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Thursday, 29 March, 2001, 12:14 GMT 13:14 UK
Evidence of a European slowdown
ECB president Wim Duisenberg may give markets something to smile about later this week
ECB president Wim Duisenberg may give markets something to smile about later this week
There is increasing evidence that growth in the major European economies is slowing down in response to fears of a global recession.

So far the European Central Bank, unlike other major central banks, has refused to cut interest rates. But analysts remain convinced that rates will go lower, as fears grow that the slowdown in the world economy will hurt the European recovery.

New figures showing that French business confidence fell for the fifth month in a row reinforced the belief that European growth is slowing.

"Our expectation remains that slower export growth will lead to increased weakness in industrial production and headline GDP growth in coming quarters," said investment bank UBS Warburg.

The news follows a sharp drop in business confidence in Germany.

But the task of the ECB is complicated by the fact that the smaller European economies on the periphery, like Spain and Ireland, are still growing fast.

Spain, which has both inflation and growth of over 4%, has warned the ECB that it needs to take into account the situation of all countries when deciding on rates.

Slowdown

In recent months, the eurozone economy has shown some signs of emerging from the recession it was mired in for much of the 1990s.

At the World Economic Forum in Davos, Europe's leaders had predicted that the eurozone economy will be the engine for world growth as the US slows down.

The US economy is forecast to grow by between 1.5% and 2% this year while the European economy is forecast to grow by about 2%.

In theory, European consumers would - buoyed by interest rate cuts and subdued inflation - buy the goods the US consumer no longer had the disposable cash to buy.

ECB president Wim Duisenberg has said that eurozone countries were somewhat insulated from such a slowdown as companies in the eurozone exported only 17% of their goods and services to countries outside the 12-member currency area.

The nations within the eurozone were a more closed economy as whole than they were in their respective parts, he explained.

Euro under pressure

But even amid signs of growth in the eurozone, the euro currency has failed to gain investor confidence.

This is in part because of a failure to implement the structural reforms needed to drive real change in Europe's economy. These reforms could make its business more competitive as well as encourage investors to put their money there for the long term.

Europe's reluctance to open the electricity and gas markets at the recent summit in Stockholm highlights the extent to which it can drag its feet and slow competitiveness in the region.

The euro is also weak because of a perception that the ECB itself is weak and divided, lacking experience of managing its currency.

Fears of further weakening the euro have made the ECB more reluctant to cut interest rates.

Higher rates generally make a currency more attractive to investors.

Inflation threat

Part of the reason for the ECB's reluctance to cut interest rates has been stubbornly high inflation.

Inflation has been over the ECB's medium-term ceiling of 2% since last May and was 2.6% on February, thanks largely to high oil prices.

But ECB governors have indicated recently that they are no longer as worried about inflation.

"While we were very, very concerned about inflation a month or a month and a half ago, we're not anymore today," Bank of France governor Jean-Claude Trichet said.

The key question for the European economy is whether it will be hurt by the slowdown in the US.

"There are certain areas in the economy that will be more affected than others ( by the US slowdown) but Europe is far from the situation of the US. We still are on a path which is robust and we still have growth conditions," Yves Mersch, president of the Luxembourg central bank said.

However, while Ireland and other countries on the periphery continue to do well, other European countries are flagging, notably Germany.

Germany the key

Business confidence in Germany has sunk to its lowest level since July 1999, signalling a deterioration in the outlook for Europe's biggest economy.

The closely watched Ifo business climate index for west Germany tumbled further than expected in February.

The German economy is the biggest in the 12-country eurozone, making up one third of the total eurozone output. The health of its economy is a significant indicator for the whole euro area.

"It's very poor. It raises the chance of seeing a 50 basis point interest rate cut from the ECB rather than 25 (basis points), when they eventually start moving," Merrill Lynch's Peter Saacke said at the time.

Germany's Chancellor Gerhard Schroder has been keen to counter talk of a downturn.

In early March, he said that Germany's economy was "still on a path of robust growth", adding that he saw "no reason for the exaggerated optimism".

According to data issued by Eurostat last month, unemployment in the 12-nation eurozone stood at 8.8% of the workforce in January from 8.7% in December.

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See also:

01 Feb 01 | Business
ECB leaves rates unchanged
11 Jan 01 | Business
ECB admits fallout from US slowdown
21 Mar 01 | Business
German business confidence sinks
23 Mar 01 | Business
Euro inches higher
18 Dec 00 | Review
The euro: Still in the doldrums
30 Oct 99 | Business Basics
European Central Bank
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