A sluggish French economy may force the hand of European regulators.

It's almost an annual tradition. Spring arrives, and France's citizens take to the streets in protest.

This season is no different. France is suffering its third day of a paralyzing strike that has brought transportation, utilities, schools, hospitals, newspaper distribution and mail delivery to a virtual standstill.

Le problem¿? A government proposal to reform a ballooning retirement system that lets workers retire at half-pay by age 55 -- and sometimes sooner. The government knows it won't be able to foot the bill for a growing retirement-aged generation. Hence, it's proposing a reform that would require civil servants to work an additional 30 to 60 months, phased in over the next five years, to qualify for the full benefit.

The reform is risky for Prime Minister Jean-Pierre Raffarin, who is just a year in office. The last government that tried to transform the pension system in 1997 was thrown out of office. The 25% of the French labor force (yes 25%) that works in the public sector represent a considerable voting constituency that could deliver Raffarin a similar result.

Whatever the prime minister's fate, political and social turmoil during the interim is assured. So, too, is at least a week of economic stagnation brought on by the strike, a negative that will bite away at gross domestic product.

French-Fried Rates

Political uncertainty and economic sluggishness are factors France could do without. GDP for the past three quarters has languished, scraping along just fractionally above zero.

An unofficial U.S. boycott of France in the wake of disagreement over the Iraq conflict is also impeding economic growth. The U.S. normally represents about 10% of France's export market, and exports to the U. S. are already on the skids because of the slide in the dollar/euro exchange rate. Now many Americans are avoiding everything French, from Brie to Bordeaux, and possibly even larger ticket items such as Airbuses.

The 2.7 million U.S. tourists who visit France each year also are scaling back travel plans, a factor that could directly knock off as much as 0.4% from GDP but will more likely shave 0.1% to 0.2%. Indirect costs such as tourism job losses and reduced taxes also will burden the French economy.

The way things are shaping up, France could be a net drag on the collective growth of the 12 countries that use the euro. And as the second-largest economic force in Europe, French weakness may work to tip the scales for the European Central Bank to cut its benchmark rate from 2.50% when it meets June 5 or later this summer.

Three weeks away from the ECB monetary policy setting meeting, July Euribor futures traded on the Euronext.liffe are pricing in a 25-basis-point cut to 2.25%. That would leave short-term rates European rates just 1% above the comparable Fed funds rate.

Interest rates differentials have been a factor driving June euro FX futures to record highs and dollar index futures to a multiyear low. Add to the rate differential a grimmer economic outlook for France and euroland, and it takes the shine off buying the euro FX at these lofty levels and selling the dollar index at current depths.

Talking Politics

Political pressure from French and ECB officials also is showing up. French Finance Minister Francis Mer appeared to jawbone for ECB action Wednesday when he said the euro's rise against the dollar was "not very favorable in terms of growth" and that ECB monetary policy still had room to maneuver. ECB Council member Ernst Welteke also said earlier this week that the bank had room for "rate cuts."

The two-month old rally in stocks and unrequited momentum in debt futures I pointed out on May 2 and May 12 should also attract buyers of American securities and spur some dollar buying.

Finally, on the technical front, notice that June dollar index futures are finding support less than 50 cents above the measured move target of 94.00 projected three weeks ago.
Marc Dupee is an independent trader and co-author of the book The Best: Conversations With Top Traders. Dupee was formerly markets analyst and futures editor for TradingMarkets Financial Group. At time of publication, he held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he invites you to send your feedback to Marc Dupee.

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