German Bundesbank President Axel Weber is developing a reputation as a leading indicator for the European Central Bank.

In the same way as a pickup in confidence can foreshadow a pickup in the economy, Weber’s comments about the direction of ECB policy this year have tended to be borne out by events.

The ECB’s broad hint on Nov. 5 that it will drop its super-long, one-year loans to euro zone banks next year follows a similar suggestion by Weber a week earlier.

And earlier this year, the 52-year-old publicly argued (and succeeded) for the ECB not to cut its main interest rate below zero, or follow other central banks in adopting a massive asset-buying programme.

Some economists wonder whether Weber – seen along with Italy’s Mario Draghi as an heir apparent to  ECB President Jean-Claude Trichet in 2011– just dares to say publicly what others are already thinking, showing little regard for the unwritten rules that make Trichet the official barometer of ECB opinion.

But others say Weber’s record this year shows he is successful at convincing others to follow his lead. A former academic, he can talk eloquently about the nitty-gritty of economic analysis and as the representative of the euro zone’s biggest economy and banking sector, his opinion carries weight. 

“When Weber speaks, the market does tend to listen,” says Societe Generale economist James Nixon, a former ECB staffer.

European Central Bank President Jean-Claude Trichet  signalled on Thursday that the days of 12-month loans to banks will come to an end soon and that will be the start of a gradual exit from unlimited liquidity injections.
“The market, as far as I see, it is not expecting that we will prolong (our) one-year operation, I will say nothing to dispel this present sentiment of the market,” Trichet said in a news conference after the 16-country bloc’s central bank kept rates at 1 percent. “The enhanced credit support … was not for eternity,” he added.

The ECB started the 12-month cash injections to help the ailing banking sector back into form, and banks reacted with joy, snapping up nearly half a trillion euros of cheap money in the first such operation in June.

But Trichet also had soothing words for banks addicted to cheap money. The ECB would keep interbank interest rates well below the main refinancing rate, he said.  But it seems banks will have to learn to play again with each other rather than relying only on the ECB’s largesse.

And before signing off, Trichet also had words of advice for the media.  “This is exactly the same language as we always have utilised. Everybody knows that, so no news there.”

That advice seemed fall on deaf ears, as most media, including Reuters, would make a lot of hay out of his words on 12-month liquidity injections and keep it the centrepiece of their coverage.

BofA Merrill Lynch Global Research economist Ethan Harris thinks all the talk of a Federal Reserve rate hike is just that — talk. Harris, a former Federal Reserve Bank of New York economist, said much of the recent hawkish commentary has come from presidents of the regional Fed banks, and that may not be indicative of the thinking on the Fed’s board.

“The signals don’t  come from Reserve Bank Presidents or advisers,” Harris wrote in a note to clients. “They come from either the overall committee — in the form of the official statements — or from the core of the committee — that means (Chairman Ben) Bernanke, (Vice Chairman Donald) Kohn, and to a lesser extend, New York President (William) Dudley.”

The Fed starts its two-day policy-setting meeting on Tuesday, and Harris is certainly not alone in thinking they’ll stay the course, keeping benchmark interest rates near zero. In fact, BofA Merrill thinks it will be the European Central Bank that hikes before the Fed.

“The bottom line is that faced with roughly the same economic backdrop — very low core inflation, moderate headline inflation and a large but slowly closing output gap — we expect the ECB to be more hawkish than the Fed,” they wrote. “We expect a replay of the summer of 2008, when the ECB hiked in response to high headline inflation, but Bernanke held back the Fed for fear of fragile financial conditions. Of course, thankfully, a replay of the fall of 2008 is unlikely.”

Bankers worried about losing their bonuses might be well advised to consider a cost-benefit analysis of the contribution of their public sector colleagues.

Central bankers not only earn much less than their high-flying private sector counterparts, but over the last year have spent almost every second weekend in high-level, save-the-world meetings aimed at clearing up the mess created by Wall St and City banks.     

European Central Bank head Jean-Claude Trichet (who earns a mere 350,000 euros a year ) confessed to a group of student journalists that he spends almost every weekend working.

“My week often consists of seven working days, because we always have international meetings during the weekends,” he was quoted as saying by Germany’s Frankfurter Neue Presse. 

Trichet spent last weekend, for example, at the G20 meeting in London followed by a meeting of central bankers and regulators in Basel to thrash out a new framework for bank regulation.

