Sunday, January 26, 2003

Euro: What to Do Now?

Brad de Long scratches his head and asks: what to do now:

The Euro: One Size Fits None

Marty Feldstein, back before the start of the euro, was greatly worried that a single currency would result in too much business-cycle volatility across Europe: countries would not be able to use either fiscal or monetary policies to stabilize their domestic economies because both would be fit to a common European pattern. In Business Week this week, some evidence that his fears were well-founded. Of course, that doesn't tell us what to do now...
Source Brad de Long's Semi-Daily Journal

BW Online | January 24, 2003 | The Euro: One Size Fits None: Too much political capital is at stake -- especially in Germany and France, the euro zone's key economies -- for the euro ever to crumble. But as Germany's economy slumps into its second year of recession, the difficulties of designing a single monetary policy for 12 different countries are increasingly evident. That's worrying many of the senior businessfolk gathered in Davos, Switzerland, for this year's World Economic Forum. "The euro zone's monetary policy isn't a case of one size fitting all but of one size fitting none," says the chief financial officer of one Spanish company. "The result is that Germany is having to cope with higher interest rates than it needs, and its economy is slowing as a result. And that's affecting everyone across Europe."

SPENDING LIMITS. The problem is the Maastricht Treaty mandates that the European Central Bank maintain price stability across the entire euro zone. It can't take conditions only in Germany into account when setting rates, even though Germany is the Continent's largest economy and is a drag on growth in other countries. The ECB's key interest rate stands at 2.75%, whereas economists say Germany really needs a rate as low as 1% to stimulate demand, investment, and growth. Fiscal policymakers in Berlin are powerless to kick-start the sputtering economy because the Stability & Growth Pact puts tight limits on state spending. In particular, they may not run a budget deficit above 3% of gross domestic product. Germany's euro-zone partners have just censured it because it breached the 3% limit last year and will probably do so again this year.

Some eminent economists, such as Robert A. Mundell, professor of economics at the School of International & Public Affairs at Columbia University, argue that the Stability Pact should be scrapped and that the ECB should be given a broader mandate. Yet many European business executives take the opposite line. Gerard J. Kleisterlee, president and chief executive officer of Dutch manufacturing giant Royal Philips Electronics, says the single currency needs to be underpinned with sound state finances. Ironically, German government officials agree. Caio Koch-Weser, Germany's Secretary of State of Finance, says it would be a mistake to abolish the pact.
Source: Business Week On Line

What to do now is an extremely moot point. I don't suppose there's much mileage in repeating the old British expression: always look before you leap.I suppose the best we can do is watch and wait since it will be some time before any of the responsible parties are likely to be prepared to admit to a mistake and start to undo the dammage. Meantime various possible scenarios do of course suggest themselves

On the one hand the inflation riddled southern fringe (Spain, Greece, Portugal) may find themselves launched into an Argentina-style rapid exit mode as rapidly rising costs make it increasingly difficult to create new jobs. On the other the German voters who are being asked time and again to foot the bill for what is at heart an unworkable system, may themsleves get so fed up that they decide they want the mark back and leave.

Either way things are still going to have to get a lot worse before anyone bites the bullet on decisions. However recent events on the Iraq front may ironically have given matters a hefty push. I don't know if anyone else is following this, or it's just me, but I can't help noticing that each time an Iraq hawk makes a strong speech the dollar drifts down a few points. Meanwhile the US treasury stays strangely silent. Reading Ben Bernanke carefully, it's clear that a weak dollar is a good hedge against perceived deflation dangers, so letting it drop without openly changing policy seems like a good move. A kind of knock-on Iraq effect. Meantime up and up goes the Euro. Since one common candidate on everyone's shortlist of potential 'Japans' is in fact Germany this could be just the shock they need (this and the firm fiscal tightening coming from the stability pact) to get them well and truly going. In which case, ZIRP will be well and truly on the order of the day, and then.......

