Update ECB Poliltics

A German paper is reporting that Chancellor Merkel is not accepting the fait accompli that is being delivered to have Bank of Italy Governor Draghi replace Trichet when his term expires in early Q4.

Since Weber submitted his resignation, Merkel has been without a German candidate for ECB head. Recall that previously she had done a lot of "horse trading" to ensure that after Trichet, it was Germany's turn. This includes in the European Commission posts and also getting a small southern county to be represented as the vice president of the ECB.

In recent weeks, support for Draghi seemed to grow. Eurogroup's Junker suggested Draghi's candidacy enjoyed unstoppable momentum and France's Sarkozy offered his backing. First mover is not always advantageous and since Sarkozy tipped his hand, we suggested that Merkel would try to eke out some concessions for her "willingness" to support "France's candidate".

Observers have raised a few issues about Draghi's candidacy, which seemed to have been overlooked because 1) there did not seem to be another strong candidate and 2) Draghi has said all the right things and is in any event a competent and well respected central banker.

These issues included the kind of balance Europe likes including a balance of southerners and northerner, Draghi's tenure at a large investment bank during the period in which that investment bank sold derivative to Greece (and others) that allowed some concealment of sovereign debt, and that Italy is a heavily indebted country. In recent days some tried to take the last point and turned it on its head: That an indebted country may be more able to rein in other debtors. This is a weak argument and this seems to be where Merkel, according to the German paper, is making her stand.

It is not clear whether this is a principled issue or whether the master tactician Merkel is simply "negotiating". That she reportedly favors Draghi for the next IMF head does not clarify the issue and pretends that no doubts have been raised to the tradition of a European at the head of the IMF.

While the immediate market impact of the possibility that Germany does not endorse Draghi is not obvious. Yet who heads up the ECB is arguably an important influence on policy, even though the ECB is a diverse group of national central bankers with a small core, which as we have pointed out previously, is the exact opposite structure of the FOMC.