Bank of France attacks ECB strategy

The European Central Bank has raised interest rates a quarter point to 3.75pc despite an unprecedented attack on the "reliablity" of its strategy by the Bank of France and a barrage of attacks by French leaders.

Jean-Claude Trichet said the ECB acted in part to curb the 9.8pc rise in the M3 money supply, the highest since the creation of the euro.

Jean-Claude Trichet, the ECB's president, said monetary policy for the 13 countries of the euro-zone was still "accommodative", a coded warning that further tightening is on the way after seven rate rises since December 2005.

Mr Trichet fears that credit growth of 10.6pc is fuelling property booms and storing up future trouble.

The ECB's staff expects inflation to peak later in the year, even if it is falling now as a result of lower oil prices.

The rate rise was slammed as monetary overkill by Europe's unions and French politicians of all stripes.

"If the ECB does not realise its mistake, the long-awaited recovery will be endangered," said the European Trade Union Federation.

Well-signalled in advance, the move comes despite the market shake-out across the world since late February, a flight from risk described by Mr Trichet as potentially worrying. "I would say that what has happened was in some respects very rapid. This is a phenomenon that we are following very carefully," he said.

There are already signs of faltering growth in Germany, where retail sales tumbled 5.1pc in January after a rise in VAT. More ominously, German factory orders dropped 1pc, with sharp falls in export sales. This comes hard on the heels of an 8.7pc collapse in US durable goods orders in January and a fall in Japan's leading indicator. The risk is rising that the world's three biggest economies could all slow in lockstop.

For Spanish and Irish borrowers who mostly take out floating rate loans - and the army of Britons who have borrowed from Spanish banks to buy houses in the sun - monthly payments on a €200,000 (£136,000) mortgage have now risen by €315 in less than a year a half. Most people in Germany and France borrow at fixed rates.

Mr Trichet said the ECB acted in part to curb the 9.8pc rise in the M3 money supply, the highest since the creation of the euro. Like the old Bundesbank, the ECB follows M3 as the lodestar of orthodoxy even though critics say it has been rendered useless by the slew of new financial instruments on offer.

Now the Bank of France - Mr Trichet's old home before he moved to Frankfurt, and a major force within the ECB system - has begun to mutiny, publishing a report that rasies "serious questions about the reliability of M3 growth as a pillar of the ECB's monetary policy strategy".

While M3 has risen, the study found that money is circulating more slowly - offsetting the effect. Specifically, "income velocity" has been falling at 3.5pc a year.

"The existence of a strong, stable, and predictable relation between money and prices in the euro area cannot be taken for granted," it said. The implication is that M3 data is causing the ECB to over-tighten.The policy revolt comes after repeated attacks on the ECB by French political leaders, who argue that rising rates are pushing up the euro, with dire effects for Airbus and France's car industry.

President Jacques Chirac has called on EU states to use their Maastricht Treaty powers to seize control of the exchange rate, a back-door way to dictating interest rates.

A defection by the Bank of France would be a dramatic escalation, creating a rival policy camp within the heart of the ECB itself.

Business comment

By Damien Reece, City Editor Last Updated: 3:20am GMT 09/03/2007

As the easy money dries up, the cracks begin to show

Bank of France turns on ECB

One twist at a time, the world's central banks are turning off the tap of easy credit that has bathed asset markets with liquidity for five years. The European Central Bank has now raised interest rates seven times since December 2005 to 3.75pc, and clearly intends to keep going even if inflation appears to be falling. The Swiss, Japanese, Chinese and Indians are all tightening.

The markets have been complacent in the face of this synchronised squeeze, at least until last week. They may now be waking up to the irksome reality that vigorous growth without inflation cannot go on forever. The trade-off between the two is deteriorating, as always near the top of the cycle. The central banks are now trying to slow growth. This is a game they always win. Profits are the casualty, and shares follow.

For the eurozone, rising rates are starting to expose the yawning gap in economic character between the low-inflation bloc in the north and the recidivist spendthrifts down at Club Med. Countries such as Spain and Ireland, in the midst of a torrid property boom, and relying on floating-rate mortgages, are going to be affected very differently from Germany, where house prices have been flat and mortgages are on fixed rates. Add to this the unequal effects of the strong euro on German and Spanish industry, and it is not hard to see the eurozone doing the splits.

Because of their failure to grasp the nettle of reform, the French now find themselves in with Club Med. Their share of world exports is crumbling. Their car industry is in crisis. No surprise, then, that the French political class is now at war with the ECB, barracking the bank daily for easier money. What is a surprise is that the Banque de France is implicitly lining up behind them. The bank, of course, has legitimate academic grounds for releasing a report that rubbishes the ECB's monetary doctrine, and calls for looser money. The timing may just be a coincidence. But if you believe that, we have a bridge on the Seine we could sell you.

Yesterday the Flat Earth Society aka the EU (the prime ministers and foreign minsters of the countries in the EU) had a large get together and discussed the stillborn EU "constitution" and how to reduce the threat of global warming by curbing greenhouse gas emissions.

In the meantime in the real world things are happening (as shown above) and here

Regarding the economy and the Euro in particular we may be in for a real rocky ride. (I use the word "we" very loosely - the Swedish voters decided to stay out of the EMU). Not only are the differences in the Euro north and the Euro south starting to show up, but historically when the French start to throw their weight about, it has had large effects on the "European project".

So, is this just pre-election jitters, or have the French found out that they no longer are served by the EU/euro collaboration?

In any case - troubled waters ahead on the financial markets. A Spanish bubble collapse may have huge repercussions.

Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.