EU political/economic outlook for 2005-06
Following the referendums on the constitutional treaty in France and the Netherlands, EU internal politics are likely to be characterised by disputes between member states and stalemate on EU policies. Foreign policies should, however, avoid major divisions. No significant changes are likely in EU- or euro area-wide economic policies, although reforms will continue in Germany. We expect no change in European Central Bank (ECB) interest rates. Growth will fall this year, with a modest recovery expected in 2006. Inflation should come down in 2006.
The political scene
The proposed EU constitution has been decisively rejected in referendums in France and the Netherlands. While some of the "no" votes came from the right, the decisive move against the constitution, which took place during the campaigns, was among left-wing voters in both countries. In France the constitution was seen as embodying a neo-liberal Anglo-Saxon economic model. In the aftermath there are signs of member states asserting national interests more strongly, with the British adopting an intransigent line on the EU budget. One effect of the referendums has been to make prospects for further enlargement more distant, adding to the importance of the neighbourhood policy. The EU has backed away from lifting its arms embargo on China.
Economic policy
There has been no change in monetary policy, although the ECB is coming under more pressure. Reforms to the Stability and Growth Pact have not noticeably changed fiscal policy. Italy's fiscal position seems to be deteriorating, and the European Commission has begun an excessive deficit procedure.
The domestic economy
National accounts figures show a quarter-on-quarter recovery of growth in the first quarter, but almost all other indicators have suggested that the modest 2004 recovery is fading, as investment stagnates and consumers lose confidence. Industrial output has come close to a halt, but financial, trade, transport and communications services are still growing. Unemployment remains at record-high levels, although employment has risen slightly. Headline inflation has risen to 2.1%, but the underlying rate has fallen to 1.4%. Long-term interest rates have declined.
Foreign trade and payments
In the first quarter of 2005 export growth slowed in the EU25, while euro area exports fell, with the trade balances of both deteriorating. However, exports have risen strongly to Russia, Norway and Switzerland.
Outlook for 2005-06: Domestic politics
The decisive rejection of the proposed EU constitution by voters in France and the Netherlands on May 29th and June 1st has dramatically altered the political outlook for the EU. There is no realistic chance of the constitution as agreed a year ago being revived, or of a revised one being agreed and passed in the foreseeable future. The most that supporters of the treaty can hope for is that a few of the proposed changes are introduced individually over the coming years. Moreover, the impact of the "no" votes goes beyond the defeat of the constitution itself. The reasons given to opinion pollsters included only slight references to the actual text of the treaty. Rather, voters saw the constitution as symbolising a direction in which they suspect the EU of going, and one of which they do not approve.
The task of policymakers therefore has to be to reconnect to voters, but this is very difficult, because there are different reasons for discontent both within and between countries, and not all the reasons are compatible. Nevertheless, there would appear to be two messages—that voters want to slow down the pace of integration, including market-opening, and that they want to slow down enlargement. Indeed, some would argue that there should be a complete halt to both. Certainly more efforts will need to be devoted to selling any proposed future developments if they are to be implemented.
The chances of any such leadership being provided in the next 18 months do not look very encouraging. The immediate aftermath of the referendums has seen an intensification of arguments, particularly between France and the UK, over who does better or worse out of the small EU budget. This is topical, because the budgetary framework for 2007-13 is being discussed with the aim of agreement by early 2006. At present the budget is running at close to 1% of gross national income (GNI). The European Commission would like to raise this to 1.14%, but contributor member states, apart from arguing among themselves, are together trying to resist an increase anywhere near this magnitude. The budget will not in any case have a major influence on overall economic policy, because it is too small, but the way in which expenditure is allocated to different categories (agriculture, regional funding, external policies, research and so on) is of political importance as a guide to the EU's objectives.
In the second half of 2005 EU meetings will be chaired by British ministers. This is unfortunate, because the UK will be mainly preoccupied with defending its privileged budget rebate agreed in 1984, when the UK was relatively poor, and will therefore not be able to take a lead in resolving differences between member states. Under the presidency of two smaller countries—Austria in the first half of 2006 and Finland in the second half, both of which should be less preoccupied with national interests—the chances of agreement on the budget are better, and this could also spill over into a better atmosphere on other issues. Nevertheless, it is likely that, with the governments of most member states preoccupied with domestic political struggles, such consensus as is reached will be to try broadly to preserve the existing acquis communautaire (body of EU law) while making attempts to streamline it, rather than taking new initiatives.
Despite the negative message sent by the referendums on future enlargement, commitments to Romania and Bulgaria have gone too far for their planned accession in 2007 to be refused. It is not likely that the western Balkans, which would then be surrounded by EU members, could be permanently excluded, but delays to their accessions will probably be considerable. The EU is committed to start accession negotiations with Turkey in October 2005, and the Economist Intelligence Unit expects this commitment to be met, but the EU has not committed itself to guaranteeing Turkish accession after the end of negotiations (which is in any case not expected until 2013). Another large country, Ukraine, may also hope for negotiations, but these are unlikely to start in the next few years.
Outlook for 2005-06: International relations
At present the EU's foreign policy stance on a range of issues is less divided than has often been the case in the past. Defeat of the EU constitution and disputes over internal EU matters will weaken its authority and capacity for initiative, but we do not envisage a major foreign policy divide comparable to that over the Iraq war to emerge in the forecast period. Relations between EU countries and the US have improved somewhat this year, and although the EU's internal difficulties will prevent the improvement being built on very much further, our forecast is that there will be no sharp deterioration over the next 18 months. Relations will be helped by the expected victory in the German election, likely to be called in September, of the Christian Democrats, who, while disagreeing with the US on certain matters such as the Kyoto Protocol and the International Criminal Court, have committed themselves to working more closely with the US than the current Schröder government.
The European Commission and member states will work together to try to support the transitional government in Iraq, although the actual contributions of member states will vary from negligible to substantial, and two countries which had troops in Iraq, Poland and the Netherlands, are withdrawing them. EU countries will also remain active in trying to provide stability and help the non-drug economy of Afghanistan. Three EU countries, France, Germany and the UK, with tacit support from other countries, will continue to negotiate with Iran with the aim of persuading it to abandon its efforts to develop nuclear weapons partly by supporting its civil nuclear power programme. It will make proposals by August. If there were to be a breakdown, the EU has agreed with the US to go to the UN Security Council and call for UN sanctions. If Iran does go ahead with its nuclear weapons programme, there is a risk of a new crisis in European-US relations and new divisions in the EU's foreign policy.
The new EU trade commissioner, Peter Mandelson, with the full backing of the Commission president, José Manuel Barroso, has committed himself to working hard to bring about a successful conclusion to the Doha development round of World Trade Organisation (WTO) negotiations, with an emphasis on the opening of markets to developing countries. Changes in the common agricultural policy (CAP), switching expenditure from price support to income support, have enabled the EU to make some moves towards reducing the adverse effects of the CAP on agriculture in developing countries, but further concessions, especially on sugar and cotton, are likely to be necessary. Mr Mandelson faces a considerable challenge as a UK commissioner in persuading the countries that benefit most from the CAP to accept further concessions.
