EUROZONE is suffering from nothing worse than a growth pause
Although Germany remains a major concern, the eurozone as a whole is probably experiencing nothing worse than a growth pause, according to Richard Reid of SchroderSalomonSmith Barney.
Reid said the problem is in finding the catalyst that will end the pause, particularly as US demand growth is likely to be modest for the next couple of quarters.
Further difficulty comes from the fact that fiscal policy is handicapped by high deficits in the larger eurozone economies and by the constraints imposed by the Stability Pact.
Reid said: 'One problem for the European Central Bank (ECB) is that its favoured core inflation measure has been at or above the 2% inflation target for the past 18 months. However, there have been three rate cuts during this period, although two of these followed the events of September 11.
'We do not expect inflation to prevent the ECB from cutting rates should the economy continue to weaken. While the next meeting probably comes too soon, we expect the ECB to cut rates either late this year or early next.'
By comparison the UK economy looks in much better shape, he said. The UK consumer remains in a buoyant mood. Annual house price inflation is running well above 20%, personal borrowing remains strong and mortgage equity withdrawal is at its highest since the housing boom of the late 1980s, he said. Underlying this performance is the resilience of the labour market and the subdued inflation that has allowed the Bank of England to hold interest rates at 40-year lows.
Reid said: 'Even though lower rates would only seem to boost the household sector and raise the risks of overheating, the most recent Bank of England MPC meeting still saw three of the nine members vote for lower interest rates. We continue to believe UK rates will remain on hold, but it is still possible weaker than expected data could tip the balance in favour of further monetary easing.'
Looking more closely at the state of the German economy, Reid said: 'While we would hesitate to suggest that Germany is actually in recession, it is clear recovery has stalled and the economy is extremely weak and in need of some form of stimulus. From a German perspective, there is an urgent need for lower interest rates.'
The ECB sets monetary policy for the whole of the eurozone and Germany continues to give a false impression of economic life elsewhere in the single currency area, Reid noted.
This is evident in retail sales, which have collapsed in Germany but have held up fairly well in the eurozone outside of Germany, he said. 'The ECB will probably cut interest rates in coming weeks, but not aggressively enough for Germany. We expect German growth to register just 1.1% in 2003.'
One of the main reasons for Germany's growth problems is that the Deutschmark was converted to the euro at an overvalued exchange rate.
'Faced with a weak competitive position against its eurozone partners and with no escape via currency depreciation, German companies have sought to reduce labour costs,' Reid said.
'This has been reflected in the labour market. German employment has risen by just 4% since 1995 compared with 13% for the eurozone ex Germany. In the last year alone, German employment has fallen by 0.6% compared with average growth of 1% in its EMU partners. This has clearly taken its toll on consumer spending.'
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