The euro-zone's economic recovery will gather pace in the second half of this year despite stubbornly weak consumer demand, according to the European Commission's quarterly economic report.
Euro-zone exports remain healthy despite the euro's appreciation against the dollar, which has been offset by buoyant world demand.
The Commission is concerned, however, by the sluggishness of consumer spending, which is identified as the biggest risk to Europe's economic recovery.
"The lack-lustre performance of consumption in recent years can partly be explained by sluggish growth in disposable income and lagging adverse wealth effects.
"However, other factors seem to have weighed on consumption as well. Household confidence has probably been dented by concerns related to deteriorating public finances in some member-states, an increasing awareness of the challenges posed by population ageing, and an excessively slow control reform process," the Commission says.
The report adds to pressure on the European Central Bank (ECB) to cut interest rates - a move that some analysts predict could come as early as this Thursday, when the ECB's governing council meets in Frankfurt.
ECB president Mr Jean-Claude Trichet has made repeated pleas to European consumers to spend more.
Most economists, although reluctant to rule out an ECB rate cut this week, still believe the bank would prefer to wait and see whether data over coming weeks confirm its suspicions that the euro-zone recovery is flagging.
They believe a cut in May or June, when the ECB releases its growth and inflation projections, is more likely.
Recent data have been mixed. Germany's Ifo business climate index fell in March for the second consecutive month, although Italian and Belgian confidence indicators improved and French retail sales picked up.
The Commission said it was too soon to assess the impact of the Madrid bombing of March 11th on consumer confidence but said the threat of terrorism could act as an added dampener on household spending.
The report plays down the impact of the exchange rate on euro-zone exports, which are more sensitive to fluctuations in world demand.
"As a result, a surge in world demand is currently more than offsetting the negative impact on exports of losses in competitiveness. Overall, the impact on the euro area should be most. The positive effect of the strong euro on household purchasing power has so far been slow to materialise but will gain in importance in the coming months.
"Indeed, history suggests that exchange-rate appreciations tend to dampen consumer price inflation only with substantial time lags," it says.
Despite the Commission's optimism about the economic recovery, industrial orders in the euro zone fell by 3.2 per cent in January compared to December 2003.
The Commission will update its economic growth forecast for 2004 during the next few weeks but officials said there was unlikely to be a major revision of its forecast of 1.8 per cent for the year.
Additional reporting, the Financial Times Service
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