There are two tugs of war in the European economy. There is the tussle between strong current data and weaker indicators of future activity.
And there is the struggle between Nicolas Sarkozy, the new French president, and Jean-Claude Trichet, president of the European Central Bank (ECB).
It’s too early to say which way the economy will fall.
The eurozone grew at a remarkably fast 3% in the first quarter. Germany is doing especially well, with 3.6% growth and the lowest unemployment rate in 12 years. But the Ifo survey of business sentiment has dropped back sharply, although it remains at historically high levels. The eurozone index of retail purchasing intentions is gloomier. It’s at a level that implies falling sales.
That’s nowhere near enough weakness to deter Trichet from his desire to fight off the threat of future inflation. So ECB is happy to look through the current 1.9% rate of inflation—low enough to relax. The central bank is focused on growth in the supply of money—a distressingly rapid 10.7% in the M3 measure in May.
Sarkozy thinks Trichet is pulling too hard, overvaluing the euro through unnecessarily high interest rates.
The euro is certainly up—15% higher against the dollar since its 1999 launch and up by more than a half from its 2001 low.
Whether or not ECB is responsible for the currency’s rise, the strong euro has not yet dragged down exports much.
Even in April, when the region’s results were a little weak, exports from Germany were 13% higher than a year earlier.
That success suggests that France needs labour reforms more than a lower euro.
Trichet is French, but his job is to be a good unified European. So it will take a clear victory for the slow-grow side before he lets up on his side of the rope. He knows what he wants.
The higher rates go, the more insurance he has on inflation—and more spare line to let out if European growth slows in 2008.