It is interesting to note that Euro membership is not synonymous with EU membership, as with the 10 new entrants a majority of EU members (13-12) will not be in the Euro. The following link from Morgan Stanley's Global Forum might be of interest since it shows that the 4 key new Eastern entrants are all quietly dropping their currencies with the dollar to maintain competitiveness: Central Europe Currencies - The Tide Turns
Euro at 1.10 Dollars 'Now in Sight'

Or at least this was the sentiment expressed by one anonymous City trader in the FT yesterday. Now, as with all expressed trader opinion, this needs to be taken with a pinch of salt, but it does seem that this figure could become something of a psychological target in days to come. Certainly the Euro is going up and up - over 15% in six months now. Clearly if it does go through the $1.10 barrier this will give the ECB and European Commission something to ponder over, since a high Euro will be good for some and bad for others - another example of how difficult it is to manage monetary policy in a currency union. This is surely a falling dollar story more than it is a rising Euro one. The economic grounds for optimism on the European front are thin on the ground. So one day this will turn, but that day doesn't seem to near right now. However with Germany teetering on the brink of creeping deflation, and the ECB desperately looking for good reasons for another rate cut at a time when core inflation is still stubbornly hovering over the 2% mark, stemming the rise of the Euro could be just the excuse they need.

The euro continued to edge higher against the dollar on Wednesday amid mounting tensions between the US and Iraq.The recent bout of more aggressive rhetoric from the US administration has kept the dollar under pressure in recent days. On Wednesday, the dollar hit a fresh three-year low against the euro at $1.0744.Traders said that $1.10 now appeared in sight.

Risk reversals - an indication of the bias of the options market - provided an interesting hint into the psychology of the marketon Wednesday. Although euro calls continue to trade at a premium to euro puts - suggesting the market still expects a rising euro - this premium is at its lowest level so far this year.Marc Chandler, chief currency strategist at HSBC in New York, said this could be explained by traders long of euros trying to hedge against a fall in the currency. "This hints that many of those who hold a long euro postion do want some protection, but are not willing to sell their spot position," he said. "This is an encouraging sign for the euro," he added.
Source: Financial Times

Incidentally, reading again the US administration hawkish rhetoric argument, it couldn't be that they are using the pre-war atmosphere to move away from the strong dollar policy, now could it. While all eyes are focused on the Bagdad/Washington axis, the dollar is quietly allowed to drop, much to the relief of a deflation worried Greenspan, and a hard pressed US manufacturing sector. Spelling this out: talking hard on Iraq is in fact talking down the dollar without saying so. Or am I being too cynical?
Germany in 'Make or Break' Tussle

Or at least that's how Wolfgang Clement the country's economics and employment minister sees it. In an interview with the Financial Times, he said 2003 must be a reform year for Germany. "It will also be decisive in determining the competency and strength of this government. It is a decisive year in all aspects." His declaration came as new data show that the German economy grew by only 0.2 per cent last year, its worst performance since 1993, sparking concern over growth prospects this year for Germany and its Euro zone partners.

"We are certainly going through a difficult phase, no question," Mr Clement said. "No one can accept a situation with 0.2 per cent growth and such high unemployment, myself included." Seasonally adjusted unemployment reached a four-year high last month of 4.2m.Mr Clement's comments came as Josef Ackermann, chairman of Deutsche Bank, last night attacked German reluctance to embrace reforms, insisting the country was "a prisoner of its status quo".

Pitching into the reform debate for the first time, Mr Ackermann said many people did not seem to appreciate "how serious the country's problems really were" and appeared to be trapped by existing social structures.He said Germany had long ceased to be the land of the Wirtschaftswunder, or economic miracle. Now commentators increasingly saw it as another Japan, trapped in a vicious spiral of slow growth and falling prices.Mr Clement said the European Union needed an "American approach" to setting interest rates, arguing that the rates set by the European Central Bank should be lowered to US levels.The ECB's policy of maintaining high interest rates was one explanation for Germany's economic problems, Mr Clement said. "From a German viewpoint, we need an interest rate policy similar to the American approach. That means sharp interest rate cuts."
Source: Financial Times

So does this mean the pressure on Euro zone rates is now really going to be on. And what if Germany needs to head for the zero-bound, where will this leave the inflation riddled Mediterannean trio - Spain, Greece and Portugal - flying upwards out of the window perhaps (as I often comment the Spanish expression 'saliendo disparados' says it all). No idle question this in a week that sees Gustav Horn, Head of Macro Analysis at Germanys leading economic research institute thinking the unthinkable and asking the 'D' question, Germany on the road to deflation?

