German breach of EU pact likely

The Bundesbank has suggested that Germany may breach EU budget deficit guidelines in 2004 for the third consecutive year.

The Frankfurt-based central bank has also warned of premature hopes of an economic turnaround in Germany. However, it said that conditions for a global economic recovery had "noticeably increased" in recent months.

The government's plans to stimulate the economy with €15 billion in tax cuts were "welcome in principle", the bank said in its monthly report yesterday, but it called for further measures to "flank" the existing reforms. The report called for urgent cost-saving measures to help meet the tax shortfall, estimated at €10 billion, that the government plans to finance with new borrowing.

"As things look today, it would be regrettable if. . . not only Germany's own national debt limits were to be breached but the 3 per cent public deficit limit," said the bank, referring to the debt-to-GDP ratio set down in the Stability and Growth Pact.

Germany breached the pact with a deficit of 3.6 per cent and is expected to do so again this year.

Leading economists, and now the Bundesbank, take a sceptical view of the government's plans to bring down the debt ratio on condition of 2 per cent growth.

Mr Pedro Solbes, the European Commissioner for Economic and Monetary Affairs, has said he has "no plans to change" the stability pact.

"The council of finance ministers set Germany a very clear task of bringing its public deficit back below 3 per cent in 2004. We're in favour of structural reforms but we're still a little concerned by the budget numbers," said Mr Solbes to the Financial Times Deutschland yesterday.

The Bundesbank was cautious on a possible upswing in Europe's largest economy.

The report's authors said they had noted a "brightening of mood in economic surveys" and that the German financial markets had become more optimistic.

"The chance is still there that the economy will recover later this year and shake off its current stagnation trend," said the Bundesbank, acknowledging rising optimism among Germany's business leaders and consumers.

"But these hopeful signals have yet to register in the official statistics," the report said. "The brightening mood in parts of industry has not been matched by increases in production expectations. The export prospects continue to be viewed very sceptically by firms."

The Bundesbank pointed to last week's official government statistics, which indicated a drop in exports that couldn't be compensated for by domestic demand.

After two quarters of negative growth, the German economy is technically in recession. The Bundesbank expects only marginal economic growth this year of up to 0.2 per cent, far below the official forecast of 0.75 per cent.

Meanwhile, the bank was optimistic of an upswing in the global economy.

"Important conditions for a recovery of the world economy have improved markedly," it said.