Cracks showing in Germany's fragile truce with the ECB

September 25, 2016 6:56 AM EDT

The headquarters of the European Central Bank (ECB) are pictured in Frankfurt, Germany September 8, 2016. REUTERS/Ralph Orlowski/File Photo


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By Noah Barkin

BERLIN (Reuters) - Michael Stuebgen, a conservative member of the German parliament, was speaking with the head of a local savings bank recently about the European Central Bank's quantitative easing (QE) program.

"He told me the bond market was being emptied out," Stuebgen recalled. "He likened it to going into a supermarket where everything has been bought up. You might find a shriveled old carrot or potato. Pretty soon you're starving."

Stuebgen, a spokesman on European affairs for Chancellor Angela Merkel's party in the Bundestag, credits the ECB and its President Mario Draghi with saving the euro zone from collapse four years ago.

But conversations like the one with the banker have convinced him that its policies, in particular the massive bond-buying program known as QE, have gone too far. He is not alone.

Stuebgen and his colleagues plan to send Draghi a message when he makes a rare appearance in the Bundestag on Wednesday to explain his policies and answer questions from lawmakers.

"It is time for the ECB to change course," Stuebgen said.

Last spring German criticism of the ECB reached new heights (some would say lows) when Finance Minister Wolfgang Schaeuble blamed Draghi's policies for fuelling the rise of the far-right Alternative for Germany (AfD), which was founded in 2013 in opposition to euro zone bailouts and has since morphed into an anti-immigration party.

Schaeuble's attack was unusual for two reasons. First, it was coming from Germany, where central bank independence has long been sacrosanct. Second, it was personal. Schaeuble was not only expressing concerns about ECB policies, which he had done off and on for years, but he was singling out Draghi.

A storm ensued, eventually forcing the two men to sit down over lunch in Washington in late April and agree a fragile truce.

It has held for five months, but there are signs it could be on the verge of collapse.

TOXIC POLITICS

Instead of changing course, as Stuebgen and his colleagues want, the ECB is widely expected to announce an extension of its QE program by the end of the year. The program is due to expire in March.

As early as next month, it could also announce steps to broaden the scope of what it can buy in response to a dwindling pool of available assets. The most controversial change would be abandoning the so-called "capital key", which limits the proportion of government bonds the ECB can buy from any given member state, based on its size and economic weight.

"The big challenge for Mario Draghi will be to prepare the Bundestag and German public for a further easing of monetary policy," said Marcel Fratzscher, head of the DIW economic institute and a former senior official at the ECB.

That message is unlikely to go down well in Berlin. In addition to concerns about the distorting effects of QE on financial markets and the impact of low interest rates on German savers and insurers, the political landscape in Germany has become decidedly more toxic for the ECB over the past months.

With one year to go until the next federal election, the AfD has risen to a record high of 16 percent in national polls. On the defensive, Merkel's conservatives are desperate to shift the debate away from her increasingly unpopular stance on refugees.

In this environment, the ECB could become the target of choice.

"I expect the German debate over ECB policy to ratchet up again if we see an extension of the QE program or adjustments to it that broaden the scope of what the ECB can buy," said Thorsten Frei, another lawmaker from Merkel's party, who will attend the Draghi session.

"There is certainly a risk that this becomes an issue in the election campaign next year."

Juergen Stark, a former ECB board member who resigned over concerns about the direction of policy at the height of the euro zone crisis in 2011, said he expects a more intense debate in the coming months.

"The longer the ECB stays on its current course, the fiercer the public reaction in Germany will be," he told Reuters.

ON THE OFFENSIVE

The latest Eurobarometer survey, which measures public opinion in the European Union, shows that only 30 percent of Germans say they trust the ECB, below the EU average of 34 percent.

"Many perceive the rescue measures to lack democratic legitimacy," a report published this month by the Delors Institute and Bertelsmann Foundation said.

"Even a central bank that is independent of direct political influence relies on trust and public support to be credible and effective in the long run."

The ECB, for its part, has gone on the offensive to address the criticism from its biggest and most important shareholder.

Board member Benoit Coeure visited Berlin in May to defend the policies. A month later, Francois Villeroy de Galhau, the German-speaking governor of the Bank of France, also paid a visit and explained ECB policies to Bundestag members in their own language.

Villeroy was back in Berlin last week for a meeting of French and German ministers and central bankers and said that, while it was fine to have a public debate about monetary policy, calling the legitimacy of the ECB into question was problematic.

"What is not always taken into account in Germany and elsewhere is that there was a serious risk of deflation in the euro zone and ECB actions have significantly helped to avoid this danger," Villeroy told Reuters.

"We may need to explain our policies better," he added. "But there has to be an effort from both sides."

Worryingly for the ECB, Schaeuble has begun criticizing the bank once again and was reported to have urged lawmakers to give Draghi a relentless grilling when he visits Berlin this week.

Speaking at an evening event in Berlin last week, Schaeuble mocked the ECB's bond-buying program, drawing laughter from the audience of German industrialists.

"I think it's called QE," Schaeuble said. "I don't even know what that means."

(Additional reporting by Reinhard Becker and Michael Nienaber; Editing by David Goodman)



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