The outlook for the German economy is bleak. Given the still moderate pace of global economic activity, the deep crisis of confidence on capital markets and a hesitant monetary policy in the euro area, there is not much leeway for a production expansion all over Europe. In addition to that, recently published intentions of the German coalition government point to a marked reduction in public expenditure accompanied by a significant increase in taxes and social security contributions. Consequently, fiscal policy will be very restrictive next year. Against this backdrop, the German economy will almost stagnate towards the end of next year, again falling behind the rest of the euro area.

A matter of great concern is the development of prices. Already the German inflation rate is one of the lowest in the euro area, and accordingly real interest rates are higher than in the rest of the euro area, hampering a recovery. In such a low growth environment prices will be under heavy pressure. In the course of this process the German development is beginning to resemble the Japanese one at the beginning of the 1990s more and more. The Japanese deflation also started with a crash on stock markets, a lack of confidence and reduced wages in line with the cutting of bonus payments. For some years this just led to low inflation rates until price development turned negative during the mid nineties.

The general advice in such a situation is that monetary policy should reduce interest rates swiftly to prevent the unfolding of a deflationary process right from the beginning. However, in a monetary union such a course is only appropriate if the union in aggregate is negatively affected. At some later stage this will doubtless be the case. But a swift loosening may not be possible as long as inflationary tendencies in other countries are close to the stability target. In that case only fiscal policy could deliver immediate help. But the German government has blocked this road by planning to observe self-imposed deficit targets. Therefore there is a danger that the German policy mix may lead to a prolonged phase of stagnation, and this could easily prove to be the beginning of the dead end road to deflation.
Source: DIW Berlin, Economic Outlook

Germany Continues its Slide

These days there is little post christmas cheer from Germany. The more data we receive the more the double-dip looks like a done deal. Today's new unemployment figures revealthat seasonally adjusted unemployment rose 28,000 to 4.19m in December, a fresh four-year high. The number of Germans looking for work at the end of last year rose by 200,000 on an unadjusted basis to 4.22m, the strongest monthly increase since 1997. At the same time gloomy trading statements from two of Germany's leading retailers today confirmed fears that the sector, which registered its biggest contraction in five decades last year, could be heading for an equally difficult time in 2003.The 2002 turnover figures from Metro, the country's largest retail group, and Douglas, a perfume, jewellery, and book seller, also added to anecdotal evidence of poor Christmas sales after official statistics this week showed a steep drop in November consumption.

The Nuremberg-based Federal Labour Office said on Thursday the average number of jobless was 4.06m, 220,000 higher than in 2001 and marking the highest annual increase for five years. The annual unemployment rate in 2001 was 9.8 per cent.The broad difference between Germany's east and west persisted last year with unemployment more than twice as high in the former communist east. Baden-Württemberg in Germany's south boasted the lowest unemployment rate at 5.4 per cent while Saxony-Anhalt in the east topped the list with 19.6 per cent. The Labour Office said the increase meant it would need an extra E2bn from the federal government to pay the higher number of people receiving unemployment benefit. Rainer Schmidt, labour market expert at a prominent Kiel-based economic think-tank, said: "We cannot see light at the end of the tunnel yet." He expects another rise in unemployment in January to an unadjusted "minimum of 4.5m people, probably slightly more," depending on the weather.
Source: Financial Times

