The battle for the heart and soul of the ECB continues

*Update 15:30* - It seems after a quiet morning, the predictable fightback has begun in the battle over the ECB, and its a double whammy. First of all, although not addressing the French election campaign specifically, Bundesbank president Jens Wiedmann has entered the fray, ruling out any ECB participation (large-scale bond buying) in an eventual Spanish rescue, arguing that:

"We shouldn't always ring the doomsday bell when long term interest rate of a country temporarily exceeds 6%"

Secondly, Focus magazine reports that tomorrow's FAZ will carry a joint article from a number of major economic institutions criticising the eurozone crisis management strategy and warning that the ECB's independence is at risk.

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If any German happened to be tuning into French radio station RMC this morning, we're sure they must have choked on their semmel - at least if they have any cash stashed away. This is what French President Nicolas Sarkozy had to say about the role of the ECB:

"What is the good value of the euro against the [US] dollar? If the euro rises too much, our exporters can’t sell anymore. They lose money because they’re not competitive, but also because the value of the euro is too high. This is a discussion that we need to have with the President of the ECB.”

He made similar remarks over the weekend, but the explicit call for an ongoing dialogue between governments and the ECB over the strength of the euro goes against everything Germany believes in.

In other words, the battle for the heart and soul of the ECB - which we have looked at extensively - rages on. On the dramatic side, a leader La Tribune argues that the “Merkozy” couple committed suicide on Sunday, after Sarkozy suggested revising the role of the ECB:

“In calling for a revision of the role of the ECB …Sarkozy has declared war on Germany for domestic political reasons”.

Yes, it's all part of election politics, but still, this tension at the heart of the Franco-German alliance won't go away as the eurozone continues to grapple with how, precisely, the euro should be backstopped. As a reminder of the battles ahead, yesterday we learnt that the according to Unicredit, the perceived inflation in Germany is now at 3.7%, compared official 2.1% figure.

Meanwhile, on the topic of the ECB promoting inflation 'growth', over on the Telegraph blog, we argue that:

"Economically, ECB-induced inflation would not present a long-term solution to the eurozone’s ills by any means. Although the initial effect would be make adjustment in the struggling countries easier, the eurozone would remain split into at least two parts running at very different speeds. What happens after the initial boost in demand, as the transfer is, per definition, time limited? Sure, there’s a chance that struggling eurozone countries use the time bought effectively to really reform their economies. However, on current evidence, a more likely outcome is some reform, but that the imbalances remain. Would the ECB then continue to spray money on the Continent to keep the party going?

In addition, such massive ECB intervention also sets the scene for further boom and busts in Europe, which again threatens confidence in the system. Fears of a housing bubble are already doing the rounds in Germany. In reality, maintaining a 4% – 5% target could actually turn out to be substantially more difficult than a 2% one, as people would naturally expect inflation to increase even further (managing inflation expectations is an absolutely vital task of central banks). Even if a higher average level of eurozone inflation were achievable the level needed in Germany to balance this out would likely be too high to be economically acceptable. Furthermore, the transition would be incredibly tricky as people’s expectations take time to adjust to the new "normal", possibly increasing volatility or even feeding through to wage pressure (and other second round inflationary effects).

Politically, such a change is very unlikely as long as the ghost of Weimar looms large over Germany. But if ever the Bundesbank is outvoted, beware what you wish for. If the perception is that the ECB is really turning into a “bad bank” that actively pursues inflation, that would be one of the few scenarios under which German support for the entire euro project really could evaporate."

Full piece here.