EMU GDP rises in 2011-Q1 As the ECB 'Rings the Bell' for Germany

Growth is mixed and mingled - The table shows 2011-Q1GDP growth by quarter (annualized) and Year-over-Year growth quarterly for a batch of early-reporting EMU countries that has announced GDP this morning. I include as references the UK (an EU member) and the US. Figures in RED highlight Q/Q slowdowns or slowdowns in the Yr/Yr rate posted in adjacent quarters. On this basis Portugal's Yr/Yr pace of growth is continually slowing over the past four quarters and the US is slowing over the last two quarters in a row. Italy has slowed in the recent quarter and slowed in two of the last three quarters but has growth hovering at or below 1.5% over the last year.

The German Beast- Germany is a beast with growth stuck near the 4% mark (or better) over the last four quarters. For EMU, growth has been steady at about half that at 2% Yr/Yr - until this quarter when it bopped up to 2.4%. But EMU growth has done so amid new news of continuing debt troubles in the Zone involving the usual suspects and signs of softening economic data. Moreover, the IMF has just warned that the debt problems that so far have been sequestered in the EMU periphery could begin to encroach on 'the core,' a reference to the possibility that the large and more stable EMU members could be dragged into debt problems. Usually this sort of warning that cites a nameless 'core' is meant to suggest the possibility of a transmission to Italy where the national debt load remains huge and growth is of the faltering sort.

These observations remind us that GDP is backward-looking not forward looking.

The 'have' Vs the 'have nots' Emu style! - The ECB gave rate hiking one shot. But remember that German growth is twice the rate of the EMU itself. EMU sans Germany is much weaker. Once the German growth rate is weighted and subtracted out, the EMU pace is much weaker and significantly below the safe-sounding 2% level of growth. Indeed, at the table bottom of the table we subtract German GDP from GDP in the Zone and we construct a Non German EMU-wide GDP growth rate that is even weaker than Italy.

Rates were hiked? Seen in this way you can more easily understand why the ECB stopped hiking rates. Seen this way you have a hard time understanding why the ECB ever started hiking rates in the first place!

Where has judgment gone? We argued during the financial crisis that the ECB focus on headline inflation is de-stabilizing. In the crisis the ECB cut rates with inflation over the top of its target under the pressure of matching rate cuts abroad. It did so using the argument that inflation was expected to fall. With high and sharply rising energy prices having contributed so much to the elevation of the prices level (inflation) in EMU this time around and with a similar elevation for oil prices less likely (highly unlikely) in the future, isn't that same point relevant now?

Inflation is a rear-window target- The problem with inflation is that it is backward looking. So the Fed looks at inflation expectations to solve that problem. But the problem with that 'solution' is that inflation expectations are about as observable as anti-matter. You may be able to predict their existence, but you do not see them directly. The Fed's focus on inflation as the core measure coupled with a focus on expectations is a much sounder approach than the highly restrictive ECB approach. Still there is no doubting that the ECB has had success with its method when comes to inflation-fighting yet European growth has been softened and stifled by a too tight monetary policy and other Euro-Area rigidities.

The dilemma- So we see these differences in philosophy paying out on central bank interest rate policy and with the non-EMU reading on GDP growth so weak we can see the nature of the dilemma faced by the ECB: a fast-growing somewhat inflation-building economy that is about 30% of EMU GDP (called 'Germany') Vs sluggishness in the other 70% of the Zone with inflation nearly totally a commodities phenomenon. Trichet is lucky to be near the end of his term. Good luck to the next guy, Mario Draghi?

For whom the bell tolls – Meanwhile, it does appear that even this bifurcated and weak non-German EMU growth result is going to weaken further in the period ahead. The notch up in rates and impact on the euro fx rate will take some toll (despite some FX market reversal that is in progress). And the industrial reports already are signaling slower going ahead. Will the inflation numbers cooperate in time for the ECB to be able to hold steady and keep its honor? What about a new ECB head, faced with a razor's edge choice and coming from a country that is renown as an inflation softie? Will he have to earn his inflation-fighting credibility by being too tight? Trichet has not done him any favors by starting the rate hikes early. Nor has he done any favors for growth in the weaker Euro-Area member countries. But in making the choice that he has, Trichet has made it clear that when push comes to shove and division exists for whom the bell will toll in EMU. Call it what you will but, the EMU is the deutschemark zone

Euro-Area and Main G-10 Country GDP Results   Quarter Over Quarter-SAAR Year/Year GDP Q1-11 Q4-10 Q3-10 Q1-11 Q4-10 Q3-10 Q2-10 EMU (est) 3.2% 1.1% 1.4% 2.4% 2.0% 2.0% 2.0% Austria 3.3% 6.6% 3.0% 4.2% 3.3% 2.2% 2.4% France 3.9% 1.4% 1.7% 2.2% 1.4% 1.7% 1.5% Germany 6.1% 1.5% 3.2% 4.8% 3.8% 3.9% 3.9% Greece 3.4% -10.7% -6.3% -4.8% -7.4% -4.1% -3.1% Italy 0.4% 0.5% 1.2% 1.0% 1.5% 1.4% 1.5% The Netherlands 3.5% 2.8% 0.3% 2.7% 2.2% 1.9% 2.7% Portugal(est) -2.8% -2.1% 1.3% -0.4% 1.0% 1.2% 1.4% Spain(est) 0.4% 0.9% -0.1% 0.6% 0.6% 0.2% 0.0% UK 2.0% -2.0% 2.9% 1.8% 1.5% 2.5% 1.5% US 1.7% 3.1% 2.6% 2.3% 2.8% 3.2% 3.0% EMU-Germany 2.0% 1.0% 0.7% 1.5% 1.3% 1.1% 1.2%