"There are serious indications that 2003 will be yet another difficult year for the retail trade," Henning Kreke, chief executive, said, declining to give sales targets for the current year. Analysts said the 2.6 per cent drop in German sales in 2002 betrayed a passable performance at Douglas-branded perfume and cosmetics shops but a sharp fall in sales at its Christ jewellery stores.German retailers have been plagued by Europe's lowest margins for decades. But consumption saw its sharpest drop since the war in 2002 as consumers have grown concerned about unemployment, the country's faltering economy, a perceived rise in inflation, and talks of tax increases.In this context, analysts have praised Metro's expansion of its wholesale Metro and Makro stores beyond Germany over the past few years and the repositioning of its high-end Saturn electronics store as a quasi-discounter through its popular "thrift is cool" campaign launched late last year.
Source: Financial Times

Getting High on the Euro

The Euro continues its rise. For the prestige of the ECB and the standing of the EU I suppose this is a good sign. But since this rise is more a 'dollar fall' and since what the economists love to call the 'fundamentals' don't seem to justify it at all, permit me to have my doubts. With low uptake of new tecnologies, sluggish momentum from the US and downright deflation in Japan, and ageing populations perhaps it will be more like a reamke of an old Eastwood movie: Hang-em High 2.

Clearly the rise in the Euro will have a deflationary impact on the European economy generally (remember the Chinese Yuan is pegged to the dollar), exports will decline and imports rise, and with deflation and not inflation the buzzword, all this doesn't augur too well. As the article blogged below points out, Europe as a whole is twice as dependent on exports as the US, with Germany (the EU motor?) especially vulnerable:

The strengthening euro is beginning to pinch European exporters, and it is increasing expectations that the European Central Bank will cut interest rates this year. In recent weeks, international companies ranging from beer brewers to electronics manufacturers have warned that the appreciating currency is chipping away at foreign sales and profits. All other factors equal, a rising euro makes European goods more expensive overseas, and therefore less competitive, or yields exporters smaller earnings when they convert foreign profits into euros. The cries are loudest in Germany and Ireland, the two euro-zone countries most reliant on exports. Last week, the euro briefly rose above $1.05 to a three-year high. It traded at $1.0417 late Friday in New York, making for a 16% rise over the past year against the dollar and a 6% rise against a basket of major currencies used by the ECB.

The common currency was intended partly to help shield the 12-nation euro bloc from currency shocks by creating a large, unified economy. But Europe is still more sensitive to currency fluctuations than is the U.S., because Europe's economy is nearly twice as reliant on trade. The ECB estimates that a 5% increase in the euro sustained for a year can knock as much as 0.9 percentage point off annual growth, seven times the impact a similar rise in the dollar would have on the U.S. For Germany, the euro zone's largest economy, sales to the U.S. dropped 15% in euro terms during the first 10 months of 2002, compared with a 9% increase in 2001 and double-digit rises during the previous three years. By value, 40% of Germany's manufactured output is exported. One firm feeling the pinch is Siemens AG. The electronics firm generates about 80% of its sales outside Germany. In the year ended Sept. 30, sales slipped 3% to 84 billion euros and new orders declined 7% to 86.2 billion euros -- partly because of currency moves.
Source: Yahoo News

Europe Groping for an Identity?

Last week's EU enlargement agreement has been hailed as historic by some, and as a lost opportunity by others. Whatever decision is finally passed by history one thing seems sure, this is an important turning point. Among other changes, the Euro zone countries will now be a minority within the EU. In redrawing the map of Europe, the 15 men whose countries represent one of the world's most important and exclusive clubs tore down one border only to build another. The summit formally invited 10 new members, most with dysfunctional economies, to join the European Union by 2004, thereby expanding eastward into territories whose future economic and political development is far from clear. At the same time they rejected Turkey's demand that its candidacy be given more urgency, erecting a wall that is sure to be seen by the mostly Muslim country of 67 million people — and by the rest of the Muslim world — as a division between the Christian West and the Islamic East. The Europeans rejected a plea from Turkey to set a date for starting talks on its eventual admission. The response from within Turkey itself was predictable. The front page of one Turkish newspaper - Hurriyet - was illustrated with da Vinci's "Last Supper". Below figured the question, "Will the E.U., like Christ's last supper, be purely for Christians or will there be a Muslim at the table?"

