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2003 unlikely to herald recovery
By CNN's Gordon Isfeld
LONDON, England (CNN) -- For European politicians, businessmen and consumers alike, 2002 was a year of disappointments. The much-heralded economic recovery stalled just as it was getting started. After a dismal 2001 -- when the world's biggest economies in the United States, Japan and Germany were gripped by recession -- the past year was supposed to be one of consolidation, reinvestment and, yes, growth. But very little of that materialised -- thanks to volatile markets, labour unrest, corporate accounting scandals and growing military tension. (Full story) And the hangover from 2002 is expected to last well into the new year and even beyond. Growth forecasts trimmedThe Organisation for Economic Cooperation and Development -- a highly respected global think thank -- has joined government agencies and independent investment groups in trimming 2003 growth forecasts for the 12-nation euro zone and the UK. It now expects the region to expand by 1.8 percent in 2003 after growing by just 0.8 percent in 2002. The OECD is calling for growth of 2.7 percent in 2004, slightly above the consensus forecasts, but tempered by concern over the fragile state of the manufacturing sector as exports and consumer demand remain weak. "Forward-looking indicators suggest that a solid recovery may be rather slow to materialise," the organisation said in its annual global economic outlook. The European Central Bank has also cut back its forecasts, saying euro zone growth will be limited to between 1.1 and 2.1 percent in 2003 and between 1.9 and 2.9 percent in 2004. "The downside risks to economic growth have not vanished," the ECB said in its December bulletin. That pessimism is shared by most private economists who see more trouble ahead before sustained growth can be realised. "We are cautious about growth in Europe in 2003," says Merrill Lynch economist Ian Stewart. "Recovery is heavily dependent on a global upturn. It is too early to count on dramatic shifts in the Euro zone's fiscal and monetary rules. And all this in a region whose largest economy, Germany, no longer controls its own macros rules and which is suffering a Japanese-style de-rating of growth expectations." Germany -- once the engine of growth for the region -- has struggled to expand after falling temporarily into recession in the second half of 2001. The economy has been plagued by high unemployment, inflexible labour laws and a sluggish manufacturing sector. Budget deficits a concern
Chancellor Gerhard Schroeder, whose coalition government was re-elected in September, is also under fire for breaching the European Commission's 3 percent ceiling on budget deficits. He has responded by cutting public spending and raising taxes for consumers and businesses -- a move that has drawn criticism from political opponents, business leaders and labour groups who say the economy needs more government spending not less to help stimulate a recovery. "Whenever an economy is struggling, one should not raise taxes," says Holger Schmieding, an economist at the Bank of America. "New taxes will probably cut growth by 0.3 percent of GDP." The OECD sees the German economy expanding by 1.5 percent in 2003 after growing by just 0.4 percent in 2002. But it adds: "Growth may turn out lower if deficit reduction is implemented mainly via revenue increases." The organisation is predicting 2.5 percent growth in 2004, if Germany's deficit does not exceed 2.6 percent of gross domestic product. That deficit is currently running at 3.7 percent and should decline to 3.3 percent in 2003. France, which has the euro zone's second largest economy, is close to running afoul of the EC's 3-percent deficit rule. It is expected to overspend by 2.7 percent of GDP in 2002 and by 2.9 percent in 2003. At the same time, France's economy will likely expand by 1.9 percent in 2003, up from 1 percent in 2002, and by 2.9 percent in 2004, according to the OECD. Italy, the region's No .3 economy, is expected to expand by 1.5 percent in 2003 after a sluggish 0.3 percent growth in 2002. Unemployment running high
Another major headache for European governments has been the rising number of people on unemployment rolls. Without a sustained recovery in the United States, which is the region's biggest market for exports, there can be no recovery on this side of the Atlantic. And without a recovery here, especially in the manufacturing sector, more companies will cut back on operations and staff. In the UK -- which has fared much better than most major economies -- the jobless rate has fallen to a 27-year low of 3.1 percent, while the euro zone rate is running at 6.8 percent. Jobless rates in both Germany and France are hovering above 9 percent, while Italy's has eased slightly to 8.9 percent. "As economic activity gathers momentum, employment growth should start strengthening again. However, unemployment may not start to decline until 2004 as labour force growth is also projected to rise," says the OECD. Inflation fears easeWeak demand has had at least one positive side effect on the euro zone economy. Inflation, which has been the ECB's main gauge of economic health, now appears to be in check -- which prompted the central bank to cut its key interest rate by half a percentage point to 2.75 percent, the first adjustment since November 2001. "The evidence has increased that inflationary pressures are easing, owing in particular to sluggish economic expansion." the ECB states. It predicts inflation will fall below its 2 percent target ceiling in 2003, likely in the area of 1.9 percent before easing to 1.8 percent in 2004. "The good news [for 2003] is that a period in which euro zone inflation has shocked to the upside is probably drawing to an end," says Merrill Lynch's Stewart. "This, in turn, should allow the ECB to be more aggressive in cutting rates." "In the Euro area ... surveys show that manufacturing may be sliding back into recession," the OECD states, which means the ECB may need to cut rates more aggressively if the sector doesn't improve soon The UK ahead of the pack
In the UK, the manufacturing sector has also been suffering but to a lesser degree than elsewhere, and the economy has been buffered by strong consumer demand and a hot housing market. The economy expanded at its fastest rate in almost three years in the third quarter of 2002. Merrill Lynch expects growth to be 1.7 percent for the year, rising to 2.8 percent in 2003 -- below many original forecasts and higher than OECD's revised outlook of 2.2 percent. While it has avoided many of the pitfalls of its neighbours, the UK now sees inflation as its main concern going into 2003. Inflation rose to 2.8 percent in November -- its highest level since June 1998 -- fuelled by soaring housing prices and the lowest interest rates in almost 40 years. This has put pressure on the Bank of England to consider raising its key lending rate -- which has been at 4 percent since November 2001 -- in the coming year to cool borrowing and rein in prices.
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