* Berlin criticism of ECB course reaches new heights
* Draghi relationship with Weidmann said to have broken down
* Strained ties raise questions about euro policy response
By Noah Barkin , Eva Taylor and Paul Taylor
BERLIN/FRANKFURT/PARIS, Oct 23 (Reuters) - In early October, European Central Bank board member Benoit Coeure paid a discreet visit to the Chancellery in Berlin to express concerns about rising criticism of the bank from German politicians.
The Frenchman, one of ECB President Mario Draghi’s closest allies in Frankfurt, hoped for reassurances that the bank bashing, led by Finance minister Wolfgang Schaeuble, would stop.
But the message from Chancellor Angela Merkel’s advisers was not entirely comforting, according to one official familiar with the discussion.
Merkel would continue to refrain from questioning the ECB’s policies in public. But the broader backlash would be difficult to contain, especially if Draghi pressed ahead with unconventional measures to bolster the European economy, for example buying mass quantities of government bonds.
“Then you would see a real debate,” a top German official told Reuters on condition of anonymity. “Public criticism in Germany would take off.”
Back in 2012, Draghi appeared to save the euro zone from breaking up with his promise to do “whatever it takes” to defend the single currency, a stance that won swift backing from Merkel, who said the ECB was acting within its mandate.
But two years on, the Italian’s relationship with his most important stakeholder - the Germans - is fraying, with worrying implications for Europe and its faltering economy.
This tension is most obvious in the relationship between Draghi and Bundesbank President Jens Weidmann, which according to numerous officials who spoke to Reuters on the understanding they would not be identified, has almost broken down. But it goes further than that.
According to German officials, Merkel felt betrayed by Draghi’s speech at a central banking conference in Jackson Hole, Wyoming in August in which he pressed Berlin for looser fiscal policy to stimulate the economy.
Her entourage is also deeply sceptical about Draghi’s plan to buy up asset-backed securities (ABS) and covered bonds in the hope of encouraging commercial banks to lend.
Most of all, politicians in Berlin worry that if this scheme doesn’t work, the ECB president will be tempted to launch full-blown government bond buying, or quantitative easing. This is a taboo in Germany and a step Merkel’s allies fear would play into the hands of the country’s new anti-euro party, the Alternative for Germany (AfD).
Losing the support of the euro zone’s biggest and most influential member state would be fatal for the ECB’s credibility, eroding confidence in its ability to work with governments to get the euro zone economy growing again.
“Until now the ECB was confident, despite all the criticism in the German media, that it could count on Schaeuble and Merkel,” said Marcel Fratzscher, the former head of international policy analysis at the ECB and now president of the DIW economic institute in Berlin.
“But the recent criticism has been a real wake up call. There are questions about whether they have the full support of Berlin. The German criticism is a big concern for the ECB.”
The ECB, citing its independence, declined specific comment on the state of relations with Berlin.
A German government spokesman said Berlin trusted that the ECB was acting within its mandate to ensure price stability, and would therefore not comment further on its policy decisions.
Ties between Draghi and Weidmann, a former Merkel adviser who became head of the conservative German central bank three years ago, are now severely strained, according to half a dozen central bankers and government officials who spoke to Reuters.
The relationship has never been easy; Weidmann publicly opposed the OMT bond-buying programme that Draghi unveiled months after making his landmark promise.
Weidmann has also not shied away from criticising the ECB chief’s decisions since then. But in the past months, mutual suspicions have grown, according to officials who know both men.
A week after Coeure’s visit to Berlin, Draghi and Weidmann’s communications chief gave separate briefings on the same day to small groups of German reporters at an International Monetary Fund (IMF) meeting in Washington.
Draghi listed all the ECB measures Weidmann had opposed since taking the helm of the Bundesbank. The Weidmann aide complained that the ECB president was keeping national central banks in the dark and not taking time to build consensus in the 24-member Governing Council, according to people who attended the briefings.
Days later, at a Governing Council meeting in Frankfurt, the long-simmering row boiled over, with the two central bankers accusing each other of active sabotage through the media, according to one official familiar with the exchange.
That evening, at the ECB’s annual cultural evening, held at the grand Alte Oper concert house in Frankfurt, the tension around them was palpable.
