Commission’s forecasts are too cheerful, say economists

By Stewart Fleming

Date: 28/10/04

THERE is a problem with the economic forecasts the European Commission published this week for the eurozone. They are probably too optimistic. If so the institutional confrontation over the Stability and Growth Pact will sharpen, further damaging the fraying credibility of the EU's leadership.

Only the day before the Commission published its figures, German Chancellor Gerhard Schröder signalled his dissatisfaction with the Commission's proposals to make the Pact more flexible, describing them as "interesting but not sufficient". He also expressed his deepening anxiety about the economic outlook.

Barclays Capital's chief European economist, Julian Callow, is among those who fear that the Commission's economic forecasts of 2.0% growth for 2005 (down from the 2.3% it predicted in the Spring) may be optimistic.

He describes the new forecast as "upbeat". Investment bankers Morgan Stanley are expecting growth of only 1.7% in the eurozone.

Lower growth would produce a higher budget deficit for the eurozone as a whole. As for the country by country position, which is what the Pact looks at, even with the help of one-off window-dressing measures, Morgan Stanley suggests that France, Germany and Italy will all breach the 3.0% limit next year. In testimony before the Parliament this week, Jean-Claude Trichet, the European Central Bank president, underscored the importance of sticking to the "nominal anchor of 3%" and reiterated concern about any moves to weaken the Pact rules.

In his comments in Berlin, Schröder said that behind his call for a more growth-friendly Pact lie fears about the current threat to the economic recovery coming from high oil prices and the "worrying exchange rate between the euro and the dollar".

Through much of this year the governments of the Group of Seven advanced industrial countries and Eurozone officials have been relatively relaxed about the rise in oil prices.

They have argued, for example, that compared with the oil shocks of the 1970s, the advanced economies consume less oil per unit of output now than at that time. And they have been hopeful that the risks of oil price increases triggering an inflationary spiral can be contained.

But since the meetings of the International Monetary Fund (IMF) in Washington at the beginning of the month and against the backdrop of the oil price surging to a record &036;55 (€43.30) a barrel this month, there seems to have been a change of tone.

The IMF, in its recent World Economic Outlook, remarked that, "the sharp rise in oil prices has contributed to the weakening of the expansion in recent months". And before the European Parliament this week Trichet warned that "if oil prices were to remain high, or even increase further, they could dampen the strength of the recovery both inside and outside the euro area".

But it is not just oil, it is the recent rise in the value of the euro on the foreign exchanges and signs of potential economic instability too, which are worrying policymakers, hence Schröder's comment about the euro-exchange rate.

On the one hand, the strengthening euro will help to combat inflationary pressures. But if, as one of the world's most noted international economists, Professor Barry Eichengreen of Berkeley University in California, noted this week, "the markets are finally realizing that the dollar can go only one way, namely down" then it may be time to fasten the seatbelts.

Bundesbank President Axel Weber, it seems, shares this concern. He recently argued that it is unwise to take too much comfort from the way a strong euro has mitigated the inflationary impact of the oil price rise. "The key issue we see ...is that with exchange rate arrangements in Asia being very rigid, most of the pressure, in terms of the current account deficit adjustment in the US, is on the euro," he said.

In other words, the upward pressure on the euro if the dollar sinks could also seriously affect eurozone economic growth.

Brussels may this week be devoting most attention to the conflict between the Parliament, the Council and the Commission. It should also be watching the world's uneasy financial markets.

• Stewart Fleming is a freelance journalist based in Brussels

Author suggests that the economic forecasts the European Commission published for the eurozone in October 2004 were probably too optimistic. If so the institutional confrontation over the Stability and Growth Pact would sharpen, further damaging the fraying credibility of the EU's leadership.

• Primary Source