ROI-How to boost EU competitiveness? Choose a German ECB chief: Mike Peacock

By Mike Peacock

LONDON, March 17 (Reuters) - The European Central Bank is widely expected to hold rates steady when it meets this week, so alongside discussions of the Middle East energy shock, attention may turn to who will be the policy-setting body's next chief.

If the bloc is serious about boosting competitiveness, it should appoint a German. Most of the central bank headlines of the past year have focused on who will replace current Federal Reserve Chief Jerome Powell when he steps down in May. But with markets mostly mollified by U.S. President Donald Trump's orthodox nominee, former Fed board member Kevin Warsh, focus is turning to who will next lead the ECB. The European rate-setting body isn't due to get a new chief until late 2027. But the Financial Times reported in February that Christine Lagarde may stand down early to allow her successor to be chosen by euro zone leaders before French elections that could deliver a far-right, eurosceptic president.

Lagarde has denied that report, at least when it comes to an imminent departure, but the French polls are more than a year away, so she still has plenty of time to step down before her official term ends. Regardless of the exact timing, the next appointment will come at a critical moment for the 27-member bloc's economy, given the region's fraying relationship with the United States, growing defence requirements and urgent need to boost competitiveness in the face of rapid technological change. European governments are already jockeying for position. Spain has lobbied for the seat and the term of its ECB vice president, Luis de Guindos, ends in June, leaving the euro zone's fastest growing economy short of a representative at the top table. Pablo Hernandez de Cos, the former head of Banco de Espana, appears to be in the running. Outside of Spain, another top candidate is ex-Dutch central bank chief Klaas Knot.

But the candidate best-suited to enact change as head of the ECB may, perhaps surprisingly, be Bundesbank President Joachim Nagel.

GERMAN DARK HORSE If Nagel took the top ECB job, it could help bind Germany more firmly to the critical EU economic reforms identified by former ECB President Mario Draghi that many experts believe are required to lift the region's economy. These include a capital markets union and increased mutual borrowing by member states.

The current Bundesbank president has already shown far greater flexibility on reforms than his hawkish predecessors, who often tried to block or dilute extraordinary ECB measures before, during and after the euro zone crisis. For example, Nagel has not only backed the ECB's Transmission Protection Instrument, a bond purchase scheme launched in 2022 to prevent financial fragmentation within the currency bloc, but last month he went even further, telling Politico the EU should issue more joint debt. That is something German leaders, fearful of being the bloc's bankroller, have long chafed at. While Nagel has signalled a willingness to take the job, internal EU politics make his appointment far from certain. For one, because the ECB was substantially modelled on the Bundesbank and located in Frankfurt, there has long been an unspoken rule that a German should not lead it. So far, a Dutchman, two French nationals and an Italian have headed the currency area's central bank. The EU also has a firmer unwritten rule that no country should hold more than one of the bloc's top jobs simultaneously, and Germany's Ursula von der Leyen will remain head of the European Commission until 2029. The time may have come to set these customs aside.

A BOLD CHOICE

Nagel's appointment would be a bold choice.

His willingness to support EU reforms puts him in line with German Chancellor Friedrich Merz, who, since his election last year, has made the case for the EU to move quickly on critical initiatives, such as a capital markets union and a sweeping simplification of regulations in the bloc. One of Merz's first acts in power was to scrap Germany's long-held "debt brake" to allow for a big increase in defence spending to 3.5% of GDP by 2029 and to establish a 500-billion-euro fund to revamp the country's fraying infrastructure. Traditional Bundesbankers would have railed against such perceived fiscal profligacy, but under Nagel, the central bank had already come up with its own proposal to allow for a marked increase in government borrowing with the lion's share devoted to investment.

Putting Nagel at the helm of the ECB could thus signal to the markets that - with the EU's largest economy on board - a new direction in the bloc's policy could truly be coming. Nagel, if he gets the job, might sound more hawkish on interest rate policy than Lagarde. But euro zone inflation fell below the ECB's target in January and only ticked up slightly in February. Additionally, the bloc's current policy rate of 2% is well below those of its major peers. So unless the Iran conflict generates a persistent increase in inflation, there is little prospect of significant policy tightening.

Espousing German-style orthodoxy on interest rates would likely play well with Nagel's domestic audience, potentially allowing him to be bold on those much-needed bloc-wide reforms.

For an EU struggling to come to terms with a fragmented new world order, that could prove pivotal.

(The views expressed here are those of Mike Peacock, the former head of communications at the Bank of England and a former senior editor at Reuters.) Enjoying this column? Check out Reuters Open Interest (ROI), your essential new source for global financial commentary. Follow ROI on LinkedIn, and X. And listen to the Morning Bid daily podcast on Apple, Spotify, or the Reuters app. Subscribe to hear Reuters journalists discuss the biggest news in markets and finance seven days a week.

(Writing by Mike Peacock Editing by Marguerita Choy and Anna Szymanski)