My feeling on these decisions is that on the one hand the enlargement programme is far more problematic than is normally recognised, while on the other a great opportunity has been missed. But the Europeans are getting old, and old is not normally synonymous with bold. The newly admitted countries are not a re-run of the Spain, Portugal, Greece expansion of an earlier era. The new countries do not have the demographic 'gift' that lay before the mediterranean countries at the time of their entry. They are mainly economies which have barely survived the transition shock from the old centrally-planned type. They are ageing societies whose birth rates have long been among Europe's lowest, where women - of all ages - have long since been out of the home working. If they do not face the negative debt dynamics of the other EU countries, then this is only because they have assumed only minimal responsibility for the welfare of their aged, and thus the anticipated costs of ageing are lower. But this is not exactly good news. It means, among other things, that we are extremely unlikely to see an expansion of internal consumption 'mediterranean-style', but rather an increase in decrepitude, misery and dispair.

Turkey's stuation could not be more different. Turkey is going through a 'demographic transition' and birth rates are steadily falling towards that magic number: 2.1 live births per woman of childbearing age. But they have not got there yet, and Turkey's young population - nearly 30% of the 70 million population are under 15, compared to an average of only 15 % in the new entrants - could give EU consumption growth a much needed boost. But while the economic arguments for an early accession date for Turkey are compelling, the political and cultural ones should be decisive. Turkey has a human rights problem, sure. But there is an internal battle inside Turkey over this, and bringing the Turks into dialogue with the Union would give important aid to the pro-democratic, pro-human rights forces that exist there. In addition, moving Turkey's dossier forward would give the world another, and even more imporant, message about Europe's cultural identity. It would give a message about diversity and openness, a message of hope for that enormous majority among the islamic populations of the world who have no more sympathy for the Bin Laden's of this world than we do.

European politicians wave away talk of a clash of religions or of blocking Turkey to control immigration and insist that their decision was based on standards of democracy and human rights, and on controlling immigration and terrorism. With the decisions here, the European Union has given itself the thankless task of defining Europe, a task that has baffled scholars and politicians for centuries. "Geographical Europe," wrote Norman Davies in "Europe: A History," "has always had to compete with notions of Europe as a cultural community, and in the absence of common political structures, European civilization could only be determined by cultural criteria." Jean Monnet, the visionary advocate not just of economic union but of an eventual United States of Europe, took the extreme position in the immediate years after World War II, writing, "Europe has never existed; one has genuinely to create Europe." His way of doing so was to bring together that part of geographical Europe that was democratic into a common unit by knitting its economies together. The aim was that politics would follow. Now, the European Union is embarked on the task of adapting that vision to a very different political landscape. Even as it struggles to create political, economic, social and even military institutions to serve its current members, it has been challenged by events to enlarge itself — and is faced with the question of what other societies might fit in.
Source: New York Times

German Debt to Lose AAA Status?

It seems Germany's status as the benchmark in the eurozone debt market is under threat because of growing concerns about their ability to hold on to their triple A credit ratings. Arguably investors are already begining to price in the risk of a German downgrade as the fiscal position continues to worsen. Standard & Poor's this week affirmed Germany's triple A rating with a stable outlook, but pointed to growing debt and fiscal deterioration as an indication that Germany "has begun to fall behind its triple A rated peers in terms of fiscal and economic indicators". Because of its benchmark status - the result of Germany's historically strong finances - Berlin has been able to borrow more cheaply than other eurozone governments, this position could now be in the process of changing, making the debt more costly to maintain and thus in principle increasing the deficit.

