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Eurozone economy: Will the upswing last?

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Published 25 October 2006 - Updated 26 October 2006
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ECB economic forecasts economic growth euro Euro-zone European Central Bank
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For the first time in six years the eurozone has enjoyed several consecutive quarters of healthy economic growth, but this upturn could end as badly as in 2001 unless policymakers respond adequately, warn research institutes.

The IMK and the ETUI-REHS note that “the European economy has seen a number of false dawns” since 1999 but that each time, despite the positive indicators and business surveys, hopes for a long-term recovery have been dashed. 

Policymakers must learn from their past errors and not over-brake the economy, as they did in 2000, if they wish to avoid a repeat of the 2001 sharp downturn, states the report. It adds that, because a weakening of economic activity is already planned for 2007, it is vital that monetary, fiscal and wage policies support the growth process until it has become self-sustaining. 

However, the IMK-ETUI-REHS report claims that the European Central Bank, in particular, is failing to do this. It explains that, given an unemployment rate of 7.9% and limited wage growth, what is needed to strengthen and prolong the nascent upturn is an expansionary monetary policy. 

It states that the effects of the ECB’s monetary tightening will largely be felt in 2007, as they will be exacerbated by budget consolidation measures in Germany and Italy (which together account for nearly half of the eurozone GDP) and by the global economy’s downturn. 

However, ECB President Jean-Claude Trichet has signaled that the bank is poised to raise borrowing costs - for the sixth time this year - to 3.50% from 3.25% in December. 

Positions: 

The IMK and the ETUI-REHS criticised the ECB policy saying: “Monetary policy has not taken adequate steps against the economic weakness pervading the region since the year 2000.” It adds: “Recent ECB rate rises have been premature. In the current situation the ECB should refrain from further rate hikes until the recovery is well established and core inflation has begun to rise.” 

However, a number of the ECB’s 18-member governing council are suggesting that borrowing costs are likely to increase again towards the end of the year and in early 2007. President of Germany's Bundesbank Axel Weber has said that the bank must ensure it doesn't over-stimulate the eurozone economy in 2007, adding that slower inflation is “temporary” and that there are “a number of risks that the inflation rate will climb again significantly over 2%”. This, he implied, would mean that the bank may continue raising interest rates next year to. 

However, Europe's main business lobby group, UNICE, has urged the ECB to pause before raising interest rates again, pointing to the surprisingly low inflation rates currently recorded in the EU (economists are predicting that eurozone inflation in October could fall as low as 1.5% – the lowest since November 1999) and to falling oil prices. "The ECB could afford to wait and measure all the causes and repercussion of the recent positive surprises on the inflation front before acting again, if deemed appropriate, and should avoid giving excessive weight to the consequences of the VAT hike in Germany on euro area inflation," the group said. 

IMF chief economist Raghuram Rajan has also pointed to Europe’s "very good” economic outlook, questioning the ECB’s use of a predetermined plan for rate hikes and saying that further changes should instead be based on economic data. 

Next steps: 
  • December 2006: Expected increase in the ECB's borrowing rate from 3.25% to 3.5%
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Background: 

Although economic data shows that the eurozone economy is finally picking up, with growth levels higher than they have in the past six years, most studies are also pointing to a decline in economic growth in 2007 as interest-rate hikes, tax increases in Germany and Italy, a slowdown in the US economy and a deceleration in world-trade start to weigh on activity (see EurActiv 3 October 2006). 

In their bi-annual economic forecast and policy recommendations to the eurozone, the Macroeconomic Policy Institute (IMK) and the European Trade Union Institute (ETUI-REHS) stress that EU policymakers must make sustaining the current upturn their top priority. 

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