Scoop has an Ethical Paywall
Work smarter with a Pro licence Learn More



Cablegate: Ecb Staff Projections: Growth to Pick Up in 2004 -

This record is a partial extract of the original cable. The full text of the original cable is not available.




E.O. 12958: N/A
SUBJECT: ECB Staff Projections: Growth to Pick Up in 2004 -
Forecasting External Sector Is Tricky Business


This cable is sensitive but unclassified. Not/not for
Internet distribution.

1. (SBU) Summary: The European Central Bank's (ECB's)
December staff projections suggest real Euro area annual
average growth of 0.4% in 2003 rising to 1.6% in 2004 and
2.4% in 2005. The basic story is that exports will help
lift growth in the near term followed by a strengthening of
domestic demand, particularly private consumption. The
staff projections carry a larger range of uncertainty for
exports and imports, understandably so given the euro's
appreciation against the USD. While a "rule of thumb" would
suggest an appreciating euro could be, on balance, a drag on
EU growth, the strong pick up in US demand suggests that the
negative growth effects may not be as strong as the "rule"
implies - at least in the near term. End Summary

Advertisement - scroll to continue reading

Are you getting our free newsletter?

Subscribe to Scoop’s 'The Catch Up' our free weekly newsletter sent to your inbox every Monday with stories from across our network.

ECB Staff Projections

2. (SBU) In its December monthly bulletin the ECB
presented current staff projections for macroeconomic
developments in the euro area. The ECB, which expresses its
growth projections in terms of "ranges," adjusted expected
GDP growth downwards for 2003, slipping the mid-point of the
projection ranges from 0.7% to 0.4%. This adjustment is due
to a weaker than expected outcome in the second quarter.
However, they left the growth projection for 2004 unchanged,
with a mid-point of 1.6%. In their view, the impact of the
announced expansionary fiscal measures in the euro area is
limited, as the increase of households' real disposable
income due to tax cuts is expected to be counterbalanced by
higher consumer prices. For 2005 projections show the mid-
point of the growth range rising to 2.4%.

3. (SBU) Inflation, as measured by the Harmonized Index of
Consumer Prices (HICP) is expected to be around 2.1% in
2003. However, the staff shifted upward the range projected
for the HICP in 2004 from a mid-point of 1.3% to 1.8%,
compared to their last forecast in June. The increase is due
to various planned fiscal measures, such as increases in
indirect taxes and administered prices, as contained in
national budget plans.

4. (SBU) The staff projections are based on the following
main assumptions:
short-term interest rates are constant over the
projection horizon at slightly below 2.2%;
EUR/USD exchange rate assumed to be constant at 1.17
over the horizon;
Annual average oil prices assumed to decline from 28.5
USD per barrel in 2003 to 24.5 USD in 2005;
World real GDP growth outside euro area estimated at 4%
on average in 2003, increasing to 4.5% in 2004 and 5% in

ECB projections, December 2003
y/y in %
2002 2003 2004
Real GDP 0.9 0.2 - 0.6 1.1 - 2.1
0.5 1.9 - 2.9
2.8 1.0 - 1.4 1.1 - 2.1
1.4 - 3.0
-2.8 0.9 - 2.1 0.6 - 1.6
0.3 - 1.3
-1.7 - -0.7 0.2 - 3.2
0.0 2.3 - 5.5

2.3 -1.6 - 1.2 2.8 - 6.0
5.0 - 8.2


0.1 - 2.7 2.9 - 6.3
5.1 -8.5

2.0 - 2.2 1.3 - 2.3
1.0 - 2.2
Private Consumption
Gross fixed
Capital Formation
Exports (goods &
Imports (goods &

Real GDP Growth Projection

5. (SBU) The ECB expects only a weak GDP growth between
0.2 and 0.6% for 2003 (mid-point of 0.4%), since in the
first half of the year real GDP stagnated in the euro area.
For 2004 and 2005, they project an acceleration of GDP
growth, reaching values between 1.1 and 2.1% (mid-point of
1.6%) and 1.9 and 2.9% (mid-point of 2.4%), respectively.
Economic development will be characterized by a pick-up in
export growth and recoveries in both investment and private
consumption. The ECB expects a significant rise in
employment at the earliest in 2005, as reflecting the usual
lag in the cyclical pattern of employment.

Price and Cost Projections

6. (SBU) The ECB estimates HICP to be in a range between
2% and 2.2% in 2003. For the following years, the ECB
expects lower inflation rates due to the assumed decline in
oil prices. Import prices are currently dampened by the euro
appreciation. They are estimated to remain subdued in 2004,
not least because of decreasing energy prices, then passing
over to a modest increase in 2004. Unit labor cost growth is
forecast to decline in 2004 and 2005, which will be driven
by a recovery in labor productivity. After remaining low in
early 2003, labor productivity would pick up at the end of
2003, moving back to rates close to the long-term average at
the end of the staff projection horizon.