David Riley, head of sovereign ratings at Fitch, said: "Germany's triple A rating can no longer be taken for granted." Fitch plans to review Germany's rating in the first quarter of next year. "We are going to Germany because we are concerned about the structural issues and I would not rule out a negative action," Mr Riley said. Moody's is also planning to visit the country next year but it said that its main concerns focused on long-term structural issues, such as the state pension system, rather than on the shorter-term fiscal position. A downgrade or even a change of outlook on Germany by any of the three large rating agencies could affect its benchmark status. While German 10-year yields are still the eurozone's lowest, some analysts now expect France, its closest rival since the euro came in, to achieve benchmark status next year in terms of the price of its debt.
Source: Financial Times

Meantime Italy, with a current debt GDP ration of around 109.8%, plans to use a piece of 'coupon-clipping' to reduce the outstanding stock of debt to around 108.5% by swapping €39 billion of 1% government bonds held by the Bank of Italy in its own portfolio with comparable issues carrying higher coupons (say in the 4-5% range). Since an increase in the coupon would reduce the nominal value of the debt this move would help the debt/GDP ratio, the stream of future budget deficits, in contrast, would go up by around one-tenth of a percentage point a year in paying the higher interest. The real problem, however, is that a country with a stock of debt larger than its GDP keeps living beyond its means and borrowing from the future, and no amount of financial jiggery-pockery is going to change that reality.
Portuguese Workers Are Not Happy

Portugal was brought to a virtual standstill by a general strike yesterday as unions challenged reforms introduced by the centre-right government in its effort to cope with the eurozone's spending and borrowing rules and the impact of European Union enlargement. The 24-hour stoppage, Portugal's first general strike in a decade, mainly involved public sector workers who say they are bearing the brunt of the austerity measures which are designed to bring the budget deficit back within the limit set under the eurozone's growth and stability pact. Whatever the complexity of the problems lying behind Japan's deflation problem, it is not too hard to look into the proverbial crystal ball and see how the future is likely to pan-out for some Euro-zone members. Faced with an inflation dynamic which makes them increasingly less competitive they are finding growth hard. At the same time an ageing population and escalating future pension liabilities mean they have a debt trap - they cannot try to stimulate growth by getting into debt because the future growth expectations, which would enable them to pay-off the debt, just are not there. Hence deflation is an ever present danger.

"Portugal is in danger of losing an important dimension of social solidarity and stability if the government goes ahead with these reforms," said Manuel Carvalho da Silva, general-secretary of the CGTP-Intersindical trade union federation, which called the strike. But António Bagao Félix, labour and social security minister, said the reforms were vital if Portugal was to compete successfully for export contracts and inward investment with the east European countries due to join the EU in 2004. The strike, which disrupted hospitals, schools and courts and brought public transport to a standstill, was mainly targeted at government proposals to replace about 80 labour laws with a single new code designed to increase efficiency.
Source: Financial Times

EU Expansion Agreement Proving Difficult

With a summit aimed at admitting 10 more countries to the European Union only two days away, the candidate governments are still bargaining hard for better financial terms of membership, and the member governments are still trying to decide how much to offer. According to the experts, with so much unresolved, the summit that opens Thursday in Copenhagen could well extend beyond its scheduled two days. In fact European officials are saying that the most difficult issues will not be resolved until government leaders sit down behind closed doors for last-minute deal-making. Of course, the main sticking point in the negotiations between the 15 EU countries and the candidates is money. The countries joining the union will get direct cash payments in the form of development aid and support for farmers, far beyond the amounts they will have to pay into the EU. But they are joining at a time of economic constraints in Europe generally. In return for the aid the new countries would have to accept a series of strict agricultural production quotas. Poland, which has more farmers than Germany and France combined, has been particularly vocal in crticising the proposed terms, pressing for more farm aid and higher production quotas in areas such as milk. The nub of this problem is that all this comes at a time when the leading EU countries are experiencing far more economic difficulties than were expected at the time of proposing entry. Germany in particular is having to propose a very difficult package to its own citizens this winter to maintain its commitment to the stability pact, while having higher than desireable interest rates due to Euro membership. This means that it is in no position to be especially generous. Hence we have an 'expectations gap', the new, poorer, countries being in a worse position that the existing members imagine, while the existing members are unable to meet the generosity expectations of the newcomers. All-in-all it is difficult to see how this can work well long-term.

