OECD slashes growth forecasts - ECB rejects rate cut advice

Tuesday, May 24, 2005

The OECD (Organisation for Economic Cooperation and Development) slashed its growth forecast for the Euro zone from 1.9 to 1.2 percent in 2005 and sees a soft landing in the USA, where GDP growth should be around 3.6 percent, according to its semi-annual forecast (pdf) published today. In 2006 growth in the US is expected to slow to 3.3 percent whereas the Euro area should record 2 percent. This forecast is based on the assumption that short term interest rates in the US will rise on average to 3.42 (2004: 1.58) percent this year and to 4.69 percent next year. Euro short term rates are seen flat at 1.85 percent this and next year. The OECD sees a further worsening of the US current account deficit to 6.4 (2004: 5.7) percent in the current year that will expand to 6.7 percent of GDP next year. This is a level never seen before in history. The Euro zone will continue its marginal current account surplus with a level of 0.1 percent this year and 0.35 percent in 2006. The Japanese economy is expected to crawl along with growth rates of around 1.5 percent on the basis of unchanged near-to-zero interest rates.
The OECD advised the public on its website that its outlook no. 77 will include one special chapter, highlighting "Measuring and accessing underlying inflation" which will be available in early June. For the detailed country figures download this Excel file.
In its handout (pdf) to journalists the OECD stressed the point that the recovery problems in the Euro zone cannot be explained anymore with the known arguments, such as the Iraq war and higher commidities prices. "As a result, and looking ahead, growth prospects seem bound to differ widely across the OECD and the world economy, ranging from solid in Asia to back on trend in the United States, and weak and uncertain in Europe," it said and added, "policy must address this chronic pattern of weak resilience and diverging activity within Euroland as thoroughly and promptly as possible. It is of course a matter of central importance for the growth prospects of the countries involved but also, to some extent, for the credibility of the Economic and Monetary Union itself."
Call for more self-discipline in respect of deficits
"With domestic demand sluggish, resilience feeble and possible upward pressures on the euro looming ahead, the balance of risks on growth and inflation is clearly tilted to the downside, calling for an early easing of monetary policy," the OECD said.
Suggestions for such a rate cut in the Euro zone were immediately repelled by the European Central Bank, Reuters reported. Austrian ECB council member Klaus Liebscher said, "a rate cut would hurt credibility and raise inflation expectations." The benchmark Euro rate of 2 percent, unchanged since two years, just about matches the current inflation rate of 2.1 percent.
The OECD urged the US to correct the current account deficit as this was needed to protect the world from another sharp drop of the dollar exchange rate and also suggested that the US make a move on fiscal consolidation.
High oil prices are here to stay, it also said, forecasting that a barrel of oil will continue to cost 48 dollars until the end of 2006.
French referendum could change all that
The big question mark hovering above these projections is the French referendum on the drafted EU constitution. If the French vote against the constitution next Sunday, the whole project of the European Union is in imminent danger which could weaken the Euro significantly as it would create huge uncertainties about Europe's future.
The Swiss Franc appears more and more attractive as an investment when one does not forget that the US outlook is anything then rosy despite the relatively healthy growth expectations which are based on too many uncertainties as well. In times of crisis money has always been flocking to the safety of Swiss bank vaults. Of course, one can argue "this time it will be different."
China will roar ahead
The outlook on selected non-OECD (pdf) members looks better. China is expected to hold on to growth rates above 9 percent and should see its current account surplus grow to 100 (2004: 68.7) billion dollars this year. Inflation is projected to remain at 4 percent.
Another coungry with strongly improving macroeconomic indicators is the Russian Federation. The OECD sees a growth rate of 6 percent for both 2005 and 2006 while the current account surplus is projected to jump to 92 (58.2) billion dollars or 12 (10) percent of GDP. But Russia will have to continue its fight against double-digit inflation rates. The rouble's purchasing power is expected to fall 13 (11.7) percent this year.


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