“The relationship is totally rotten, it’s beyond repair,” said a second official who knows them both.
“It has become personal,” a third official from the ECB said. “Whenever Draghi and Weidmann are somewhere at the same event, there are bets about whether their paths are going to cross. Weidmann avoids Draghi like the plague.”
An ECB spokesman played down the conflict, saying it was “healthy” for Governing Council members to hold different views “which are then exchanged in a frank yet collegiate manner”.
“The decisions taken in the last three years have been backed either unanimously or by the overwhelming majority of Governing Council members,” the spokesman added.
The Bundesbank declined comment.
Tensions between the ECB president and German members of the council are not entirely new. Weidmann’s predecessor at the Bundesbank, Axel Weber, and ECB board member Juergen Stark both resigned in 2011 in protest at the bond-buying policies of Jean-Claude Trichet, the Frenchman who led the bank before Draghi.
There are no signs that Weidmann might be considering a similar step.
“WE WILL HAVE TO FIGHT”
But even senior Bundesbank officials have begun to express concerns about the deteriorating relations between the two institutions.
ECB Council members admit to being worried about hardening attitudes towards the bank in Germany, where supportive voices like Fratzscher have been drowned out by sceptics such as influential economist Hans-Werner Sinn and Holger Steltzner, the hard-line commentator for the Frankfurter Allgemeine newspaper, who dismiss the ECB as a “bad bank”.
“We will have to fight” to keep the Germans on board, said one member of the council.
Merkel’s government stood by the ECB when Weber and Stark bolted three years ago, helping Trichet to ride out the defections. But it seems more unsettled by Draghi’s course, partly because of the threat posed by the AfD, a party created last year which made big gains in recent regional elections, stealing votes from the chancellor’s Christian Democrats (CDU).
One problem, officials says, is that since the departures of board member Joerg Asmussen and Draghi’s top adviser Christian Thimann last year, the ECB president has not had a German ally in Frankfurt who can spread his message in Berlin.
Asmussen was replaced by Sabine Lautenschlaeger, an expert in financial regulation with no political experience, and Thimann’s post was taken by Frank Smets, a Belgian.
This is why it fell to Coeure, who took over responsibility for government relations when Asmussen left, to make the trip to the Chancellery earlier this month.
Frustrations have been exacerbated by Draghi’s leadership style, officials say. The Italian prefers to operate with a small group of confidants, led by Coeure and Peter Praet, the bank’s Belgian chief economist, rather than sounding out a broad range of views on the ECB Council, as Trichet often did.
“There is a lack of team playing going on in the Governing Council,” Juergen Stark, the former ECB board member, told Reuters. “The governance is changing.”
Before his speech in Jackson Hole, Draghi sought advice from U.S. Federal Reserve Vice Chairman Stanley Fischer, his professor at the Massachusetts Institute of Technology in the 1970s, while leaving some ECB Council members out of the loop.
According to one ECB source, Draghi has also clamped down on circulating policy papers to national central banks because they were often leaked. This close-to-the-chest approach has irritated others besides the Germans.
But the ECB source played down the idea that there were big tensions between the bank and Berlin, noting that Draghi and Schaeuble had talked on the sidelines of the recent IMF meeting and that Merkel had steered clear of criticising the ECB.
Still, Schaeuble has grown increasingly outspoken on the direction of policy, saying last month that he was “not particularly happy” with the idea of the ECB buying securitised products like ABS, and telling parliament the ECB had “exhausted” all its tools for reviving the European economy.
One official in Berlin who is critical of Schaeuble’s recent rhetoric pointed to the AfD as an important new factor that was encouraging Merkel’s party to take a tougher line with the ECB.
Regardless of the reasons, a growing list of conservative German lawmakers are joining the bandwagon.
Earlier this month, Hans Michelbach of the Bavarian Christian Social Union (CSU), the top conservative in the Bundestag’s finance committee, went so far as to label Draghi’s appointment to the top ECB post a “mistake”. (Reporting by Paul Carrel, Andreas Framke and Eva Taylor in Frankfurt, Noah Barkin, Andreas Rinke and Gernot Heller in Berlin, Paul Taylor in Paris, Jan Strupczewski in Brussels; Editing by Mike Peacock and David Stamp)