Europe's finance ministers have indicated that Germany may be allowed to ringfence the €10 billion cost of severe flooding, easing the pressure that a budget deficit would breach the stability pact.

Europe's Economic Affairs Commissioner, Mr Pedro Solbes, said Germany had not made such a request, but the Commission would have to examine the reasons for a large overrun in borrowing.

"An explanation of why their deficit has been produced has to be considered," he said yesterday.

The finance ministers held informal discussions on the stability pact and the difficulties facing some states in terms of meeting these obligations because of sluggish economic growth.

Worsening economic conditions were confirmed yesterday by Eurostat, the Commission's statistics arm, which recorded that, in the second quarter of this year, the euro-zone economies expanded by just 0.3 of a percentage point.

This growth was underpinned by a recovery in consumer spending and exports but was hampered by a fall in investments.

The figures also noted particular weakness in the retail and construction sectors.

Figures for the first quarter however were confirmed to have been fractionally higher at 0.4 of a percentage point up from 0.3 of a percentage point.

Against the weakening economic climate, the European Commission has now cut its forecast for economic growth across the euro zone for the third quarter of this year to between 0.3 and 0.6 of a percentage point, compared with earlier estimates of up to 0.9 of a percentage point. It expects a similarly weak expansion in the final quarter of 2002.

Earlier this week the Commission had indicated that it was likely to cut its growth forecasts for this year below 1.4 per cent.

The ministers also indicated some hardening of their position in their negotiations with the Swiss government on a taxation package that is aimed at combating tax evasion.

Yesterday Internal Market Commissioner Mr Frits Bolkestein said that, while time was running out, he was hopeful that an agreement could be achieved by the next Ecofin meeting in October.

"I refuse to believe that the Swiss government would not be beside us in fighting tax evasion."

During the meeting, the EU's powers governing the movement of capital were noted as a means to force the Swiss to agree to some form of information exchange.

This was part of a package to tax the interest on monies invested and deposited by EU citizens in Switzerland. Mr Bolkestein said these measures were mentioned "in passing" during their discussion.

"It is too early to think in such dark and dire terms. A retention tax seems to be possible but the details have to be worked out."

Some progress was reported on moving closer to an agreement on the minimum levels of taxation on the use of energy sources such as coal and gas across the EU.

Denmark's Finance Minister, Mr Thor Pedersen, said the Presidency and Commission have agreed to work hard to finish the directive by the end of the Danish presidency.