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By Jason Simpkins
The European Commission, the executive branch of the European Union, said yesterday (Monday) that Eurozone growth would continue to erode throughout 2008 and 2009.
But here’s the wild card: Inflation is actually expected to accelerate for the rest of this year and much of next – even in the face of declining growth – until the pricing pressures recede in the last part of 2009.
The EC said the combined growth rate for the 15 countries that use the euro would slow to 1.7% this year and 1.5% next year. This marks the second time since November – when it was projecting growth of 2.2% – that the commission has reduced its growth estimate for the region.
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"The moderation in growth results from the persisting turmoil in the financial markets, the marked slowdown in the United States and soaring commodity prices, all of which are taking their toll on global activity," the commission said.
The commission noted that Europe was nowhere near a recession itself, but warned that an actual recession in the United States – along with a weak dollar and soaring commodity prices – would combine to hurt exports out of the Eurozone.
"The negative impact on euro-area exports is likely to be larger in the future than it has been in the recent past, due to the usual lags in the reaction of trade to exchange rate developments and cooling global growth," the commission concluded.
Just last week, for instance, Airbus S.A.S., the world’s largest commercial aircraft manufacturer, was forced to raise the price of several of its jetliners, including its A380 super jumbo. The chief culprits: The falling U.S. dollar and higher expenses for such key commodities as steel and aluminum.
Still, the commission remains more concerned with inflation, which it considers "the main problem that we have to face in the short term." According to the commission, inflation will climb to 3.2% this year, more than it previously forecast and well outside the group’s comfort zone of just under 2%. Inflation is expected to throttle back to the 2.2% level late in 2009.
According to the EC, nominal compensation per employee grew an average of 2.5% per year in the euro area over the past decade. By keeping inflation below 2%, the group wanted to ensure that some room was left for increases in real income.
"However, the recent sharp rises in food and energy prices have depressed households' purchasing power and consumer spending in the last quarter of 2007 and are expected to continue to do so during most of 2008," the commission said.
An Uphill Battle for the ECB
The European Central Bank (ECB) has remained hawkish on inflation, holding its benchmark interest rate steady at 4.0% – despite an aggressive string of rate cuts that has left the U.S. Federal Funds Rate at 2.25%, and an expectation that American central bank policymakers. But so far, the ECB’s high-interest-rate policy seems to have had little effect on soaring prices.
Because they are priced in U.S. dollars, key commodities have been rising in response to the greenback’s slide. As a result, Eurozone inflation hit 3.6% in March -the highest reading for that measure since the founding of the European Union in 1997.
ECB president Jean-Claude Trichet recently described the current economic situation as "very challenging," but said he was convinced that Europe can "meet those challenges thanks to its stability-orientated monetary policy strategy."
However, French Economy Minister Christine Lagarde is one member of a growing constituency that thinks the gap between interest rates is too big.
"We are in a delicate situation where we have, on the one hand, an American Federal (Reserve) which has a policy of very low rates and a European Central Bank which has maintained high interest rates," Lagarde told LCI television and RTL radio. "The differential in interest between the two, it seems to me, is a little too big at the moment."
Of course, many analysts anticipate Fed Chairman Ben S. Bernanke will announce another quarter point cut rate cut after policymakers meet today (Tuesday) and tomorrow.
The euro hit a new all-time high of $1.6018 last week, after the dollar rebounded for much of the month.
News and Related Story Links:
Spring Economic Forecast 2008/09
New York Times:
Weak Dollar Forces Airbus to Raise Price for Jet
Fed Will Grab Headlines This Week With "Last Hurrah" Interest-Rate Cut; Key GDP Stats Also Anticipated
BOE Cuts Rate, ECB Holds Steady