One of the proposals: supervisors should make sure banks ”limit excessive dividend payments, share buybacks and compensation.”

Professor Charles Goodhart of the London School of Economics explains the difference between inflation targeting and price level targeting in the lobby of Jackson Lake Lodge after taking part in an animated discussion of whether central banks should target price levels rather than inflation.

A paper University of California, Santa Cruz economist Carl Walsh presented at the Federal Reserve’s annual mountain retreat suggested that one lesson from the recent financial crisis is that central banks would benefit from the greater flexibility that price level targeting might give them.

A former Fed governor,  Frederic Mishkin, said that while in theory price level targeting may sound attractive, in actual practice it is more difficult to use effectively. One difficulty he cited was in explaining to consumers how it works. 

 Juergen Stark of the inflation-targeting European Central Bank, said that inflation targeting was working well for the ECB, and that changing tactics in a crisis would be inappropriate.

 Bernanke’s tone may have been slightly more optimistic today — but the first thing policy-makers from around the world see as they enter the conference room for the Fed’s annual Jackson Hole symposium is a large stuffed bear.

Bernanke told the conference on Friday morning that the prospects for return to global growth appear “good” in the near-term — his clearest signal yet that he thinks the global recovery is at hand.

The ECB’s Trichet, on the other hand, expressed uneasiness at what he saw as premature talk of a return to normal from a financial crisis.

Five things to think about this week

TUSSLE FOR DIRECTION
- The tussle between bullish and bearish inclinations -- with bears gaining a bit of ground so far this month -- is being played out over both earnings and economic data. Alcoa got the U.S. earnings season off to a good start but a heavier results week lies ahead and could toss some banana skins into the market's path. Key financials, technology bellwethers (IBM, Google, Intel), as well as big names like GE, Nokia, Johnson and Johnson will offer more food for thought for those looking past the simple defensive versus cyclical split to choices between early cylicals, such as consumer discretionaries, and late cyclicals, such as industrials, based on the short-term earnings momentum. Macroeconomic data will need to confirm the picture painted by last week's unexpectedly German strong orders and production figures to give bulls the upper hand.

FINANCIAL FOCUS
- The heavy financial results slate (Goldman, JP Morgan, Bank of America, Citi) will show the extent to which balance sheets are being cleansed of toxic assets and the health of, and outlook for margins, trading revenues, etc. The relative performance of the firms reporting could put the spotlight on the split between investment banking and retail exposure. In Europe, Swedbank's results will be watched for Baltic exposure while clarity is still being sought on what banks plan to do with the large chunk of ECB one-year money which they continue to park back at the ECB in the form of overnight deposits.

JAPANESE DILEMMA
- The BOJ's policy meeting poses thorny questions on quantitative easing (QE), with the policy debate complicated by sharp gains in the yen. The yen has risen as much as 10.5 percent in three months against the dollar and is nearing the 90 threshold which is viewed by the foreign exchanges as the point at which the Japanese authorities start ratcheting up the rhetoric. Further sustained yen gains will fuel market debate about the fallout for carry trades and for exporters -- and by extension economic activity.

HOOKED ON QE
- The sharp jump in yields in gilts, euro zone debt, and Treasuries seen after the Bank of England deferred any decision on expanding its QE programme gave a good indication of how bond markets could react when central banks flag that the QE taps will finally be turned off for good. Implementation of exit strategies may be some way off and producer and consumer price data from both sides of the Atlantic this week are likely to be subdued. However, base effects from the oil price peaks of 2008 are expected to fade in the coming months, leaving a less supportive inflation backdrop.

CHINA
- The FX reserve debate was aired by the highest-ranking Chinese politician to date at L'Aquila summit and U.S. TICs data this week should keep the reserve holdings issue on the boil. Attention is also on Chinese domestic/trade policy following violence in Xinjiang and strains in relations with Australia over Rio Tinto staff detention. Any escalation in either could prompt investors to review the potential for regional outperformance.

Central bankers in the euro zone will have to get out their dictionaries and calculators to work out how often they are entitled to vote on European Central Bank decisions under a complicated new voting system.

New rules show that the size of a country’s economy, the health of its banking sector and the spelling of its name will all influence how often a governor from one of the euro zone’s national central banks gets to vote on setting ECB interest rates and other crucial policy decisions.

This could make the difference between a governor from a similar-sized economy being sidelined for as little as six months in a three-year period or as many as nine.

