Euro zone growth is being held back by the strength of the euro and the weakness of Germany, the IMF warned today, saying the ECB may have to cut rates again.
"The ECB's 50 basis point reduction in interest rates in June was welcome. Further easing will be needed if inflation threatens to undershoot significantly: for instance, if activity fails to pick up quickly or the euro appreciates significantly," the IMF said in its autumn World Economic Outlook.
The fund has halved its 2003 GDP growth forecast for the common currency bloc to just 0.5 per cent and now only expects 1.9 per cent growth in 2004 versus 2.3 per cent in April. Output in the zone expanded by 0.9 per cent last year.
But even this tepid recovery faced a number of risks, including yet another year of underperformance in Germany, the IMF said.
"The German economy remained weak for the third year in a row, adding to the subpar performance of the euro area as a whole and threatening to hold back the region's prospects."
Euro strength is another factor and currency alignments will be tackled by the Group of Seven on Saturday.
China and Japan face calls to let their currencies appreciate to stem a tide of cheap Asian exports which US and European officials say are hurting their domestic manufacturers. The IMF, noting that the euro had born the brunt of the pain from falling dollar so far, said that this strength was working against the currency bloc's fragile recovery.
With Germany facing zero growth this year, the IMF urged the ECB to take "a more activist approach" if weakness in an individual country spilled over into the wider bloc.
This contradicts ECB policy of dealing with the zone as a whole but might be warranted in certain circumstances, it said.
Too-low inflation rates, which risk a downward spiral into Japan-style deflation, was another risk that the fund urged that the ECB guard against and again named Germany as prime suspect.
Nor was the fund very optimistic about France and Italy, who together with Germany account for roughly 70 per cent of the euro zone's output. One of the euro zone's problems has been rising public deficits which in Germany and France already stand above the three per cent of GDP outlawed by EU budget rules with Italy heading in the same direction.
The fund said that euro zone countries should allow full play to automatic stabilizers, with the deficit rising due to lower tax receipts because of slowing growth and higher spending on benefits but that fiscal discipline was still warranted.
As a result, it argued that they should still lower their structural deficits by half a percentage point of GDP every year or, if backed up by other budget measures and structural reform, by 1.5 per cent over 2004-2006.