Europe struggles to ward off recession

Businesses hope the European Central Bank will cut interest rates again today.

In Ireland, the national airline is selling off its art collection to raise desperately needed cash.

In France, jobless figures were up again last month, for the fifth time in a row.

In Germany, business confidence is falling faster than at any time since the 1973 oil shock.

Eight weeks before European countries launch their most ambitious economic adventure ever - a common currency, the euro - excitement at that prospect has been severely dampened by gloom about the future.

In the wake of the Sept. 11 terror attacks, earlier hopes that Europe could weather the gathering economic slowdown in the United States have been dashed, as countries from one end of the continent to the other battle to stave off recession.

Europe's economic powerhouse, Germany, is slated for just 0.7 percent growth in the last quarter of this year, according to the country's six top economic research institutes, which said in a recent report that the economy "on the brink of recession."

And next year, the picture is not much brighter. The Organization for Economic Cooperation and Development (OECD) has slashed its 2002 predictions of European growth from 2.7 percent to 1.5 percent - and that only if no more unforeseen catastrophes strike.

September 11's "negative impact on business and consumer confidence is partly real, and partly it may be exaggerated by psychological factors," says José Luis Alzola, European expert with investment bankers Salomon Smith Barney. Either way, he warns, companies will be investing less and laying off more workers in the current atmosphere of uncertainty, and households will be putting off big purchases.

How long this mood will last "depends to a large extent on the political developments," OECD chief economist Ignazio Visco said in the organization's monthly bulletin recently.

"Perhaps the current fears will be dispelled quickly, thanks to a credible coordinated international effort to combat terrorism. But there are also downside risks of a long drawn-out process, punctuated by setbacks."

The terrorist strikes were by no means the cause of Europe's economic slowdown. Just as in the United States, signs of faltering growth were evident before September. But the terrorist attacks have made matters considerably worse.

Salomon Smith Barney, for example, knocked half a percent off its estimate of growth in the euro zone this year, from 1.5 percent before the attacks to 1.1 percent now. "And our expectations of recovery have been pushed back six months, to the second half of next year," says Mr. Alzola.

This is partly because European economies have been unable to withstand the shock of a 3 percent drop in growth this year in the US, a major export market. And next year, European exports are expected to shrink after several years of healthy growth.

But at the same time, as they cast about for ways of pulling themselves out of stagnation, the 12 nations launching euro notes and coins next January are finding their hands tied by the very project they conceived as an engine of prosperity.

When they decided on the euro, the governments involved (Britain, along with Sweden and Denmark, is not adopting the euro) set themselves strict economic performance rules so as to guarantee the new currency's strength. By binding treaty, they pledged never to allow their budget deficits to exceed 3 percent of their gross domestic product.

That fiscal prudence means that European countries cannot do the same sort of maneuver as the United States, where Congress is currently studying a budget-busting $100 billion economic stimulus package to snap the American economy out of its doldrums.

Some European politicians have hinted that they would like to see the spending limits lifted. The 'Stability and Growth Pact,' they point out, is all very well in good times, but it puts them in a double bind when their economies slow down: Just when tax revenues are falling, unemployment and other welfare payments are going up.

But with the pact a cornerstone of the euro project, finance ministers are very wary of amending it at this delicate stage. "Leaving the path of budgetary consolidation or breaking with it would open a dam," German Finance Minister Hans Eichel told his critics recently.

If governments find their room for maneuver limited, the European Central Bank has not helped much, either. While the US Federal Reserve has cut interest rates 10 times this year, to a 40-year low of 2 percent, the ECB has made only three adjustments, bringing European rates down to 3.75 percent.

Governments and businesses are hoping the bank will follow the US lead today, and make another cut, but it is by no means certain that it will do so. Bank President Wim Duisenberg never tires of pointing out that, while the Fed is mandated to encourage economic growth while controlling inflation, the ECB was created - at Germany's insistence - with one overriding responsibility: to keep annual inflation below 2 percent.

Europe seems on course to meet that target this year, but the cautious men at the helm of European central banks, who set the ECB interest rates, have their eye on next year, too.

"The 2 percent target may be unnecessarily tight, but once they set it, they had to stick to it," says Alzola. "They are in a trap."

If all goes well, analysts from the OECD and other institutions agree, European economies should begin to pick up in the middle of next year - stimulated as much as anything by renewed consumer spending. If the current mood is encouraging people to be prudent and save their money, "at some point, if these fears are overcome, consumers will have money to spend," Alzola points out.