Euro zone growth will be lower than expected next year and the European Central Bank should be ready to cut interest rates if the economy falters again, the International Monetary Fund said today.
In a bleak assessment of the 12-nation common currency bloc, the IMF's semiannual report on the world economy said weak domestic demand, a lack of structural reform and rising fiscal deficits had exposed euro-zone vulnerability.
"Notably, the lack of internal dynamism makes the euro area particularly susceptible to external shocks, including higher oil prices, a renewed sharp appreciation of the euro, or a rebound in global interest rates," the IMF said.
"The consistent overestimation of the strength of the euro area in recent years, as well as the fact that corporations as yet show little sign of investing their now substantial profits, underscore the risks of a more extended period of weakness." it said.
Nor did the IMF think that inflation was even in danger of getting out of hand, in a clear sign it disagreed with the inflation hawks in the ECB.
"Core inflation has slowed significantly, unit labour costs are essentially flat, and inflationary expectations remain reasonably well anchored," the IMF said.
On government finances, it said the fiscal balance had got worse with five countries -= France, Germany, Greece, Italy and Portugal - expected to break the euro zone's self-imposed budget deficit cap of 3 per cent of GDP this year.
"The IMF staff's assessment of present budgetary policies, particularly in the largest countries, suggest they fall far short of meeting this requirement, with most showing little improvement, or a deterioration, in 2005-2006," it said.