Eurozone Watch

This week provided a number of highly positive news for the eurozone economy. Not only accelerated growth strongly all over Europe, reaching 0.9 percent quarter-on-quarter (3.6 percent in annualized terms), there were also indications that domestic demand in Germany, the euro area's problem economy, gained further traction.

The surprise was not so much in the headline figures (production and trade figures had already pointed to a sizable acceleration), but in the backward revisions. As it turned out, the upswing in Germany has been much more steady for the past year than previously though. Moreover, growth has already reached 0.7 percent (2.8 percent annualized) in the first quarter 2006 when an adversely cold winter depressed construction output. At the moment, the year-on-year rate is even respectable 2.4 percent – not much by American standards, but quite impressive for an economy for which many economists estimate potential growth at little above 1 percent).

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We know that European corporates and banks intensively lobbied for the European Monetary Union. We can see from recent studies that the private sector (including small and medium-sized companies) in the EU largely profits from the fact that the euro is there. However, when we look at the debate on economic governance of the eurozone, it seems that this is a non-issue for companies and those who claim respresenting their interests in most EU countries.

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Yesterday, the ECB hiked interest rates as expected to 3 percent. With this move, the central bankers stepped up their speed of tightening. Instead of hiking once every quarter, they seem to come to a rhythm of hiking once every two months. Most ECB watchers now expect a refinancing rate of 3.5 percent by the end of this year.

While this step might look prudent from a monetarists’ point of view given the still strong growth in the money supply M3, in my eyes it is a dangerous gamble which risks to damage not only the upswing in the euro-area, but also the ECB’s year-long crusade for sound public finances.

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