Outlook for 2005-06: Policy trends
We do not expect major changes in the economic policies of the EU or the euro area over the next 18 months. The Commission president, Mr Barroso, has tried to refocus attention on the various objectives designed to boost economic performance that were set by heads of state and government five years ago at Lisbon. He will try to persuade member governments to draft national action plans in the second half of 2005. However, the results of the French and Dutch referendums suggest that public opinion in member states will react against attempts by the Commission to tell them what they should do, so most aspects of economic policy will depend very much on national debates and initiatives.
Monetary policy is a full exception and fiscal policy a partial exception, with monetary policy for the euro area, which encompasses a large part of the EU economy, conducted by the European Central Bank (ECB), and fiscal policy supposed to be guided by the Stability and Growth Pact (SGP) between euro area participants. For reasons described below, no major changes are expected in either monetary or fiscal policy. Germany has made important domestic reforms, particularly to its labour market, and further reforms are expected if, as we assume, a Christian Democrat-led government comes to power there in October. There are also ongoing reforms in the Netherlands, but given the political obstacles to reforms, which in the short term cause more pain than benefit, little major change is expected in any other euro area country over the forecast period.
Outlook for 2005-06: Fiscal policy
Fiscal policy in the euro area should be regulated by the SGP, which stipulates a budget deficit not exceeding 3% of GDP in all but exceptional economic circumstances and calls for balance over the course of the economic cycle. With France, Germany, Greece, Portugal and more recently Italy persistently flouting the 3% of GDP limit, a revision to the pact was agreed in March 2005. This called for more factors to be taken into account in assessing whether breaches of the 3% limit were permissible, thus providing partial retrospective justification to the non-compliant states. However, the pact continues to state that any excess should be small and temporary, with efforts made to return below the limit, and in the medium term to balance. The SGP should therefore continue to exert some pressure on member states.
One country, the Netherlands, has succeeded in bringing a deficit of over 3% of GDP in 2003 to well below 3% in 2004, despite adverse economic conditions, and is likely to remain compliant. Germany, though less successful, is making efforts to bring down the deficit, which would have been successful had economic growth not continued to disappoint. In Italy, however, which faces an election in 2006, the fiscal situation is likely to deteriorate. The fiscal deficits are of great concern to the ECB and are likely to be one factor influencing its policy.
Outlook for 2005-06: Monetary policy
There have been some doubts cast over the future of the euro area in recent weeks. We do not expect any participating government to question remaining in the euro during the forecast period, but some continued discussion of a possible departure of one country or even a total break-up will continue. The ECB is not expected to respond to such doubts or criticisms of its policy. It has kept its main refinancing rate unchanged at 2% since the last cut by 50 basis points in June 2003. It considers this level to be low and is concerned about money supply growth, which has been well above its target, and fiscal deficits. The recent weakening of the euro has had the effect of stimulating monetary growth, and we do not therefore expect any reduction in rates, at least unless there is a return to a strengthening euro.
However, the ECB will also be in no hurry to raise rates. After a very brief pick-up in the first half of 2004, GDP growth in the euro area has weakened to below potential. There are no signs that the rise in oil prices might lead to second-round effects on inflation, and underlying inflation has fallen well below the 2% target ceiling. Consequently, we expect official interest rates to remain stable in 2005 and 2006.
The political scene: Proposed constitution is torpedoed
EU politics has been dominated by the campaigns for referendums in France on May 29th and in the Netherlands on June 1st on the proposed EU constitutional treaty and the repercussions of the strong negative votes in both countries. Despite attempts to continue the process of ratification in the hope that a large majority of countries will eventually ratify (11 have completed the process so far), it is very difficult to see how the treaty can come into effect, given the opposition it faces from public opinion in these two countries, the UK and others. While even Tony Blair, the prime minister of the most sceptical country in the EU, the UK, has said that institutional reform cannot be abandoned, the approach will have to be a different one, probably item by item and with sensitivity to possible opposition in any member state. The implications of the "no" votes will, moreover, go further. Both rejections appear to have been motivated by a wide range of factors related to the perception of the EU and the direction in which it is seen by citizens to be going.
The political scene: Defeat came from the left
There were some similarities and some differences between France and the Netherlands as to why the majority of voters rejected the constitution. In neither country was the actual wording of the constitution, which was probably seen by most voters as incomprehensible, of much importance. In both countries the less well-off were more inclined to vote against. In both countries unpopular centre-right governments are in power. Although "no" voters were to be found among supporters of all political parties, those in favour tended to be supporters of the centre-right parties. Most of those against were supporters either of parties on the left (the Socialists and Communists in France, the Labour Party and the Socialist Party in the Netherlands) or the far right (National Front in France and Group Wilders in the Netherlands). With the far right having long been opposed to the EU in France and more recently also in the Netherlands, it was voters on the left, including the moderate left in both countries, whose rejection proved decisive. From initial positions, which slightly favoured the treaty in France and in which most voters were undecided, they were persuaded to come down against the treaty as a result of the campaigns. Anxieties about the economic situation and the threats to jobs from actual or potential immigrants played a part in both countries.
The political scene: French felt threatened by neo-liberalism
Nevertheless, there were also considerable differences between public opinion and the reasons for the "no" votes in the two countries. For the French, the perceived threat, particularly to the decisive numbers of left-of-centre voters, came from what was characterised as a "neo-liberal" ideology promoted by the Anglo-Saxon countries, the UK within the EU and the US outside, and supported by the new member states in central and eastern Europe. According to this view, France and other EU countries are being forced to sacrifice their social models to a deregulated economy which includes long hours, low wages, precarious job tenure, no trade union rights, low public expenditure on social services, and the abandonment traditional public services such as public transport and the post to the free market. This was associated with the opening up of EU frontiers to unbridled global competition from low-wage developing countries with no labour rights, as well as competition from cheap labour from central and eastern Europe undercutting service providers in France from plumbers to hairdressers.
This portrayal of the pressures to which French society was subject had been given prominence by two developments this year. The first was the ending of quotas on textiles and clothing by all developed economies, as had long been required under the Uruguay round of trade negotiations going back a decade. This led to a huge surge in cheap clothing imports, especially from China, which had the effect of accelerating the job losses in the sector in the EU that had been going on for many years.
The second, in contrast, was a relatively new policy initiative within the EU, dating from early 2004 and known as the Bolkestein directive, named after Frits Bolkestein, who was internal market commissioner in the previous Prodi commission that served until November 2004. This directive aimed to accelerate the somewhat gradual progress previously made in opening up EU markets for the provision of services by covering the broad range of services under one umbrella (with a few exceptions such as transport, telecommunications and financial services, which are being opened up through other legislation).
