Country Report European Union June 2008

Outlook for 2008-09

Following the defeat of the treaty of Lisbon in a referendum in Ireland, other countries will continue to ratify it. However, the treaty cannot take effect in its current form, which will add to uncertainty over the EU's future, particularly over foreign and justice policies. Angela Merkel is likely to remain German chancellor after an election (due by September 2009). Economic policy will focus on efforts to keep down inflation and the European Central Bank (ECB) is forecast to raise its intervention rate by 25 basis points in July. There will be some slippage from recent progress in reducing government deficits. Economic growth is likely to slow sharply, but not fall into recession, in 2008-09. The Economist Intelligence Unit believes that euro area inflation will ease gradually from 3.7% in May 2008, to average 2.3% in 2009, but this is subject to forecasts of a stabilisation in oil and food prices and avoidance of second-round impacts.

The political scene

On June 12th Irish voters rejected the treaty of Lisbon, which was designed to enable the EU institutions to function more effectively. Elections in Serbia in May produced a better-than-expected result for pro-EU parties, despite resentment over support for Kosovo independence. The vetoes of Poland and Lithuania on negotiations between the EU and Russia for a new partnership and co-operation agreement have been lifted. The Spanish Socialist Party was re-elected in March and Silvio Berlusconi's right-wing alliance won the Italian election in April, but its policies to expel immigrants, especially from Romania, are controversial.

Economic policy

The governing board of the ECB voted on a possible rise in interest rates on June 5th. The move was defeated, but the ECB president, Jean-Claude Trichet, emphasised that the Bank is seriously concerned about rapid inflation. The average general government deficit in the euro area fell to 0.6% of GDP in 2007, but potentially excessive deficits remain a problem in several countries.

The domestic economy

Economic growth was stronger than expected in January-March, at 0.8% quarter on quarter, with an especially strong performance from investment. However, retail sales have been falling and confidence indicators fell in April and May. After easing in April, inflation in the euro area jumped to 3.7% in May. Wage growth has edged up, but remained moderate.

Foreign trade and payments

Euro area exports increased by 7% in the first quarter in relation to a year earlier, but with imports rising by 10%, the trade balance swung into deficit. The strongest growth was to Russia, Poland, Turkey and China, all of 20% or more.