French regulator sees 'partial decoupling' of U.S. and EU economies

January 20, 2008

While there is increasing evidence that the eurozone economy is slowing, most of the factors that are contributing to the bleak outlook in the United States are not present on the Continent, according to the governor of the Bank of France, Christian Noyer.

In an interview, Noyer said he did not expect any “strong shocks” from French banks as they report their 2007 earnings, despite the constant stream of major losses by banks in the United States.
Noyer was at pains to stress that consumers and financial institutions in France and the rest of the eurozone appeared relatively insulated from the effects of the meltdown of the sub-prime mortgage market across the Atlantic.
“Historically, there was some correlation between the U.S. and the EU economic cycles,” Noyer said. “Now it seems there could be at least a partial decoupling. That's not to say that we're immune from a weakening U.S. economy, but there are a series of factors that should dampen the effect.”
Specifically, he pointed to the resilience of the housing market on the Continent. In addition, the weakness of the dollar seems to have made the rise in price of imported commodities more of a shock for U.S. consumers.
And, he said, banks in the euro zone were not as exposed to suspect financial products based on risky mortgages as those in the United States and Britain.
Noyer, who sits on the Governing Council of the European Central Bank in Frankfurt, is also chairman of the French Banking Commission, which regulates the sector in France.
As such, he said he has been assessing the balance sheets of all the big French banks before they reveal their 2007 results over the next month or so.
“I don't expect strong shocks,” he said during the interview at his office in Paris. “I'm reasonably confident that French banks will weather this turmoil without major trouble even though they are clearly, like all banks, in the world still in the process of marking down assets.”
Giving an assessment of the health of the euro area is a highly nuanced task for central bankers, since a change in tone can spark expectations of a shift in the monetary stance. Last week, at his regular press conference in Frankfurt, the ECB president, Jean-Claude Trichet, gave some analysts the impression that the bank might raise rates.
Since then, other council members, notably Yves Mersch and Axel Weber appear to have emphasized downside risks to growth, while still warning of inflation. Noyer, too, noted the risks to growth are on the downside.
“I wouldn't be surprised if the official forecasts - of institutions like the IMF, the OECD and central banks including ourselves - are revised down,” Noyer said, referring to the International Monetary Fund and the . “All the confidence indicators in the euro area have at best plateaued. And recent hard data are - at best - not positive. But for the moment there's no reason to exaggerate this sentiment.”
While the U.S. Federal Reserve has sent clear signals that it intends to lower its benchmark interest rate to spur growth, the ECB has appeared reticent. Its mandate is to control price rises, and euro-area inflation, at over 3 percent, is well in excess of its medium-term goal of close to, but below, 2 percent.
If the ECB raises rates to dampen prices, it risks aggravating the slowdown and would invite a wave of criticism from business and politicians, not least President Nicholas Sarkozy of France, who is worried about the effect of the ascent of the euro on exporters like the aviation giant Airbus.
Higher euro-area interest rates are likely to draw more investors to the euro as U.S. rates drop.
“The ECB is between a rock and a hard place” as it weighs off the risks of a slowdown versus price gains, said Jean-Michel Six, chief economist at Standard & Poor's in London.
He said the Council appeared to be divided in its assessment, and that the ultimate outcome could be three or four months of holding steady followed by a rate cut, as inflation dips and unemployment rises.
Noyer gave no hint of future moves.
“We don't feel boxed in; in any way,” Noyer said. “We remain flexible and we don't have a pre-set path. We are ready to act out of necessity to prevent the development of second-round effects.”
These so-called second-round effects refer to wages. The fear among central bankers has been that pay settlements - particularly for large German unions - could come in above the comfort zone. But so far, there is little evidence of that, Noyer said. “I don't see a spiraling development.”
In fact, the inflation spike should be short-lived, Noyer said, adding that relief might be at hand for consumers worried about rising gas and food bills. As growth moderates, the price shock should become less marked and that will “weigh downwards on inflation pressure.”
“Our expectations are that if there are no second round effects, inflation comes down to a level consistent with price stability by the year end,” he said.
(Source: International Herald Tribune)