Eurozone heads for stagnation

By Stewart Fleming

Date: 04/05/05

BELGIUM'S performance has often been a surprisingly reliable lead indicator for the eurozone's economy. EU policymakers will be hoping that this does not prove to be the case in early 2005.

The Belgian National Bank has just calculated that, judging by its initial or "flash" estimate, in the first quarter of the year one of the better performing eurozone economies has just recorded a period of zero growth compared with the final quarter of 2004.

Early in April the European Commission, in its Spring economic forecasts, took what is beginning now to look like far too rosy a view of the EU's prospects. It did indeed cut its annual 2005 growth forecast for the euro area by almost half a percentage point to 2%. But, expecting the recovery to overcome the drag on growth from near-record oil prices and for consumer spending to pick up, it left its forecast for 2006 virtually unchanged at 2.1%.

Within days, the International Monetary Fund (IMF), in its April World Economic Outlook, issued a blunt warning. "The modest recovery" in the euro area since mid-2003 had "lost momentum" in the second half of 2004, it said. This was partly because of "high and volatile oil prices and long standing structural weaknesses".

It then highlighted an ominous development. Slower global growth and the rise in the value of the euro on the foreign exchange markets "have undercut export growth which was a key driver of the economy in the first half of 2004," it said. It slashed its estimate for euro area growth for 2005 from the 2.2% forecast last September to 1.6%. "The risks lie predominantly on the downside," it added.

Now we learn that, in the first quarter of 2005, China's exports into the EU have boomed. And it is not just the Chinese currency, but also the currencies of many of the other export-orientated economies of Asia and several big Latin American countries which are pegged to the US dollar and, in the past two years, have fallen around 30% against the euro, hitting eurozone competitiveness.

How big a negative impact the traded goods sector is having on the EU economy is still in doubt. To some extent imports from China are now believed to be replacing imports from other, especially Asian, markets. This is certainly thought to be the case in textiles.

If so, the impact on the euro area economy should be limited - for the time being. But there are now growing fears that the IMF's worst fears are being realised and that the drag from the external sector of the economy is accelerating.

For some time many private economists, Michael Dicks at Lehman Brothers and Stephen King of HSBC, for example, have been taking a gloomier view of the eurozone economic outlook than the Commission or the IMF. They both think that rather than the Commission's 2.0% growth, stagnation (1.3%) lies ahead for 2005-06. HSBC is warning that Italy, which is suffering trade problems, is now on the brink of another recession.

But even these predictions are just standard forecasts. They do not take into account the dangers facing a seriously unbalanced global economy in which America is living beyond its means, financed by foreign central bank (especially Chinese) dollar investments.

Privately some EU central bankers are beginning to wonder whether the European Central Bank (ECB) might be forced to slash interest rates to near zero in the next couple of years if the feared dollar crisis emerges, a scenario the euro bond market seems to have in mind already.

Michael Dicks is not alone in arguing that the rise in ECB interest rates, which once seemed probable this year, is now looking less and less likely.

If Europe's economy is slowing faster than policymakers have anticipated, expect soon to hear politicians such as Italy's Prime Minister Silvio Berlusconi calling for the ECB to start cutting rates now. And eurozone finance ministers hinting that the time has come to make use of the new elasticity in the weakened Stability and Growth Pact. Most worryingly, the protectionist pressures which have surfaced in the textile sector and to which Trade Commissioner Peter Mandelson has responded with a "safeguards" investigation, are likely to spread.

• Stewart Fleming is a freelance journalist based in Brussels.

Article reports on gloomy forecasts for the Eurozone's economic growth in 2005 and 2006.

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