Wed, Jan 18, 2006 - Page 9 News List

Fragile eurozone recovery may not last the course

Global factors such as a strong dollar have brought recovery, but policymakers could still bring it to a halt if they are not careful

By Larry Elliott  /  THE GUARDIAN , LONDON

Something is stirring in Europe. Unemployment is coming down and growth is picking up. Business confidence is rising amid hopes that a broad-based expansion is at last under way. There are even optimists at the European commission who believe the eurozone will see faster expansion than the UK for the first time since 1995, thus sparing them UK Chancellor of the Exchequer Gordon Brown's homilies on the need for more aggressive reforms.

The next thing we know, a resurrected Britain in Europe will be banging the drum for Britain to join the single currency.

Well, perhaps not. There are certainly, as former chancellor of the exchequer Norman Lamont once said of the UK, plenty of green shoots of recovery across Europe, and in the third quarter of last year the eurozone for once chalked up stronger growth than Britain. What's more, there's good reason to expect what has so far been a pick-up dominated by exports to spread into investment and consumption.

By its own recent standards, the eurozone is set for a pretty good year this year. The problem is that its own recent standards are not high, so the consensus is for growth of around 2 percent, perhaps a bit higher if the world economy continues to hum along.

In the US, growth of 2 percent would be considered really poor and Wall Street would be baying for cuts in interest rates; in the UK, 2 percent would be seen as a soft year, not disastrous but disappointing. There seems to be no reason to quibble with the view of one City analyst who once joked that Iraq would join the euro before Britain did.

That said, there seems little doubt conditions in the eurozone have been improving since the middle of last year. Ian Harwood, head of global economics at Dresdner Kleinwort Wasserstein, compiles what he calls a surprise indicator -- a gauge of whether news is better or worse than expected. The eurozone has been on a definite upwards trend for six months.

Germany, which accounts for a third of eurozone GDP, is a big part of the story, but encouragingly we are not just talking here about exporters taking advantage of strong demand in the US and Asia. The pleasant surprises for Germany have been matched in Italy -- a country that was being identified as a candidate to quit the single currency in the middle of last year.

It is unlikely that the main problem facing Italy -- a chronic lack of competitiveness -- has gone away, but in the short term it has been helped by the weakness of the euro and by lax fiscal policies.

(It might also be said that no news could have come out of Italy last year that would have been worse than expectations priced into the markets.)

In France, unemployment has fallen for the past seven months, while surveys of employment intentions have turned upwards in Italy and the Netherlands, two countries where consumption growth has been especially weak.

It would be wrong to overstate these trends. While eurozone retailers are a lot more optimistic at present than those in Britain -- more cheerful than they have been for five years, in fact -- the surveys have yet to be supported by hard data.

Until now, the reason for the weakness of consumer spending has been easy to identify: real income growth has been weak and, unlike consumers in the US and the UK, people in the eurozone have been reluctant to borrow against a background of high unemployment and threatened welfare cuts.

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