Germany and France will break EU budget deficit limits for four years running in 2005 unless they change policies, the European Commission said today.
Such breaches of the deficit cap of three per cent of gross domestic product are expected even though euro zone growth should return to potential by mid-2004, picking up from 0.4 per cent in 2003 to 1.8 per cent in 2004 and 2.3 per cent in 2005.
Another year of budget breaches could risk damaging markets' faith in the Stability and Growth Pact on budget discipline, particularly as Italy and Portugal will also end up flouting its rules unless their governments change course.
While France is particularly in the spotlight as it resists the Commission's recommendation to do more to rein in its deficit, the overall policy mix in the euro zone is seen as conducive to growth.
However, any sharp rise in the euro would risk undermining economic activity in the bloc, compounding the pain inflicted on exports by the gains it has already racked up, the Commission said.
The Commission is forecasting France will run deficits of 4.2 per cent of GDP this year, 3.8 per cent next year, and 3.6 per cent in 2005. It expects German deficits of 4.2 per cent in 2003, 3.9 per cent in 2004 and 3.4 per cent in 2005.
Other countries are also showing budget slippage. Portugal is seen running a deficit of 3.3 per cent of GDP in 2004 and an even larger one of 3.9 per cent in 2005 while Italy is expected to have a shortfall of 2.8 per cent in 2004 and one of 3.5 per cent in 2005.
The Commission said that strengthening foreign demand in the coming months would help the euro zone economy, and offset the temporary decline in price competitiveness. It sees euro zone exports growing by 5.2 per cent in 2004 and 6.7 per cent in 2005.
It warned that further dollar depreciation could lie ahead: "Global imbalances are expected to widen further, with the risk of a fall in the exchange rate of the dollar."
However, it added that global macroeconomic policies were supportive and some Asian central banks appeared to be committed to preventing the dollar from depreciating sharply.