The system, set to kick in after three more countries adopt the euro, involves up to four groups of central bankers sharing differing numbers of votes. Votes will rotate every month, compared to the 12-month rotation seen at the U.S. Fed, and the complexity of the rules is mind-boggling.

 ”The Governing Council has decided that the number of governors gaining voting rights at the start of each month will be equal to the difference between the number of governors allocated to the group and the number of voting rights assigned to it, minus two,” the ECB said in its explanation of how it had decided on the rotation rate.

Coloured charts handily included with the announcement make the process somewhat easier to follow for the mathematically-challenged.

Currently there are 16 countries in the euro zone, and the new system is not set to kick in until membership hits 19. So given euro scepticism and budget woes in eastern Europe, policymakers are likely to have five more years to do the math before the test comes.

Five things to think about this week:

Q3 - CLUES AND CUES
- Global equity markets started the quarter positioned for economic stabilisation after a strong Q2 performance but, even so, EPFR data shows less than a third of the cash that flooded into money market funds in 2008 has exited in the year to date. The Q2 reporting season, which is about to kick off (Alcoa out this week), will show whether there are reasons for investors to draw down their cash holdings further. The U.S. data that came out before the long July 4 weekend held more negative surprises than positive ones, and macroeconomic confirmation of recovery will be needed to tempt more wary investors into equities.

BOND YIELDS
- Benchmark U.S. and euro zone bond yields broke lower after the U.S. non-farm payroll data but the VIX hit some of its lowest levels post-Lehman and a recent compression of intra-euro zone spreads has yet to go markedly into reverse. Which of these trends turns out to be sustainable will become more evident in the next few weeks, particularly as U.S. supply resumes this week with TIPS, 3, 10, and 30 year auctions.

L'AQUILA SUMMIT
- The slow-burning international reserve currency debate could pop up at the G8/G8+5 big emerging powers summit in Italy this week. China's public stance is that it is not pushing the issue but Beijing also reckons a debate on this would be normal at such a forum. It is unclear if any final statement will mention it in a way that would rattle FX markets. But sideline comments on the debate will be closely watched and particular focus will be on which countries, if any, would be willing to join China, Brazil and Russia in their commitment to buying the IMF SDR notes -- for which crucial groundwork was laid down this week.

FOLLOW THE MONEY
-  Questions remain over what use is being made of the 442 billion euros ($619.6 billion) of ECB one-year money that was pumped into the market. A spike up in overnight deposits clearly suggests banks are continuing to park a significant proportion of that cash at the ECB. Any swings in that data will be closely watched for signs that the money could be put to work in other parts of the rate/fixed income market -- or maybe even filter through to the economy in the form of lending. The BOE will also be in focus, with clues sought on the outlook for its QE strategy.

COMMODITY RISKS
- Commodity price volatility looks to be on the cards. A rally in industrial raw materials risks tapering off unless a stronger economic rebound materialises soon, both in big emerging economies and their developed counterparts. For soft commodities, the focus is increasingly turning to the potential impact on harvests from El Nino weather patterns that are developing. Investors will have to decide whether they would be better off exposed to stocks linked to the metals/minings, which will at least earn dividends, or to the commodity itself -- or neither. As for any spike up in food prices, the fallout would be even wider at the current economic juncture, and complicate both policy and investment decisions.

(Reuters photo: Santiago Pandolfi)

Central bankers have not had much reason to be happy over the last two years, as the financial crisis has lurched from bad to worse.

But the European Central Bank at least is now finding comfort in the fruits of its injection of close to half a trillion euros in 12-month funds last week, which has pushed money market interest rates to new record lows. 

“We are very happy, we see clearly that we decreased the risk premia,” ECB President Jean-Claude Trichet said on Thursday, after the ECB kept its benchmark rate on hold at 1 percent.

Still, the ECB’s generosity in filling bank coffers with cheap cash could paradoxically help financial institutions defer the day of reckoning when they will have to write down bad loans and toxic assets on their books, and adjust their balance sheets. Flush with ECB cash, banks could be encouraged to think they can hang on to past investment mistakes, rather than writing them down now. 

The Swiss-based Bank for International Settlements, a forum for the world’s central banks, says this painful process is a prerequisite for financial and economic recovery, and the International Monetary Fund  says the euro zone is lagging the United States in writedowns.

Maybe the ECB is not helping.