

So just as before the French endorsement, the choice of ECB
President will likely be decided by the popular mood in Germany and
perceived risks of political fallout. Germany’s all-important tabloid
Bild-Zeitung — after previous hostile attacks — seems to have
swallowed the idea of a Draghi presidency, suggesting that pressure on
Merkel may have subsided.

Nevertheless, any massive flare-up of the sovereign debt crisis —
such as one that might be engendered by a restructuring of Greek debt —
could yet sway the Bild-Zeitung position, and with it German public
opinion, against the southern candidate.

On that front, the ECB has continued to counter market speculation
about an imminent Greek restructuring. The most forceful recent comments
came from Stark. His German roots may lend his warning additional
weight, since unconfirmed but widespread reports suggest that Berlin is
pushing for a new solution to address Greece’s mountain of debt.

“A restructuring would be short sighted and bring considerable
drawbacks,” Stark said. “In the worst case, the restructuring of a
member state could overshadow the effects of the Lehman bankruptcy.”

He also said that “the discussion about restructuring in the
Eurozone is based on false assumptions that one state or another is
insolvent.” The EU and IMF adjustment programmes “are based on analyses
of the ability to repay debt,” he insisted.

Still, markets are not convinced that a restructuring can be
averted. Greek government bond yields hit fresh euro-era highs on
Wednesday, dragging other peripheral euro area bond yields with them.
Greek 10-year bonds were trading at 54% of their face value. Fears of
contagion pushed Portuguese 10-year yields to a peak of 10.18% and
Spanish 10-year yields to 5.55%, near their 5.6% record.

There is no doubt that the debt crisis will continue to rage for
some time. A major hit on German banks as a result of Greek debt
restructuring or, conversely, an agreement to extend the bailout funds
in the weeks ahead, could yet put Merkel’s embattled government in a
precarious political situation in which it would feel compelled to look
tough on the European front by pushing for a trustworthy, thrifty German
as ECB President. EFSF chief Kaul Regling comes first to mind.

Meanwhile, on the monetary policy front, the latest data should do
little to ease the ECB’s concerns over price stability.

German inflation data for April, released Wednesday, showed the
headline rate of HICP inflation rose from 2.3% to 2.6%, the highest
level since October 2008. As annual food inflation fell and energy
inflation was little changed, according to limited available detail, the
pick-up may have been largely driven by a rise in core inflation — a
worrying sign for the ECB.

Even if much of the increase was driven by the unusually late
Easter holidays, today’s data coupled with the latest Ifo survey —
showing another increase of selling price expectations in the retail
sector — leave little doubt that inflation pressure in Germany will
continue to push up the Eurozone average, endangering the ECB’s target
of close to but below 2%.

Although the latest Belgian national Bank headline business
confidence fell sharply in April from 6.2 to 2.8, suggesting that
activity has reached its peak, in conjunction with euro area “flash”
PMIs and the German Ifo, business surveys are still consistent with
healthy GDP growth and a narrowing output gap in the months ahead.

Further ECB policy tightening over the summer, as recently
indicated by a series of Council members, thus remains the most likely

A number of Council members have recently suggested that the ECB is
equally keen to resume its exit from non-standard liquidity measures.
April’s latest Bank Lending Survey highlighted that conditions remain
far from normal, suggesting the central bank would act very gradually.

Eurozone banks tightened their credit conditions for both firms and
households last quarter and will likely continue to do so over the next
three months, mainly due to “credit supply-side considerations related
to access to market financing and their liquidity positions.”

It also found that “despite a mild improvement in accessing very
short-term money markets, euro area banks still reported a deterioration
in access to money markets for maturities above one week” as well as an
“overall deterioration in their ability to access debt securities

–Frankfurt newsroom +49 69 72 01 42; Email:

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