The European Central Bank sharply reduced its outlook for growth over the next year and a half, highlighting economic conditions that the bank president, Wim Duisenberg, characterized as "very weak."
With unemployment rising, the euro climbing against the dollar and manufacturing in a slump, the grim assessment from Duisenberg was not unexpected. But the magnitude of the downgrade to the bank's forecasts for this year and for 2004 surprised some economists; policymakers tend to err on the side of optimism, but in this case the bank was remarkably candid.
The economy of the 12 countries sharing a single currency is likely to grow by a mere 0.7 percent this year, according a median estimate by the bank, with only a modest recovery next year, to about 1.1 percent. Those numbers fall below the forecasts of many private economists.
At the same time, the bank reduced its outlook for inflation, but said it still expected price increases to run ahead of some private forecasts. That clouds the outlook for further interest-rate reductions in the euro zone.
One week after the ECB cut its base lending rate by a half percentage point, to 2 percent, Mr. Duisenberg told the European Parliament that it was too early to tell whether another reduction would be needed. In any case, most analysts say another cut is unlikely until at least September.
Mr. Duisenberg's dose of realism casts doubt on the more buoyant growth prospects touted by some governments in the region, which are counting on an economic upturn to bolster tax receipts and get them out of a budgetary squeeze next year. The European Commission has warned France and Germany on the size of their public deficits, which have run afoul of the strict rules on monetary union. While Berlin has promised to take steps to curb the shortfall, Paris has said it will cut deficits only if economic growth permits. Both governments also face public discord over economic reform plans, with workers in Paris taking to the streets over Prime Minister Jean-Pierre Raffarin's push to overhaul the public pension system, and some Germans objecting to Chancellor Gerhard Schroeder's effort to scale back generous unemployment benefits.
The labor unrest in both countries, along with strikes in Italy and Austria, may present a picture of business as usual in countries where workers zealously guard entitlements that many analysts say have hurt the competitiveness of their economies. Yet if politicians stick to their guns on reform, some analysts say, the performance of the region's economy could surprise the ECB.
"People have been saying nothing's up in Europe," said Gail Fosler of the Conference Board, a research group. "I don't think people recognize the extent of the change. Over the next 18 months, we're going to see that tipping point." Ms. Fosler predicted that the European economy could be growing at an annual rate of 3 percent by year's end, significantly above the ECB's prediction and ahead of many forecasts of the region's sustainable growth rate. If that were to happen - or even if a more moderate rebound takes hold - it could calm fears of deflation, a sustained fall in prices that can send economic growth tumbling.
But structural reform could come at a short-term cost, too, as strikes cut into output and reduced benefits curb consumer spending and confidence, analysts warn. (Financial Times)
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