Analysis: Everyone fears prolonged low growth but can it be avoided, asks Cliff Taylor, Economics Editor

Just how bad is it going to get? Far from the post-Iraq "bounce" which optimists were counting on, the predictions for growth this year get worse and worse.

The European Central Bank yesterday faced up to reality and cut its euro-zone growth forecast for this year to 0.7 per cent - less than half its December mid-point forecast of 1.6 per cent growth. Meanwhile, more bearish commentators are warning that the recent Wall Street bounce is based on misplaced optimism about the outlook for the US economy.

Looking at the international economy, the concern is that it is hard to see where the impulse for growth is going to come from. It certainly won't be Europe, with the German economy stalled and threatened with deflation. Nor will Japan be able to take up the slack.

So what of the forecasts of a post-war pick-up in the US economy driven by rising consumer and business confidence? More optimistic commentators are still banking on this, pointing to some uplift in confidence and a boost to demand from lower interest rates and tax cuts.

However, it is not clear by any means that what has been the world's economic locomotive is going to start moving rapidly again anytime soon - or that if it does it will not quickly hit the buffers.

The US has been the key force for global growth in recent years. Calculations by Morgan Stanley, the investment bank, show that is has accounted for close to two-thirds of global growth since the mid-1990s.

However, this has come at a price, with the rapid rise in demand opening up a huge gap in US dealings with the rest of the world.

This is reflected in a massive deficit on the current account of its balance of payments, now totalling over 5 per cent of US GDP. In turn this deficit must be financed by investment from overseas in US assets such as stocks and bonds - to the tune of $1.5 billion (€1.27 billion) a day currently.

More bearish analysts - led by the man dubbed "king of the grizzlies", Mr Stephen Roach of Morgan Stanley - warn that the US economy now faces a long period of adjustment to reduce this deficit and work out the excesses of debt from the boom years.

A key difficulty is that there are no booming overseas markets for US exporters to sell into to help reduce the deficit. And if domestic demand continues to increase while exports stagnate, then the deficit will widen further. This has led Roach to predict that the world economy may now be in a prolonged period of lower growth, a conclusion that domestic "bear" Davy also comes to in a research document published yesterday.

There are worrying implications in this outlook for Ireland. One is that a poor performance in our main markets would limit overall growth - Davy expects Gross National Product to grow by less than 1 per cent this year, with only a marginal improvement likely next year.

The pressure of low growth and the competitive squeeze from the rising euro will push the unemployment rate steadily higher from 4.7 per cent now to 5.5 per cent by the end of this year and 7 per cent by end 2004, it predicts.

It will also squeeze inflation lower, possibly to 2.5 per cent by the end of this year, with price pressures having been inconsiderate enough to start falling even before the much-vaunted anti-inflation initiative under the new national programme gets up and running.

The size of the US current account deficit is one factor that could continue to lead to dollar weakness. Mr Roach of Morgan Stanley certainly thinks so, as he points out that the competitive boost from a falling currency is classical medicine for an economy with a large current account deficit.

In turn, however, a falling US dollar - and a rising euro - would further depress European growth and increase the deflationary risk in Germany, by adding to downward pressure on import prices. It would also increase pressure on the Continental EU economies and Japan to accelerate programmes of structural reform. In addition, it would increase pressure on exporting industry here to reduce its workforce and cut costs.

International policymakers are, of course, trying to see off the threat of a prolonged period of low growth. Interest rates are at their lowest levels for 50 years and look set to fall further on both sizes of the Atlantic. Incredibly, the US Federal Reserve Board is now expected to cut rates further from the current low of 1.25 per cent and Fed board members have made it clear that it will do everything possible by way of monetary expansion to combat the threat of deflation.

The question is whether this low interest rate and monetary expansion medicine - the classic monetarist remedy - can help the patient to recovery quickly. The next few months will tell much, both of the extent of the deflationary threat and of whether any kind of recovery is taking hold.

It will be a period unprecedented in recent economic history, fascinating from an economic point of view, but bringing to mind the much-quoted Chinese curse about "interesting times".