"This has to be in the hands of the heads of state and government," said Romano Prodi, president of the European Commission, the EU's appointed executive body. "The decision is too important a decision to be taken beforehand." He added, "Miracles are always possible." Prodi said he did not expect the haggling to derail plans to formally issue membership invitations to the 10 countries -- Poland, Hungary, the Czech Republic, Slovakia, Slovenia, Malta, Cyprus, Latvia, Lithuania and Estonia. "The deep sentiment of all the heads of state and government -- I repeat, all -- is in favor of enlargement," Prodi said. "The enlargement is seen as an historic goal. It is not a decision of 'if,' it is a decision of 'how.' "
Source: Washington Post

Is the ECB Rate Drop a Good Decision? It Depends Where You live

As I have been flagging in this column for some weeks now, interest rate policy for the Euro zone is a mess. The most obvious way of indicating this is to say the Duisenberg has no good decision strategy available. Not because he is a good, or bad, banker, but because undecideability is structurally in-built into the problem. The decision is rather whose interests do you favour, the low-inflation or the high-inflation countries. Even if this decision could be seen as mildly helpful from a German, or French point of view, from 'down South' in Portugal, Greece and Spain it looks decidedly risky. For Germany it seems to be a question of far too little, far too late, well behind the curve as they say. Of course, one day the inflation down South will stop. It has to, since they now have no independent currency to devalue in order to recover competitiveness, and, of course, unlike the US they do not have a central bank of their own to start the printing presses rolling. So one day the inflation will turn into deflation as their economies cease to be able to oxygenate and they start to suffer an absence-of-liquidity induced asphyxiation. Meantime we are in a kind of time-void between a decision whose chronicle was already foretold two to three weeks ago (thus there is no real market-shock as it is already priced-in), but whose consequences won't be noticed in any significant sense for six to nine months at least. Bottom line: whatever the long hard winter was which lay in front of Germany as of last Wednesday, well, it still does.

On another front, back in the UK, the consequences for Euro membership of the current interest rate divergence are starting to sink in:

After walking side by side for a while, the European Central Bank and the Bank of England have come to a parting of the ways. It may now be a long time before their paths bring them so close to each other again.In recent years, the gap between the main interest rates of the Bank of England and the ECB has been falling steadily. Last year it closed to just three quarters of a percentage point.Thursday's decisions by the two banks, however, suggested that the impression of convergence between Britain and the eurozone has been illusory......

"The ECB's next move is more likely to be down than up, while the Bank of England's next move is more likely to be up than down," said Robert Barrie of Credit Suisse First Boston. "Inflation is below target in the UK, but potentially going above it, while it is above target in the eurozone but probably going below it." Although both investment and exports have been weaker in Britain than in the eurozone, consumer demand is very much stronger. According to the Organisation for Economic Co-operation and Development, consumption is expected to have risen by 3.6 per cent in Britain this year, supported by a boom in house prices and household borrowing, compared with a mere 0.6 per cent in the eurozone.

The first four years of monetary union have shown that convergence inside it is a slow process. The dispersion of core inflation rates in the eurozone is actually greater now than it was at the euro's birth at the beginning of 1999.For some countries such as Spain and Portugal, real interest rates allowing for inflation are negative. Hence this week's complaint from Rodrigo Rato, Spain's finance minister, that "an interest rate cut is not so great from the inflation point of view". But for Germany, where inflation is low, real rates are still positive although the economy is close to a standstill. "Monetary policy is extremely expansionary in Spain, and extremely restrictive in Germany. It is amplifying the differences between unemployment and growth rates across the eurozone," said Patrick Artus of CDC Ixis in Paris. "If you have a single monetary policy with no significant migration or fiscal transfers, you're in trouble." Whatever the benefits of joining the euro for trade and investment, the risks involved in submitting to the eurozone's single interest rate will make the British government think very hard indeed before joining.
Source: Financial Times