Instead of providing detailed regulation at the EU level, which would have taken years, the directive specified that where there was no EU legislation, any services that were legally provided in one member state could be provided in another. This principle of home rather than host country control is the same as that applied to exports of goods. However, there is a crucial difference between the export of goods and the export of many services which the directive did not take into account, namely that while the manufacturing of goods is an activity that is always carried out in the host country, many services, such as repairs, catering or property services, can only be carried out in the host country. This would have two implications: first, that service provision could well involve the movement of labour, and second, that member states could no longer apply their own laws on their own territory even if there were no EU law. It therefore appeared as a way of undermining the five- to seven-year delay on the free movement of labour following EU enlargement agreed in the accession treaties, a severe new encroachment on national sovereignty, and a charter for what the French call "social dumping".
The political scene: Dutch felt short-changed by other members
The Netherlands is a country which has traditionally felt closer to the UK and the US, so the Anglo-Saxon approach did not feature as a target of the "No" campaign. Rather, there was a combination of the feeling that too much power was going to the EU institutions and a view that the Netherlands was being short-changed. Thus the high Dutch contribution to the EU budget—which is caused partly by the cost of the common agricultural policy, from which France is one of the main beneficiaries, and partly by the British rebate, which has to be financed by other major net contributors, including the Netherlands—was placed in a poll taken just after the referendum as the single most important reason for the "no" vote. This feeling of being short-changed had also been spurred by the debate on the Stability and Growth Pact (SGP), which is supposed to provide a common framework for fiscal policy in the euro area. In 2003 the Netherlands did inadvertently marginally breach the SGP's 3% of GDP deficit limit, but as a result has taken very severe budgetary measures. These have brought the deficit comfortably below the 3% mark, but they have been very painful.
Meanwhile, the two largest countries in the euro area, France and Germany, have been continuously overshooting the limit and have resisted taking the necessary action to correct their deficits. This has been seen by Dutch voters as an example of large countries feeling that they can ride roughshod over the rules by which the small countries abide, indicating that the role of a country such as the Netherlands in the EU is negligible.
The political scene: National disputes revive
EU leaders did not know how to react coherently to the news of the referendum defeats. Several, including the French president, Jacques Chirac, the German chancellor, Gerhard Schröder, and Jean-Claude Juncker, the prime minister of Luxembourg and temporary holder of the EU presidency, all called for the ratification process to go ahead in the hope that a large majority would in the end ratify the treaty, putting pressure on France and the Netherlands to hold new referendums in which their voters would be asked to reconsider. Although legally this was correct, the chances of it actually succeeding seemed minimal, since the defeats of the constitution in France and the Netherlands made it all the more likely that some other member states would reject it, with potential "yes" voters lacking motivation and any worries on the part of would-be "no" voters that their country would be isolated eliminated.
The other main item on the EU agenda has been negotiations for the 2007-13 budget framework, which should be agreed by early 2006 to allow programmes to be prepared in advance of 2007. On this issue a longstanding divide between the main net contributor states, including France, Germany, the UK, Sweden, the Netherlands and Austria, and the net recipients plus the Commission over the size of the EU budget (between 1% and 1.14% of gross national income) has more recently been complicated by the renewed flare-up of the argument over the UK's budget rebate. This special rebate of £3bn (€4.5bn), which the UK has received since the early 1980s, has long been a matter of ongoing discontent among all the UK's partners. Although the UK can argue that France as a major recipient of payments under the common agricultural policy (CAP) is treated even more favourably, other countries whose economies are now in greater difficulty than the UK, such as Germany and the Netherlands, are paying twice as much as the UK and helping to fund the UK rebate. UK ministers have counter-attacked over what they argue is the distortion of the EU budget by the fact that 40% of it is still spent on agriculture, which accounts for only 2% of GDP. However, there have already been major reforms of the CAP, and it will not be easy for any French government to accept additional reforms; moreover, some other countries may back French resistance to further change.
The political scene: Opposition to enlargement was also behind no votes
The "no" votes in France and the Netherlands have had an impact on prospects for the future enlargement of the EU, to which they have dealt a double blow. First opinion polls suggest that an important reason (though by no means the only one) for the "no" votes was opposition to future EU enlargement, because of the perceived threat to jobs through extending the area of free movement of labour as well as encouraging moving manufacturing and other facilities to new member states. Despite these concerns enlargement to Romania and Bulgaria will almost certainly go ahead, probably in 2007, and it would be difficult to place permanent obstacles in the way of the accession of the western Balkan countries, which would then be an enclave within the EU. However, prospects for Turkey and Ukraine, although not completely destroyed, have been adversely affected. Turkey will start accession negotiations in October 2005, but these will be "open-ended", meaning that even if Turkey meets the requirements for EU membership, actual accession (which is in any case not feasible before 2015) cannot be guaranteed if political opposition in the EU remains strong. Despite the victory of Viktor Yevtushenko in the contested presidential election in Ukraine at the end of last year, which has strengthened the country's democratic credentials as seen by the EU and shifted its orientation westwards, the country is bound to remain behind Turkey in the accession queue. The setback for Turkey is therefore also a setback for Ukraine, to the extent that its possible accession, though not ruled out, cannot be regarded as defining Ukraine-EU relations over the next few years.
The political scene: Potential importance of ENP increases
The impact on EU policy towards Ukraine and other countries to its east is considerable. The record of EU enlargement reflects a very successful foreign policy, which has played an important role in encouraging the development of stable, democratic countries respecting the rule of law and freeing their economies in the neighbourhood. If the EU wants to pursue the same objectives with its new neighbours, it must find new policy instruments to do so. This is precisely what it has attempted with its European Neighbourhood Policy (ENP), which the previous Prodi Commission tried to promote in its last two years. The main objective of the ENP as defined by the Commission is to offer the EU's neighbours to the south and east incentives for taking meaningful steps towards democracy, the rule of law, human rights, and good governance. The trouble is that the policies to put in place such incentives, and the financial resources allocated to them, remain feeble, and the call for more financial or other resources for this purpose has been almost absent from ongoing debates on the future EU budget or other policies.
The political scene: Some improvement in Ukraine-EU relations
Even so, there have been some moves towards closer EU-Ukraine relations. For nearly a decade relations had been marred by the EU's unanswered appeals for reform and Ukraine's empty rhetoric, but the new government's commitment to the rule of law, freedom and justice have sparked a more co-operative spirit between the EU and Ukraine. The two sides recently signed a civil aviation agreement that grants access for European airlines to the Ukrainian market from any member state. In addition, Ukraine reached an agreement with the EU to participate in the EU's Galileo satellite navigation system. Ukraine has a highly developed space industry and is a world leader in the design and production of launchers and Global Navigation Satellite System (GNSS) components. Ukraine is the third non-EU country to join the programme after Israel and China, and the agreement is the first step towards Ukraine having a stake in the Galileo Joint Undertaking.
