ECB reduces growth forecasts for euro zone

The European Central Bank (ECB) has cut its growth forecasts for the euro zone, citing a high degree of uncertainty about the global economy and declining consumer sentiment within the 12-state euro area.

The reductions, when combined with increasingly benign expectations on euro-zone inflation, suggest that the ECB could be prepared to deliver a further cut in interest rates early next year.

The bank reduced its key interest rate from 3.25 per cent to 2.75 per cent last week.

The ECB has reduced its GDP forecast range for 2002 from 0.9-1.5 per cent to 0.6-1 per cent. For next year, growth projections have been trimmed from 2.1-3.1 per cent to 1.1-2.1 per cent.

The cuts came one day after similar reductions from the World Bank, which sees growth of 1.5 per cent this year increasing to 1.8 per cent in 2003. "This disappointing picture mainly reflects the persistently high degree of uncertainty," the ECB notes in its December commentary.

Mr Austin Hughes, chief economist with IIB Bank, described the shift in growth forecasts as "a downward revision of great substance". Most significant, according to Mr Hughes, is the bank's willingness to stress the downside risks to growth.

The ECB review highlights geopolitical tensions with potential consequences for oil prices, developments in financial markets, sluggish global growth and "global imbalances" as factors weighing on confidence.

"These factors also have negative effects on euro-area consumption, investment and labour markets," the ECB says.

It is hard to predict when this uncertainty will abate, according to the bulletin, which maintains the candour observed among the euro-zone's central bankers over the past month.

The bulletin departs from its habitual acceptance that interest rates are "appropriate" for the euro zone by noting that "the Governing Council will continue to monitor closely" factors that may affect inflation.

"There is no reason to believe that the bank will be happy to leave rates on hold," said Mr Colin Hunt, director of research with Goodbody Stockbrokers.

He said the general tenor of the bulletin symbolised a move away from a "mechanistic interpretation" of the ECB's responsibilities.

"As an entity, they have become more attuned to the realities of a disappointing growth environment rather than being fixated with inflation," Mr Hunt said.

The ECB is expecting euro-zone inflation to fall into the 2.1- 2.3 per cent range this year, a slight reduction on previous estimates. For 2003, it has forecast inflation of 1.3-2.3 per cent.

It notes that "the subdued economic activity should limit potential upward risks to price stability and help to ease inflationary pressure", adding that last week's rate cut should also help.

It acknowledges that wage-related risks to inflation remain in place. The Republic's inflation rate of 4.6 per cent is the highest in the euro zone.

In another report released yesterday, the London-based Economist Intelligence Unit (EIU) predicted that GDP growth of 3.9 per cent would be recorded in the Republic this year, with a modest recovery to 4.2 per cent growth occurring in 2003. The EIU says that, while 3.9 per cent would be the highest growth rate in the EU, it represents the Republic's slowest year since 1993.