EU opens door to showdown with Germany on trade surplus

EC report said Germany’s surplus will narrow slightly from 7pc of GDP this year to 6.6pc in 2014 and 6.4pc in 2015, but this still breaches “macro-imbalances” rules

A supporter holds a book, which reads:
A supporter holds a book called 'Crime Scene Euro (currency)', at a meeting of Germany's anti-euro party 'Alternative fuer Deutschland', near Frankfurt Credit: Photo: Reuters

The European Commission has warned Germany it could face disciplinary action for running excess trade surpluses at the expense of EU partners, joining the US Treasury in criticising Berlin for doing too little to help lift Europe out of its slump.

“We will discuss this question next week,” said EU economics chief Olli Rehn after releasing the commission’s Autumn report. The text said Germany’s current account surplus will remain far above tolerable levels into the middle of the decade.

Mr Rehn said Berlin had been told by EU leaders at a summit in June that Germany has a duty to help boost demand and “create sustained conditions” for German wage rises. This would help rebalance the EMU system and lift pressure off the crisis states in the South.

The report said Germany’s surplus will narrow slightly from 7pc of GDP this year to 6.6pc in 2014 and 6.4pc in 2015, but this still breaches the EU’s new “macro-imbalances” rules. It could ultimately lead to sanctions, with a vote taken by a qualified majority of EU states. Such a dispute would in effect be a court of judgment on Germany by EU peers.

While a confrontation is unlikely, the tougher talk from Brussels raises the political temperature in Europe. An attempt to indict Germany would prompt fury in Berlin, where politicians rejected US criticism last week that the country was acting as a free-rider on scarce global demand and creating a “deflationary bias” for the whole world. Berlin has called such attacks “incomprehensible”, insisting that export success helps the whole of Europe and should be prized.

The Commission's report cut the eurozone growth forecast for next year from 1.2pc to 1.1pc, and said a “sudden stop” in emerging markets is now the biggest potential threat to recovery.

“It is too early to declare the crisis over. Risks and uncertainty remain elevated,” it said. The report predicted a “subdued recovery” as banks continue to shrink their balance sheets to meet tougher EU rules, curb lending in the process. Unemployment will remain at a record 12.2pc until 2015. “The norm for the eurozone is still pretty dreadful. Even these forecasts are still likely to be too optimistic,” said Jonathan Loynes from Capital Economics.

Mr Rehn brushed aside warnings that Europe is sliding into a Japan-style deflation trap, insisting that inflation will rebound after sliding over recent months and stabilise near 1.5pc next year. “Although there is a lot of slack in the economy, the risk of deflation seems remote at the current juncture,” he said.

Lars Christensen from Danske Bank said the EU authorities are repeating mistakes made in Japan in the early 1990s when deflation became lodged in the system. “Several eurozone countries are already in outright deflation, and that is making it even harder to deal with banking problems and the debt trajectory. There is no growth in the money supply, so this is going to get worse, not better.

"This is just like Japan. The central bank thought money was easy when in fact it was much too tight. But effects could be much worse in Europe because unemployment is so much higher."

The commission slashed its growth estimate for Spain from 0.9pc to 0.5pc in 2014, and warned that the structural budget deficit will rise instead of falling, reaching 4.2pc in 2014 and 5.8pc in 2015. This will push public debt to 104pc of GDP.

“Things are going from bad to worse and any talk of recovery is woefully misplaced,” said sovereign bond strategist Nicholas Spiro. “What is so shocking is the number of countries where public debt is going above 100pc of GDP.”

Slower growth could cause several states to miss their budget deficit targets again, creating pressure for further austerity cuts in a vicious cycle. The EU Fiscal Compact allows some leeway for missing targets but remains rigid.

Italy will contract 1.8pc this year, before eking out 0.7 growth in 2014. The turnaround is based on hopes of resurgent investment - from -5.2pc to +2.7pc - a forecast described as “Panglossian” by analysts, given the pervasive credit crunch among small firms.

Cyprus is in the eye of the storm, facing economic contraction of 8.7pc this year after its banking collapse, and 3.9pc next year. Investment dropped 19.6pc last year, and will fall 29.5pc this year and 11.9pc in 2014.

The report said the new risk is an upset in Asia, Latin America and Africa as the US Federal Reserves prepares to withdraw dollar liquidity from the global financial system.

It stated: “The external environment for the EU economy has become more challenging. Growth in some key emerging market economies has slowed down: triggered by the anticipation of less expansive monetary policies in the US. Many emerging markets appear vulnerable to sudden stops of external financing. The over-reliance of the Russian model on commodities does not appear sustainable.”

Emerging markets have rebounded from their May to June sell-off. This is chiefly because the Fed has delayed plans to wind down stimulus. This is a reprieve, not a pardon. Trouble could return once the Fed turns hawkish again.