On May 18th Ukraine adopted the Mine Ban Treaty, which will allow the European Commission to launch a project for the destruction of anti-personnel landmines in Ukraine, of which the country inherited more than 10m following the break-up of the former Soviet Union. In addition, Ukraine and the EU recently signed an Agreement for Co-operation on Peaceful Uses of Nuclear Energy, which outlines, among other things, co-operation to promote safety in Ukraine's nuclear power stations (although this may be subject to financial constraints). The EU is also increasing European Investment Bank funding and has promised to work towards the facilitation of visas.
The political scene: Barcelona Process nears tenth anniversary
The Euro-Mediterranean Partnership (Barcelona Process), which was established in October 1995 as a framework for political and economic relations between the EU and the countries of the southern and eastern Mediterranean, was in 2004 brought into the ENP. A high-level conference is planned for November this year to mark the tenth anniversary. During meetings in Luxembourg on May 30th-31st foreign ministers agreed to develop targets in the areas of peace, stability, good governance and democracy, sustainable economic development and reform, education and socio-cultural exchanges, and security, migration and social integration. In this respect, the EU is attempting to bring these states closer to the EU not through membership, but through aligning policies and legislation and moving towards a free-trade zone with a target date of 2010, although it is unlikely that this will be achieved for all the Mediterranean countries. At the political level, the two main current policy objectives are progress towards a solution to the Israeli-Palestinian conflict and the establishment of an independent, stable and democratic Lebanese state.
The political scene: Relations with Russia may become more strained
Attempts by Russia and the EU to establish a framework for their relations continued in May. In a summit held on May 10th, after much diplomatic stalemate, Russia and the EU adopted a package of programmes for the creation of the four Common Spaces—economic integration, freedom and justice, external security, and research, education and culture—agreed in St Petersburg in 2003. The goal of economic integration is to move towards a free-trade area, including increased competition, decreased barriers to investment, and aligned regulatory standards. In particular, the agreement examined ways to increase co-operation in the transport, energy and space sectors and opened discussion on issues surrounding the achievement of the Kyoto Protocol benchmarks. On the issue of the second Common Space—freedom and justice—the EU, in response to Russian requests, agreed to co-operate to achieve easier access to visas. With respect to external security, both sides agreed on the importance of multilateralism and expressed their desire to strengthen the role of the UN and the Organisation for Security and Co-operation in Europe (OSCE), but avoided discussion of more difficult issues involving Georgia, Moldova and Chechnya.
Even if the agreement was more symbolic than substantial, it came as a relief to diplomats and marked some improvement in bilateral relations after more than a year of stagnation. It came on the day after the Russian president, Vladimir Putin, and the US president, George W Bush, together with EU leaders had participated in ceremonies to mark the 60th anniversary of the allied victory at the end of the second world war. During the celebrations leaders ignored Mr Putin's comment that the greatest tragedy of the 20th century was the fall of the Soviet Union, a statement which not only signalled his distance from both the US and EU, but also indicated a reluctance to accept the full independence of other former Soviet states. EU leaders also downplayed disagreements over human rights issues in Chechnya and the recent sentencing of Mikhail Khodorkovsky, the former head of the Yukos oil company, allegedly for tax evasion, but more credibly as a punishment for political opposition, given the more favourable treatment of other leading businesmen. A change of policy towards Russia could result from the probable election in September of a German government led by the Christian Democrats, who have called for more explicit criticism of Russia on these issues.
The political scene: Improvements in EU-US relations maintained
The improvement in the climate of transatlantic relations, which took place before and during President Bush's visit to Europe in February, when he became the first US president to visit the EU institutions, has been broadly maintained. The Commission has recently adopted a communication entitled "A Stronger EU-US Partnership and a more Open Market for the 21st Century", which is aimed at bolstering economic integration and strengthening the framework and profile of EU relations with the US. Although coverage of EU affairs is generally minimal in the US, the referendums in France and the Netherlands were widely reported in the US media. At the moment, relations have not been affected by the EU's internal problems.
Although important differences remain, there has been some convergence on EU and US policies with regard to the Israeli-Palestinian conflict, Iran and Iraq. Generally, the US has been less critical than the EU of Israeli government policies such as settlements in areas that might in an agreement become a Palestinian state. This remains the case, but Mr Bush has explicitly urged Israel to freeze its settlement policy, and he met with—and showed some willingness to support—the leader of the Palestinian Authority, Mahmoud Abbas.
At the request of the new Iraqi transitional government, the US and the EU will co-host an international conference in Brussels on June 22nd. The conference is intended to serve as a forum for the transitional government to present its goals and strategies for the transition period, to mobilise support for the transitional government, and to co-ordinate support for the reconstruction of Iraq. The conference reaffirms the EU's willingness to work with the US in collaboration with the UN and to refrain from focusing on disputes from the past. Nonetheless, tensions still arise from the refusal of those EU states that opposed the war to send troops and personnel into Iraq. Furthermore, Poland and the Netherlands are set to withdraw their troops, and Italy is likely to follow suit if a new centre-left government takes over in 2006.
Although the US continues to refuse to join in negotiations between France, Germany and the UK and Iran, it has given a little support to the EU's diplomatic efforts by declaring itself willing to make concessions to Teheran if it renounces its nuclear programme. It has, for example, suggested that it could end its objections to Iran's membership of the World Trade Organisation (WTO). France, Germany and the UK, with the support of the EU high representative for foreign policy, Javier Solana, have continued their efforts to persuade Iran to abandon its nuclear enrichment activities. In a meeting on May 25th Iran agreed to continue its freeze on uranium conversion and enrichment until early August, when it is awaiting new proposals from the EU. A crucial period will then follow after a new government should have been formed in Iran. If negotiations fail, Iran has threatened to resume enrichment activities, and the EU has warned that it would refer the issue to the UN Security Council (a move that the US has repeatedly called for), which would be likely to result in sanctions.
Relations with the US have also been aided by the EU's decision to delay its plans for the lifting of the arms embargo on China. Although trade tensions have increased over US claims that the European aircraft manufacturer, Airbus, is unfairly subsidised in relation to its US counterpart, Boeing, with both parties filing suits with the WTO, EU and US politicians have managed to keep this commercial dispute separate from political relations.
The political scene: US and EU co-operate in Lebanon
Last February the murder of Lebanon's former prime minister, Rafik Hariri, in a bombing exacerbated public anger and resulted in massive demonstrations that forced Syria to withdraw its troops and led to the toppling of Omar Karami's pro-Syrian government. The US and the EU, and France in particular, have been in complete agreement regarding their desire for a Lebanese state that is fully democratic and free of Syrian influence. In this respect, the EU has welcomed the formation of a new government on condition that the elections were free, fair and transparent and without outside interference. To help in the democratic process, the EU sent an electoral observation mission for the first free elections in 29 years, scheduled for May 29th and June 5th, 12th and 19th. The first round of elections, on May 29th, was given a positive evaluation by EU observers and was won convincingly by candidates endorsed by Saad Hariri, the son of Rafik. However, just four days later a prominent Lebanese journalist opposed to pro-Syrian politicians was killed in a car bombing. France and the US have both sent teams to investigate the attack.
