Growth: third time lucky?

For the third time in three years the euro-area economy is picking up steam. But will this recovery take root? Or will the expansion peter out once again? If it fails, this time it will leave behind not just disappointment, but a real fear that Europe is incapable of meeting the intensifying competitive challenges it now faces from the integration of China and India into a fast-changing world economy.

On 1 December the European Central Bank (ECB) signalled its belief that this time the recovery is on sounder foundations, raising its benchmark interest rate to 2.25%, its first change for two and a half years. There have since been further signs that the eurozone's economy has gained momentum, leading investment bank Goldman Sachs, for example, to say it expected another ECB rate rise in the first quarter of 2006.

But economists are worried about the longer term.

"Plain sailing....for now," is how John Llewellyn, global chief economist for Lehman Brothers in London, guardedly describes the global economic outlook.

In the past three years the world economy has been in a sweet spot. Recovery from the 2001 slowdown, which accompanied the collapse of the stock market bubble of the late 1990s, was faster than expected. Real global growth has been barrelling along at more than 4% since 2003. Most economists share the optimism of the International Monetary Fund, which is expecting global growth of around 4.3% in 2006, unchanged from last year.

Around the world interest rates are still low and inflation quiescent. Budget policies in major economies are not restrictive either. Just how robust the global economy is was underlined last year when even a sustained surge in oil prices to over $60 a barrel failed to dent it.

In the US, which accounts for around one-fifth of global output, 13 successive interest rate increases by the Federal Reserve, which took its benchmark rate to 4.25% last month, seem, so far at least, not to have undermined an economic expansion which shook off with ease the impact of two major hurricanes.

In a bullish speech last week, US President George W. Bush said: "The American economy heads into 2006 with a full head of steam."

"In 2005," he went on, "the American economy turned in a performance that is the envy of the industrialised world...and I am optimistic...because of the rise of American productivity [which] has been growing at 3.5% for the last five years. That's important because it means that America will remain the leader in the world."

Despite a favourable global economic climate and the positive impact it has had on Europe's booming exports sector, eurozone economic growth is still less than half of that in the US.

Last year US real gross domestic output rose by around 3.7% compared with 1.4% for the eurozone. This year, even if the optimists are proved right and eurozone growth rises to 2%, the gap will only narrow a little.

"Germany, France and Italy have embarked on another mini-upturn, but this should not disguise their many structural problems," says Robert Prior-Wandesforde, an economist at HSBC, an international bank.

He points out that, partly because of low rates of participation in the workforce, gross domestic product per head in these three countries is now only 70% of US levels, back to where it was in 1969. Unemployment is close to double figures in each country and trend productivity growth, he says, has been slowing for 30 years and now averages only 1% over the past decade.

While European nations are lagging in their efforts to keep up with intensifying competition, European companies are not. Last year Germany's DAX stock market index covering its biggest firms, soared by 29.8%. France's CAC 40 index was up 26.6%. Corporate profits are exploding, corporate balance sheets have been cleaned up and, says Julian Callow, an economist at Barclays Bank in London, "conditions are in place for corporations to put their new-found financial health and strong profit growth to use by stepping up invest-ment spending".

The continued economic expansion of the US has coincided with an increase in its current account deficit to a staggering $800 billion, money it must borrow from abroad. This time last year investors were seriously worried about the "global imbalances", exemplified by this huge deficit. Today they seem less concerned even though the problem has become much worse.

A sharp fall in the dollar and an accompanying surge in the value of the euro remain the biggest threats to the world's and the eurozone's economic prospects.

• Stewart Fleming is a Brussels-based freelance journalist.

Major analysis feature on the prospects for economic recovery in the eurozone in 2006. Article is part of a European Voice Special Report, 'The EU in 2006'.