German Chancellor Angela Merkel is facing a
challenge to her tough line on fiscal austerity as unemployment
continues to rise across the eurozone and the region faces up to the
threat of a prolonged recession.
Hope of an early recovery from recession suffered another setback this week following figures showing the number of jobless in France and Spain swelling to record levels and key economic indicators gave a negative outlook.
This has led to calls for a shift away from the fiscal austerity spearheaded by Merkel and added to expectations that the ECB will deliver a 25-basis-point cut in interest rates next week to spur growth.
Italy's prime minister-designate Enrico Letta this followed up remarks by European Commission President Jose Manuel Barroso on easing fiscal austerity, saying Europe's policy of budget consolidation was "no longer sufficient."
"Germany's position on fiscal consolidation is under pressure," said Commerzbank economist Rainer Guntermann.
Merkel helped to fuel speculation about ECB's next move on rates when she took the highly unusual step of entering the debate on the Frankfurt-based central bank's deliberations on monetary policy.
Speaking at a banking conference in Dresden on Thursday, Merkel said the ECB faced a dilemma as it attempts to strike a balance between the monetary needs of stronger economies like Germany and weaker eurozone members.
"The ECB is obviously in a difficult position," Merkel said.
Some analysts believe that a rate cut might not be in Germany's best interests at the moment.
Instead of the ECB's current one-size-fits all monetary policy, some analysts believe the bank should consider coordinating action more with other institutions such as the European Investment Bank to foster economic growth by targeting specific problem.
"For Germany (the ECB) would actually have to raise rates slightly at the moment, but for other countries it would have to do even more for more liquidity to be made available," Merkel told the bankers.
German ECB executive board member Joerg Asmussen has questioned the benefits arising from lower interest rates in both boosting economic growth and helping debt-hit eurozone member states emerge from the recession.
"The costs of very low interest rates are real and they rise over time," Asmussen told a business conference in Frankfurt.
The debate about interest rates in the eurozone was accompanied by the publication in the German media of a paper drawn up by the German central bank criticizing the ECB's strategy to resolve the eurozone's long-running crisis.
In the paper presented to Germany's top court, the Constitutional Court, and leaked to the German business daily Handelsblatt, the Bundesbank took aim at the ECB's government-bond buying programme, saying it was a threat to the bank's independence.
ECB President Mario Draghi sees the government-bond buying programme as playing a key role in helping stabilize the eurozone since the programme was unveiled last year.
Draghi has also stressed the need for governments to back it up by pressing on with economic reforms.
The question now is how the ECB will react to attempts by eurozone leaders to give members - including France - more leeway to meeting their deficit targets.
However, both Draghi and Merkel are likely to agree that those nations should use any leeway they are granted to press on with cleaning up their state finances rather than measures to stimulate their economies.
With a German parliamentary election just five months way, the chancellor will not want to be seen as going soft on cash-strapped eurozone states.
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