The political scene: EU retreats from lifting China arms embargo
In the 30th year of partnership between the EU and China, relations continue to be dominated by the arms embargo that resulted from the violent repression of a pro-democracy protest movement in Tiananmen Square in 1989. In December 2004 the European Council set June 2005 as the deadline for lifting the embargo. This move was pushed forward mainly by France and Germany, which view the embargo as outdated and believe that relations with an emerging economic superpower outweigh human rights violations. The plan was strongly opposed by the US, because of the possibility that such arms might be used in a conflict with Taiwan. At the time it appeared as though the embargo would be lifted this month, yet several factors have come into play since then.
In April EU foreign ministers failed to reach a consensus on the issue, as the UK, the Netherlands and Sweden remain concerned about human rights violations and the conflict between China and Taiwan. The movement for the removal of the embargo had been weakened by China's adoption in March of an anti-secession law that could be used to justify force against Taiwan. Also in March, China failed to ratify the UN Convention on Civil and Political Rights that was signed in Beijing in 1998.
On May 11th the EU urged China to commit itself to refrain from using force in Taiwan, but this seemed to fall on deaf ears. The EU had plans to accompany the removal of the embargo with a strict code on the conduct of arms sales, but officials were not able to reach a consensus regarding the details of the code or whether it should be legally binding. The US had also stepped up its complaints and threatened restrictions on transatlantic defence co-operation and the transfer of technology if the EU lifted the embargo. In April and May relations between the EU and China were strained by EU complaints about massive increases in exports of some categories of textiles and clothing, following the lifting of import quotas in January. However, in early June an agreement to restrain the rate of increase was reached.
Economic policy: Policy remains unchanged
Economic policy over recent months has not changed significantly, despite the fact that economic conditions have deteriorated as a result particularly of weakening consumer confidence, while the results of the two referendums in France and the Netherlands have led some commentators to question the long-term viability of the single-currency project. The French debate made little reference to the euro as such, but in the Dutch debate it did feature, and there was clearly unhappiness about the perceived impact on inflation and economic performance of the introduction of the euro.
Nevertheless, there have been no prominent demands in the Netherlands for the break-up of the euro, probably because it is seen that this would cause further disruption with no evident benefit. In Germany there is also considerable discontent over the perceived benefits of the euro, but again there has been no strong move to bring back the D-mark. Politicians, aware that the result would probably be a stronger currency that would make Germany less competitive, have refrained from casting doubts on the viability of the euro. Only in Italy, where relatively high unit labour cost increases have led to a loss of competitiveness vis-à-vis other euro area countries, have there been calls for the reintroduction of the lira from members of the government's small coalition partner, the Lega Nord. These are unlikely to be echoed by mainstream parties, because the costs of servicing Italy's large public debt would be enormous.
A wide range of factors was involved in producing the "no" victories (see The political scene), but most commentators would agree that poor recent economic performance had an impact. The implication is that continued poor performance could lead to increased discontent. However, there are no easy answers. Monetary policy remains expansive, but increased money supply has not pushed up demand, and the European Central Bank (ECB) is reluctant to reduce interest rates further—its scope for doing so is in any case limited, with intervention rates at just 2%. Fiscal policy remains heavily constrained by the poor condition of most member states' government finances, and even without the Stability and Growth Pact (SGP) it is very doubtful whether the stimulatory effects of an expansionary fiscal policy by the larger member states, leading to even bigger deficits, would not be counteracted by the loss of consumer confidence resulting from the knowledge that the higher deficits would have to be paid for by higher taxes or lower pensions in the future. Member states are constantly being told by the European Commission, the ECB and international institutions that reforms, particularly to labour markets, would lead to better performance. However, the political obstacles to such reforms are considerable, and their benefits would probably only emerge some years later—and even then their impact is uncertain. In several euro area countries there has already been a sharp switch in income from labour to profits, but so far without positive results (other than avoiding a probably even worse scenario if profitability had remained poor).
Economic policy: ECB remains unpersuaded of case for lower interest rates
As expected, the latest meeting of the Governing Board of the ECB on June 1st ended with a confirmation of interest rates at their current levels, which have now been maintained for two years. Expectations for a rate cut had increased over the past few months, following the release of a string of disappointing economic indicators. At his press conference on June 1st Jean-Claude Trichet, the ECB president, acknowledged the more pessimistic growth environment but claimed that monetary policy conditions were generous and hence conducive to growth, and that reforms—not monetary policy—were the key to economic dynamism. However, he did not make clear how such structural reforms would increase demand, which is currently growing clearly below the potential of supply. In fact, the ECB has not entirely ruled out the possibility of a rate cut at some point in the future, and it was noted that, in reply to questions, Mr Trichet did not, as he had at early press conferences, say that a cut in interest rates had not been discussed. Despite the fact that everything else Mr Trichet said was arguing against a rate cut, this has left market actors on the verge of pricing in the expectation of a rate cut later this year. Such a cut would be more likely if the recent moderate decline of the euro against the US dollar were reversed, since a declining euro does in fact bring extra money into the economy through the increased euro value of export earnings. The impact of a rate cut to 1% would be likely to have only a marginal impact on growth prospects in 2005-06.
Growth of M3 money supply remained high in March with an annual rate of 6.5%, slightly down on its recent peak of 6.8% in January. The three-month moving average rate (January to March) was 6.7%, still well above the desired 4.5% rate of expansion. The ECB has stressed that some normalisation in the asset allocation process has taken place in recent months, as economic agents have shifted from more liquid assets into longer-term investment forms, such as bonds, equities or real estate. However, the ECB remains concerned about the slow pace of this process and the risk of a rapid price increase in certain markets, especially real estate, although it has also said that this is at present only of concern for some hot spots, not for the euro area as a whole.
Economic policy: Stability and Growth Pact is amended
At the Brussels summit on March 22nd-23rd the EU heads of state approved a reform of the Stability and Growth Pact (SGP) previously agreed by finance ministers. The reform contains amendments in three areas: improving governance, strengthening the preventive arm, and altering the criteria for the activation of the excessive deficit procedure. It is the last which has attracted most attention.
* Improved governance comprises demands for better co-operation between governments, a greater involvement of national parliaments (eg, in discussing additional fiscal measures), more reliable macroeconomic forecasts, and better statistical methods. The last is indeed important. In 2004 Eurostat seemed haphazardly to verify figures revised by the present Greek government for past years, despite having earlier endorsed the figures and methods of the previous government, and it has allowed some highly dubious accounting procedures by Belgium, Germany and Portugal.
