Germany's two-front war

ECB stopped buying government bonds last week. It's the first time since the program started in May. ECB bought 16.5 billion euros of government bonds in the first week. But since then, the amount has sharply declined, and reached nothing to zero in August. Despite the widening spreads over German Bunds, ECB's purchase has been contained for the last few months.  

ECB President Jean-Claude Trichet exchanged a spat with Bundesbank President and ECB Governor Axel Weber who advocates the early withdrawal from bond purchase program, saying "This is not the position of the Governing Council, with an overwhelming majority."

One may understand why Weber is calling for an end to the bond purchase program sooner than later if Germany's economic outlook is taken into account. IMF raised its economic forecast for Germany in 2010 to 3.3%, a staggering 1.9% point rise from a previous estimate. The reason is: weak euro.

As I showed previously, the euro has lost more than 10% of its value this year in real terms. It's due in large part to economic crisis which hit PIIGS. It's no wonder why export-dependent Germany benefits much from weak euro.

The problem is that the euro is now gaining strength because of the Fed's loose monetary policy, which could drag down Germany's feeble growth. Germany would be content if PIIGS remains weak, but their bond spreads over Germany's Bunds are narrowing since China, whose currency is widely considered to be undervalued, intends to buy Greek debt. Also, the Fed's QE2 could further strengthen the euro, thus denting the economic prospect for Germany.

The US and China. Germany would have to fight on two fronts.