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Wednesday, July 02, 2003

Chaos in the European Finance Ministries?

The only thing which surprises me in all this is other people's capacity to be surprised. Wherever have they been for the last twelve months? Now, of course, that the reality is dawning, panic may well set in. The only comment I have to add to the DIW institute forecast is that even this prediction of 1.3 per cent growth for 2004 may well be subject to significant downside risk. One last detail: if price indicators are falling in Germany next year, then any expansion there may be may well still be associated with falling nominal GDP numbers, and it is not clear to me, at least, what impact this may have on the rest of the eurozone. Remember there are a lot of historic 'firsts' here, and no-one really knows how they are going to pan out. Incidentally, when Pedro Solbes denies Germany is in a 'straightjacket', is this a direct rebuttal of Eddie's recent piece?

Germany is in an economic crisis, one the country's leading institutes warned on Tuesday, forecasting a shallow recession this year in the eurozone's biggest economy and disappointing growth rates in 2004. The prediction from the respected Berlin-based DIW institute came as Gerhard Schr?der, Germany's chancellor, repeated calls for the European Central Bank to cut interest rates next week and boost his government's plans to jump-start the economy. He said the ECB should consider "whether they have done enough to stimulate growth".

The DIW forecast that after a 0.1 per cent decline this year, the German economy would expand by 1.3 per cent in 2004 - markedly short of Mr Schr?der's claim of 2 per cent growth. The institute warned that the "biggest danger" now facing Germany was deflation, a sustained fall in price levels that hits demand and depresses growth. But Mr Schr?der's implicit criticism of the ECB, which cut rates by 50 basis points to 2 per cent last month, did little to deflect attention from the increasing strains on the German budget. Mr Schr?der on Tuesday told Pedro Solbes, the EU monetary affairs commissioner, that Germany would respect the deficit ceiling of 3 per cent of GDP set out in the eurozone's stability and growth pact - but few people believe he can honour that pledge. A third successive German breach of the ceiling in 2004 could destroy the pact's credibility and the issue is expected to dominate the next Brussels meeting of EU finance ministers on July 15. "There's chaos in the finance ministries of Europe today," said one senior EU finance treasury official, referring to fears about the effects of Mr Schr?der's budget plans on the stability pact.

Some officials say Italy, the new holder of the EU presidency, will use the German economic crisis as a chance to press for some kind of suspension of the pact until growth returns. Silvio Berlusconi, Italian prime minister, last month called for "an elastic interpretation" of the pact and France has made similar demands. A spokesman for Mr Solbes rejected the idea, saying such a suspension was impossible under EU law. "It's either alive or dead," he said.

Speaking in Berlin on Tuesday, Mr Solbes tried to hold the line on the stability pact, rejecting claims that it was "a straitjacket which keeps member states from doing what is reasonable". He accepted Germany's assurance that Mr Schr?der's recently-agreed plan for €15.5bn of accelerated tax cuts would be funded by savings in the budget but warned he expected Berlin to comply with the pact in 2004. Meanwhile, in a further sign of the EU's sluggish recovery, the Reuters/NTC Research purchasing managers' index for euro-zone manufacturing sank to 46.4 in June - its lowest level since January 2002 - from 46.8 in May. The 50 mark divides growth from contraction.
Source: Financial Times

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