* The strengthening of the preventive arm is to result from a transformation of the general concept of a budget close to balance or in surplus to country-specific targets, which are less strict for low-debt countries (-1% of GDP) than for high-debt countries (0% of GDP). Governments are committed to undertake more than 0.5% of GDP consolidation efforts in good times, defined as output above potential, and to use unexpected revenue for budget consolidation. Deviations are to be explained, and the Commission may issue recommendations, although there is no possibility of sanctions.
* Changes to the excessive deficit procedure include a substantial increase in the causes that may be taken into account when assessing whether an overshooting of the 3% of GDP deficit limit is excusable, from two (natural disasters and negative growth) to 14 (including sluggish growth over an accumulated period; implementation of the Lisbon Agenda; expenditure on research, development and innovation; public investment; burdens resulting from financial contributions to fostering international solidarity; and burdens arising from achieving European policy objectives and pension reform, among others). However, despite these large numbers of factors that can be taken into consideration, the pact continues to insist that the deficit remains near to the reference value and that the excess must be temporary.
The ECB has launched a strong attack against the revisions. In its April Monthly Bulletin it stated: "The new rules severely weaken the Stability and Growth Pact. They diminish both the incentives to pursue a sound budgetary policy and the binding impact of the rules... By differentiating between countries, the pact will become less transparent, more complex and, therefore, ultimately even more difficult to enforce." Nonetheless, the ECB has vehemently expressed the need for the rigorous implementation of the reformed SGP rules and procedures.
Economic policy: Netherlands' fiscal position improves, Italy's deteriorates
The reform of the SGP is, in fact, unlikely to have a marked impact on fiscal policy. The Economist Intelligence Unit has only made minor alterations to its fiscal forecasts for France and Germany for 2005 and 2006 to take account of the impact of lower growth forecasts. In one country, the Netherlands, a substantial downward revision in June to the estimated 2004 deficit has improved prospects for 2005 and 2006. Having taken major and painful corrective measures, the Dutch government balance remains comfortably below the 3% of GDP benchmark. As a vociferous critic of the laxity of the larger countries, the Dutch finance minister, Gerrit Zalm, is now in a stronger position to argue his case. By contrast, Italy has experienced a significant deterioration in the public finances. In May various developments highlighted that the country's growth and fiscal problems were worse than feared. On May 12th first-quarter GDP data showed that the Italian economy was in recession. On May 17th the Italian finance minister, Domenico Siniscalco, responded by revising down the official growth forecast for 2005 from 1.2% to 0.6%, thereby not ruling out stagnation. He concluded that a budget deficit in 2005 of up to 4% of GDP rather than the officially projected 3% was possible. On May 23rd Eurostat published budget deficit data for 2003 and 2004 that had been revised upwards and showed an increase from just below or in line with the 3% of GDP ceiling to 3.1% of GDP in both years. Debt levels were also revised up slightly, to 106.5% of GDP in 2003 (before: 106.3%) and 106.6% of GDP in 2004 (before: 105.8%).
The Italian government's response has not eased concerns. The admission of worse than previously reported budget deficit data for 2003-04 and of the prospective breach of the 3% of GDP deficit ceiling in the current year did not prompt any announcement of corrective measures, which is not surprising, given that the next election is due in early 2006. As a result of the government's fiscal record and failure to take measures to tackle it, Italy has become the first country to face disciplinary action under the SGP's new rules. On June 7th the European Commission issued a report on Italy, highlighting its use of faulty statistics to conceal its breach of the deficit rules in 2003 and 2004. The report also pointed out that according to the rules of the SGP, the excessive Italian budget deficit is neither temporary (it has been above the EU's target of 3% of GDP since 2003) nor warranted (it is not the result of circumstances outside the control of the government). The Commission's report will soon be scrutinised by finance ministers in Brussels, although given their past record, sanctions are not expected unless there is a further deterioration. Nevertheless, the fact that disciplinary action has been taken so soon after the adoption of reforms to the SGP is a positive sign for the pact's continuing relevance as a way of putting some pressure on governments.
Currency and bond markets have so far virtually ignored the gradual deterioration of fiscal positions in the euro area as a whole or in specific countries. Yields on Italian government ten-year bonds, at 3.40 on June 13th, were only 21 basis points above German bonds and well below yields of US or UK bonds. Average bond rates in the euro area are at exceptionally low levels.
The political scene
The proposed EU constitution has been decisively rejected in referendums in France and the Netherlands. While some of the "no" votes came from the right, the decisive move against the constitution, which took place during the campaigns, was among left-wing voters in both countries. In France the constitution was seen as embodying a neo-liberal Anglo-Saxon economic model. In the aftermath there are signs of member states asserting national interests more strongly, with the British adopting an intransigent line on the EU budget. One effect of the referendums has been to make prospects for further enlargement more distant, adding to the importance of the neighbourhood policy. The EU has backed away from lifting its arms embargo on China.
Economic policy
There has been no change in monetary policy, although the ECB is coming under more pressure. Reforms to the Stability and Growth Pact have not noticeably changed fiscal policy. Italy's fiscal position seems to be deteriorating, and the European Commission has begun an excessive deficit procedure.
The domestic economy
National accounts figures show a quarter-on-quarter recovery of growth in the first quarter, but almost all other indicators have suggested that the modest 2004 recovery is fading, as investment stagnates and consumers lose confidence. Industrial output has come close to a halt, but financial, trade, transport and communications services are still growing. Unemployment remains at record-high levels, although employment has risen slightly. Headline inflation has risen to 2.1%, but the underlying rate has fallen to 1.4%. Long-term interest rates have declined.
Foreign trade and payments
In the first quarter of 2005 export growth slowed in the EU25, while euro area exports fell, with the trade balances of both deteriorating. However, exports have risen strongly to Russia, Norway and Switzerland.
Outlook for 2005-06: Domestic politics
The decisive rejection of the proposed EU constitution by voters in France and the Netherlands on May 29th and June 1st has dramatically altered the political outlook for the EU. There is no realistic chance of the constitution as agreed a year ago being revived, or of a revised one being agreed and passed in the foreseeable future. The most that supporters of the treaty can hope for is that a few of the proposed changes are introduced individually over the coming years. Moreover, the impact of the "no" votes goes beyond the defeat of the constitution itself. The reasons given to opinion pollsters included only slight references to the actual text of the treaty. Rather, voters saw the constitution as symbolising a direction in which they suspect the EU of going, and one of which they do not approve.
The task of policymakers therefore has to be to reconnect to voters, but this is very difficult, because there are different reasons for discontent both within and between countries, and not all the reasons are compatible. Nevertheless, there would appear to be two messages—that voters want to slow down the pace of integration, including market-opening, and that they want to slow down enlargement. Indeed, some would argue that there should be a complete halt to both. Certainly more efforts will need to be devoted to selling any proposed future developments if they are to be implemented.