External Sector: Rule of Thumb and Disconnects
_____________________________________________ __

7. (SBU) Export and import components always have been
difficult to forecast. The wide range of possible out comes
for 2004, i.e., exports to grow between 2.8% and 6.0%,
reflects the difference between actual outcomes and past
projections. That is, it is a mechanical exercise and does
not reflect any judgments on a range of probability by ECB
staff. With the euro at 1.21/USD in early December, 4.1%
higher than its end-October level and 28% stronger than its
2002 average, according to ECB statistics, forecasting
external accounts is even trickier business.

8. (SBU) Although the ECB does not present its forecasting
methodology, it has made some specifications of its
macroeconomic model available. From this, some market
analysts have derived what they consider a "rule of thumb"
for computing exchange rate effects on economic
developments. Deutsche Bank Research and Lehman Brothers
both indicate that, using the ECB's model implies that a 10
percent rise in the real effective exchange rather would
knock 0.5 percentage points off inflation and 0.6 percentage
points off growth in the first year. While the ECB has
suggested that the appreciating euro's contribution to lower
inflation would contribute to higher real incomes, these
effects appear to be overwhelmed by a negative net trade
balance as imports grow while exports struggle.

9. (SBU) To every rule of thumb there are exceptions. To
this one there are many. First, in any model there is the
economists' favorite "all other things being equal"
assumption. That is, the model assumes that there is a
"shock" in the exchange rate market rather than changes in
underlying economic activity. Reality is different.

10. (SBU) In last year's Article IV consultation, IMF staff
examined the Euro area's experience when the euro was
weaker. They found an apparent "disconnect" in the exchange
rate link with trade flows between the euro and other large
currency areas. During 1996-2001 the real effective exchange
rate of the euro declined by almost 30 percent. IMF staff
compared a simulation using conventional measures of trade
elasticities and the linkage between trade flows and
exchange rates with actual changes. The simulation results
suggested that non-oil trade surpluses would have increased
by 2.3% of GDP as more competitively priced exports would
increase (2.9%) and more expensive imports decline (0.6%).
Actually, trade balances declined by 0.2% of GDP - a
deviation of a whopping 2.5% of GDP as exports increased but
so did imports. The IMF staff observed that all other
things "have clearly not been equal," pointing to the
effects of domestic and foreign absorption growth on trade
volumes and the effects of domestic and foreign cost
developments on domestic prices. In a more refined
calculation, the IMF shows that the "disconnect" was the
strongest for capital goods imports, perhaps reflecting a
rising share of relatively price-inelastic high tech goods.

11. (SBU) IMF staff findings "suggest caution using
standard econometric model simulations for gauging the
macroeconomic effects of a reversal of the euro's
depreciation." Specifically they thought the assumption
that the "close-to-one-pass-through" of exchange rate
changes to import prices "may no longer match up" for the
EMU as a whole.

12. (SBU) With much faster growth in the U.S. than Europe,
"foreign absorption," to use the IMF's phrase, could
mitigate the otherwise price competitiveness effects of an
appreciating exchange rate - at least for a while. UBS
Investment Research has a crude model that suggests growth
in global industrial production is roughly twice as
important as changes in the real trade-weight euro in the
short run. Given the lags between the increase in demand to
translate into exports, UBS expects euro area exports to
pick up over the next two (for consumption goods) to six
(for investment goods) months. Only when global (read U.S.)
demand cools and the euro continues to appreciate would the
effects of the latter begin to be more of a drag on export
performance. That would be in 2005, in UBS's assessment -
by which time the euro area should be running on stronger
domestic demand.

13. (SBU) Publicly the ECB does not want to be associated
with any "rule of thumb" on exchange rates. At his early
December appearance before the Economic and Monetary Affairs
Committee of the European Parliament, ECB President Trichet
refused to be tied down, declaring "we are not the prisoners
of a particularly equation or of a particular way of looking
at things." Informally, ECB staff admit to such formulas
but quickly point out that they are used to provide a
"perspective" or "orientation" for discussion. The exchange
rate together with external demand and profit margin
adjustments and market shares must be taken account to
produce a final result. While the formula are mechanical,
other elements, in the end, are subjective.

14. (SBU) ECB staff projections and the European
Commission's forecast are broadly similar. The Commission
forecasts euro area growth at 0.4% in 2003, 1.8% in 2004 and
2.3% in 2005. With respect to the assumptions, both assume
a pick up in world growth (EC puts it at 4.1% in 2004 and
2005). The Commission's forecast sees net exports
contributing to growth in 2004 and 2005, albeit a slight 0.1
and 0.2 percentage points, respectively. However, both
assume a Euro/USD exchange rate of 1.17. Some forecasters
see that as unrealistic - implying that the drag of exchange
rate appreciation could bite faster when external demand
begins to flag. All the more reason for European
governments to concentrate on domestic policies to generate
confidence and growth.

15. (U)This cable coordinated with USEU and Embassy Berlin.

16. (U)POC: James Wallar, Treasury Representative, e-mail; tel. 49-(69)-7535-2431, fax 49-(69)-


© Scoop Media

Advertisement - scroll to continue reading
World Headlines


Join Our Free Newsletter

Subscribe to Scoop’s 'The Catch Up' our free weekly newsletter sent to your inbox every Monday with stories from across our network.