Eurozone takes a (quick) peek at the peak

There were euphoric responses in European newspapers last week to the announcement of the figures for economic growth in the eurozone in the second quarter of 2006.

Europe’s growth tops that of US and Japan," trumpeted the International Herald Tribune. "Eurozone growth at fastest for six years," chimed the Financial Times. The data should do something to lighten the mood at next weekend’s meeting in Helsinki of finance ministers from the eurozone, which will be followed by an informal meeting of all EU finance ministers, the Ecofin council. Germany’s budget deficit is now officially expected to fall below 3% this year because of stronger-than- expected growth.

But it is far from clear that the second quarter data really is signalling the start of a broadly based eurozone economic upswing. While the European Commission and the International Monetary Fund (IMF) are expected to join the European Central Bank (ECB) in upgrading their eurozone economic forecasts for this year on the basis of recent data, there is less confidence about 2007. "A peek at the peak", was how Michael Dicks of investment bank Lehman Brothers, catch-lined his subsequent analysis of a more detailed breakdown of the GDP figures.

Lehman is not alone in pencilling in a slowdown for the third-quarter of 2006 and a decline from 2.4% growth in 2006 back to the near-stagnation level of 1.4% in 2007 - the same growth-rate as in 2005.

When EU finance ministers in Helsinki have digested an assessment by Joaquín Almunia, the economic and monetary affairs commissioner, they will be left in no doubt that the outlook is much more uncertain than some newspaper headlines might suggest.

It is widely expected that the ECB President Jean-Claude Trichet, after today’s meeting (31 August) of the European Central Bank’s Council, will signal that another hike in policy interest rates from the 3% level set at the beginning of August cannot be ruled out. Monetary growth is still too fast in the eurozone, credit too cheap and inflation, at 2.4%, still outside the central bank’s comfort zone and too persistent for Frankfurt to follow the example of the US Federal Reserve Board. Worryingly, given the inflation threat, the Fed has just called a halt to higher rates after raising them steadily to 5.25% over the past two years.

Discussion of what may be happening in America is likely to figure quite strongly in Helsinki and not just because of mounting fears that the US is now facing a collapse in its debt-fuelled housing bubble. If confirmed, a housing meltdown would, like the 2001 dot.com stockmarket bust, threaten to trigger a fully fledged US recession.

The Helsinki meetings come just a week before the annual meeting in Singapore of the International Monetary Fund and the associated session of finance ministers of the Group of Seven (G7) advanced economies.

Ahead of the Singapore sessions both the EU and the US have reached agreement in principle on an increase in voting shares in the IMF for four countries, China, South Korea, Mexico and Turkey, satisfying in particular China’s craving for increased international status. But the IMF meeting will also see an intensification of the top-level debate about how to prevent a catastrophic global slump which even the IMF itself fears could accompany a "disorderly" unwinding of so-called global economic imbalances, in particular America’s unsustainable $800 billion (€623bn) current account deficit.

There are signs that the trans-Atlantic debate on this issue is turning nasty. Harvard University professor Martin Feldstein, a Bush administration surrogate and Republican insider, called publicly earlier this month for Europe to adopt "a stimulative monetary policy" to offset America’s anticipated economic slowdown.

This is a policy prescription which will summon up memories of the 1978 Bonn Economic Summit when Germany, with disastrous consequences, was prevailed upon by then US president Jimmy Carter, to become a ‘locomotive’ for the world economy.

The decision by Fed chairman Ben Bernanke to call a halt to the Fed’s rate rises, even though US inflation is over 4%, is causing consternation in the EU, and provoking fears that Washington is inching towards a dollar devaluation strategy.

The Bank of England’s chief economist Charles Bean told a meeting in the US last weekend (26-27 August), with Bernanke in attendance, that, like the ECB, he is much more worried about inflation than the Fed chairman seems to be.

Morgan Stanley economist Stephen Roach has written that Bernanke is in danger of turning into a "serial flip-flopper" and putting Fed credibility at risk. If Bernanke does start cutting US rates before inflation is beaten global financial markets could take fright.

So Europe’s economic policymakers have to worry not only about how to respond to the probable US slowdown and possible US recession. They also have to think through how to handle pressure from an administration in Washington which has a penchant for unilateralism and a Fed chairman who could turn out to be a clone of his 1970s predecessor Arthur Burns, the man who, as the Vietnam war ended, helped to lay the foundations for a global inflationary blow-out.

• Stewart Fleming is a freelance journalist based in Brussels.

There were euphoric responses in European newspapers last week to the announcement of the figures for economic growth in the eurozone in the second quarter of 2006.

• Primary Source