The chances of any such leadership being provided in the next 18 months do not look very encouraging. The immediate aftermath of the referendums has seen an intensification of arguments, particularly between France and the UK, over who does better or worse out of the small EU budget. This is topical, because the budgetary framework for 2007-13 is being discussed with the aim of agreement by early 2006. At present the budget is running at close to 1% of gross national income (GNI). The European Commission would like to raise this to 1.14%, but contributor member states, apart from arguing among themselves, are together trying to resist an increase anywhere near this magnitude. The budget will not in any case have a major influence on overall economic policy, because it is too small, but the way in which expenditure is allocated to different categories (agriculture, regional funding, external policies, research and so on) is of political importance as a guide to the EU's objectives.
In the second half of 2005 EU meetings will be chaired by British ministers. This is unfortunate, because the UK will be mainly preoccupied with defending its privileged budget rebate agreed in 1984, when the UK was relatively poor, and will therefore not be able to take a lead in resolving differences between member states. Under the presidency of two smaller countries—Austria in the first half of 2006 and Finland in the second half, both of which should be less preoccupied with national interests—the chances of agreement on the budget are better, and this could also spill over into a better atmosphere on other issues. Nevertheless, it is likely that, with the governments of most member states preoccupied with domestic political struggles, such consensus as is reached will be to try broadly to preserve the existing acquis communautaire (body of EU law) while making attempts to streamline it, rather than taking new initiatives.
Despite the negative message sent by the referendums on future enlargement, commitments to Romania and Bulgaria have gone too far for their planned accession in 2007 to be refused. It is not likely that the western Balkans, which would then be surrounded by EU members, could be permanently excluded, but delays to their accessions will probably be considerable. The EU is committed to start accession negotiations with Turkey in October 2005, and the Economist Intelligence Unit expects this commitment to be met, but the EU has not committed itself to guaranteeing Turkish accession after the end of negotiations (which is in any case not expected until 2013). Another large country, Ukraine, may also hope for negotiations, but these are unlikely to start in the next few years.
Outlook for 2005-06: International relations
At present the EU's foreign policy stance on a range of issues is less divided than has often been the case in the past. Defeat of the EU constitution and disputes over internal EU matters will weaken its authority and capacity for initiative, but we do not envisage a major foreign policy divide comparable to that over the Iraq war to emerge in the forecast period. Relations between EU countries and the US have improved somewhat this year, and although the EU's internal difficulties will prevent the improvement being built on very much further, our forecast is that there will be no sharp deterioration over the next 18 months. Relations will be helped by the expected victory in the German election, likely to be called in September, of the Christian Democrats, who, while disagreeing with the US on certain matters such as the Kyoto Protocol and the International Criminal Court, have committed themselves to working more closely with the US than the current Schröder government.
The European Commission and member states will work together to try to support the transitional government in Iraq, although the actual contributions of member states will vary from negligible to substantial, and two countries which had troops in Iraq, Poland and the Netherlands, are withdrawing them. EU countries will also remain active in trying to provide stability and help the non-drug economy of Afghanistan. Three EU countries, France, Germany and the UK, with tacit support from other countries, will continue to negotiate with Iran with the aim of persuading it to abandon its efforts to develop nuclear weapons partly by supporting its civil nuclear power programme. It will make proposals by August. If there were to be a breakdown, the EU has agreed with the US to go to the UN Security Council and call for UN sanctions. If Iran does go ahead with its nuclear weapons programme, there is a risk of a new crisis in European-US relations and new divisions in the EU's foreign policy.
The new EU trade commissioner, Peter Mandelson, with the full backing of the Commission president, José Manuel Barroso, has committed himself to working hard to bring about a successful conclusion to the Doha development round of World Trade Organisation (WTO) negotiations, with an emphasis on the opening of markets to developing countries. Changes in the common agricultural policy (CAP), switching expenditure from price support to income support, have enabled the EU to make some moves towards reducing the adverse effects of the CAP on agriculture in developing countries, but further concessions, especially on sugar and cotton, are likely to be necessary. Mr Mandelson faces a considerable challenge as a UK commissioner in persuading the countries that benefit most from the CAP to accept further concessions.
Outlook for 2005-06: Policy trends
We do not expect major changes in the economic policies of the EU or the euro area over the next 18 months. The Commission president, Mr Barroso, has tried to refocus attention on the various objectives designed to boost economic performance that were set by heads of state and government five years ago at Lisbon. He will try to persuade member governments to draft national action plans in the second half of 2005. However, the results of the French and Dutch referendums suggest that public opinion in member states will react against attempts by the Commission to tell them what they should do, so most aspects of economic policy will depend very much on national debates and initiatives.
Monetary policy is a full exception and fiscal policy a partial exception, with monetary policy for the euro area, which encompasses a large part of the EU economy, conducted by the European Central Bank (ECB), and fiscal policy supposed to be guided by the Stability and Growth Pact (SGP) between euro area participants. For reasons described below, no major changes are expected in either monetary or fiscal policy. Germany has made important domestic reforms, particularly to its labour market, and further reforms are expected if, as we assume, a Christian Democrat-led government comes to power there in October. There are also ongoing reforms in the Netherlands, but given the political obstacles to reforms, which in the short term cause more pain than benefit, little major change is expected in any other euro area country over the forecast period.
Outlook for 2005-06: Fiscal policy
Fiscal policy in the euro area should be regulated by the SGP, which stipulates a budget deficit not exceeding 3% of GDP in all but exceptional economic circumstances and calls for balance over the course of the economic cycle. With France, Germany, Greece, Portugal and more recently Italy persistently flouting the 3% of GDP limit, a revision to the pact was agreed in March 2005. This called for more factors to be taken into account in assessing whether breaches of the 3% limit were permissible, thus providing partial retrospective justification to the non-compliant states. However, the pact continues to state that any excess should be small and temporary, with efforts made to return below the limit, and in the medium term to balance. The SGP should therefore continue to exert some pressure on member states.
One country, the Netherlands, has succeeded in bringing a deficit of over 3% of GDP in 2003 to well below 3% in 2004, despite adverse economic conditions, and is likely to remain compliant. Germany, though less successful, is making efforts to bring down the deficit, which would have been successful had economic growth not continued to disappoint. In Italy, however, which faces an election in 2006, the fiscal situation is likely to deteriorate. The fiscal deficits are of great concern to the ECB and are likely to be one factor influencing its policy.
Outlook for 2005-06: Monetary policy
There have been some doubts cast over the future of the euro area in recent weeks. We do not expect any participating government to question remaining in the euro during the forecast period, but some continued discussion of a possible departure of one country or even a total break-up will continue. The ECB is not expected to respond to such doubts or criticisms of its policy. It has kept its main refinancing rate unchanged at 2% since the last cut by 50 basis points in June 2003. It considers this level to be low and is concerned about money supply growth, which has been well above its target, and fiscal deficits. The recent weakening of the euro has had the effect of stimulating monetary growth, and we do not therefore expect any reduction in rates, at least unless there is a return to a strengthening euro.
