BRUSSELS, Sept 30 - The euro zone economy is set to gather momentum in the second half of this year and while the euro's strength on the foreign exchanges could hamper exports, it also has benefits, the European Commission said on Tuesday. European Monetary Affairs Commissioner Pedro Solbes said in the introduction to the Commission's quarterly report on the euro zone economy that the risks to growth had not evaporated but were more balanaced than a few months ago. "Following three years of low growth in the euro area, the first green shoots of recovery are appearing," he said. Global growth was picking up and the euro zone economy would gather pace in the second half of the year, with stock building in the 12-member bloc possibily making a positive contribution.
The euro's rise on the foreign exchanges would determine the extent of recovery in exports, as its strength would likely eat into the profitability of the export sector. The euro on Tuesday climbed above $1.1650 for the first time since June. "The renewed appreciation of the euro since the beginning of September is likely to have entailed somewhat tighter monetary conditions that month," the Commission said. Still, it said monetary conditions were still supportive and stressed the benefits of a rising euro. "The strong euro helps in bringing inflation down and supporting purchasing power while low interest rates alleviate the burden of debt for both households and enterprises." The European Union executive said analysis showed the euro zone's attractiveness as a destination for foreign direct investment had grown since the 1999 launch of the euro. "In particular, EMU countries have attracted a rising share of total FDI inflows into the EU in recent years," it said. The euro had also stimulated trade flows within the dozen members of the euro zone and could foster more such trade in the coming years. The volume of internal trade within the zone could increase by between five and 50 percent, the Commission said.
U.S. LEADS WAY
The Commission expects the U.S. economy to lead the global economic recovery but said the international competitivness of U.S. goods and services remained weak. Concern about the U.S. current account balance was being exacerbated by the country's burgeoning budget deficit. "If the current account deficit were to be corrected in a disorderly way, it would have a clear dampening effect on world growth," the EU executive warned. Deteriorating U.S. and euro zone public finances had put upward pressure on global bond yields but the effect had so far probably been more pronounced in the United States than in the single currency area. "However there is a risk that the impact of worsening public finance could be magnified in the euro area by a perceived weakening of long-term fiscal discipline if the existing fiscal framework were to lose its credibility," it said. The European Commission started disciplinary action against Germany and France after they broke EU deficit limits in 2002. The euro zone's two biggest economies look set to break the limits again this year.
The recent rise in government bond yields could be more worrying for households in countries where mortgage-related debt was high and where housing prices had been rising rapidly. Ireland, Greece and Spain had experienced double-digit growth in nominal house prices in 2002 and Belgium, France and Italy had reported substantial, though less marked, increases.
HOUSEHOLDS NO DRAG
Nevertheless, household debt was unlikely to brake consumption in the euro are as a whole, the Commission said. Corporate debt and firms' balance sheets should no longer be a substantial drag on the recovery and concern about the health of the euro zone banking system had eased in recent months. "Monetary and financial conditions are supportive and there are indirect signs that balance sheet constraints have begun to ease. Decelerating inflation will also foster private consumption." A rebound in oil prices, sluggish productivity growth and the slower pace of the euro's rise on the foreign exchanges had prevented a more rapid deceleration in inflation since spring. While core inflation could continue to abate, headline inflation might be more volatile due to weather-related spikes in the price of food and energy. Short term employment prospects were sluggish as firms were set to continue cutting costs even as the economy gathered pace. But euro zone business and consumer sentiment were improving and some hard data had also started to point to a rebound.//