However, the ECB will also be in no hurry to raise rates. After a very brief pick-up in the first half of 2004, GDP growth in the euro area has weakened to below potential. There are no signs that the rise in oil prices might lead to second-round effects on inflation, and underlying inflation has fallen well below the 2% target ceiling. Consequently, we expect official interest rates to remain stable in 2005 and 2006.
The political scene: Proposed constitution is torpedoed
EU politics has been dominated by the campaigns for referendums in France on May 29th and in the Netherlands on June 1st on the proposed EU constitutional treaty and the repercussions of the strong negative votes in both countries. Despite attempts to continue the process of ratification in the hope that a large majority of countries will eventually ratify (11 have completed the process so far), it is very difficult to see how the treaty can come into effect, given the opposition it faces from public opinion in these two countries, the UK and others. While even Tony Blair, the prime minister of the most sceptical country in the EU, the UK, has said that institutional reform cannot be abandoned, the approach will have to be a different one, probably item by item and with sensitivity to possible opposition in any member state. The implications of the "no" votes will, moreover, go further. Both rejections appear to have been motivated by a wide range of factors related to the perception of the EU and the direction in which it is seen by citizens to be going.
The political scene: Defeat came from the left
There were some similarities and some differences between France and the Netherlands as to why the majority of voters rejected the constitution. In neither country was the actual wording of the constitution, which was probably seen by most voters as incomprehensible, of much importance. In both countries the less well-off were more inclined to vote against. In both countries unpopular centre-right governments are in power. Although "no" voters were to be found among supporters of all political parties, those in favour tended to be supporters of the centre-right parties. Most of those against were supporters either of parties on the left (the Socialists and Communists in France, the Labour Party and the Socialist Party in the Netherlands) or the far right (National Front in France and Group Wilders in the Netherlands). With the far right having long been opposed to the EU in France and more recently also in the Netherlands, it was voters on the left, including the moderate left in both countries, whose rejection proved decisive. From initial positions, which slightly favoured the treaty in France and in which most voters were undecided, they were persuaded to come down against the treaty as a result of the campaigns. Anxieties about the economic situation and the threats to jobs from actual or potential immigrants played a part in both countries.
The political scene: French felt threatened by neo-liberalism
Nevertheless, there were also considerable differences between public opinion and the reasons for the "no" votes in the two countries. For the French, the perceived threat, particularly to the decisive numbers of left-of-centre voters, came from what was characterised as a "neo-liberal" ideology promoted by the Anglo-Saxon countries, the UK within the EU and the US outside, and supported by the new member states in central and eastern Europe. According to this view, France and other EU countries are being forced to sacrifice their social models to a deregulated economy which includes long hours, low wages, precarious job tenure, no trade union rights, low public expenditure on social services, and the abandonment traditional public services such as public transport and the post to the free market. This was associated with the opening up of EU frontiers to unbridled global competition from low-wage developing countries with no labour rights, as well as competition from cheap labour from central and eastern Europe undercutting service providers in France from plumbers to hairdressers.
This portrayal of the pressures to which French society was subject had been given prominence by two developments this year. The first was the ending of quotas on textiles and clothing by all developed economies, as had long been required under the Uruguay round of trade negotiations going back a decade. This led to a huge surge in cheap clothing imports, especially from China, which had the effect of accelerating the job losses in the sector in the EU that had been going on for many years.
The second, in contrast, was a relatively new policy initiative within the EU, dating from early 2004 and known as the Bolkestein directive, named after Frits Bolkestein, who was internal market commissioner in the previous Prodi commission that served until November 2004. This directive aimed to accelerate the somewhat gradual progress previously made in opening up EU markets for the provision of services by covering the broad range of services under one umbrella (with a few exceptions such as transport, telecommunications and financial services, which are being opened up through other legislation).
Instead of providing detailed regulation at the EU level, which would have taken years, the directive specified that where there was no EU legislation, any services that were legally provided in one member state could be provided in another. This principle of home rather than host country control is the same as that applied to exports of goods. However, there is a crucial difference between the export of goods and the export of many services which the directive did not take into account, namely that while the manufacturing of goods is an activity that is always carried out in the host country, many services, such as repairs, catering or property services, can only be carried out in the host country. This would have two implications: first, that service provision could well involve the movement of labour, and second, that member states could no longer apply their own laws on their own territory even if there were no EU law. It therefore appeared as a way of undermining the five- to seven-year delay on the free movement of labour following EU enlargement agreed in the accession treaties, a severe new encroachment on national sovereignty, and a charter for what the French call "social dumping".
The political scene: Dutch felt short-changed by other members
The Netherlands is a country which has traditionally felt closer to the UK and the US, so the Anglo-Saxon approach did not feature as a target of the "No" campaign. Rather, there was a combination of the feeling that too much power was going to the EU institutions and a view that the Netherlands was being short-changed. Thus the high Dutch contribution to the EU budget—which is caused partly by the cost of the common agricultural policy, from which France is one of the main beneficiaries, and partly by the British rebate, which has to be financed by other major net contributors, including the Netherlands—was placed in a poll taken just after the referendum as the single most important reason for the "no" vote. This feeling of being short-changed had also been spurred by the debate on the Stability and Growth Pact (SGP), which is supposed to provide a common framework for fiscal policy in the euro area. In 2003 the Netherlands did inadvertently marginally breach the SGP's 3% of GDP deficit limit, but as a result has taken very severe budgetary measures. These have brought the deficit comfortably below the 3% mark, but they have been very painful.
Meanwhile, the two largest countries in the euro area, France and Germany, have been continuously overshooting the limit and have resisted taking the necessary action to correct their deficits. This has been seen by Dutch voters as an example of large countries feeling that they can ride roughshod over the rules by which the small countries abide, indicating that the role of a country such as the Netherlands in the EU is negligible.
The political scene: National disputes revive
EU leaders did not know how to react coherently to the news of the referendum defeats. Several, including the French president, Jacques Chirac, the German chancellor, Gerhard Schröder, and Jean-Claude Juncker, the prime minister of Luxembourg and temporary holder of the EU presidency, all called for the ratification process to go ahead in the hope that a large majority would in the end ratify the treaty, putting pressure on France and the Netherlands to hold new referendums in which their voters would be asked to reconsider. Although legally this was correct, the chances of it actually succeeding seemed minimal, since the defeats of the constitution in France and the Netherlands made it all the more likely that some other member states would reject it, with potential "yes" voters lacking motivation and any worries on the part of would-be "no" voters that their country would be isolated eliminated.
The other main item on the EU agenda has been negotiations for the 2007-13 budget framework, which should be agreed by early 2006 to allow programmes to be prepared in advance of 2007. On this issue a longstanding divide between the main net contributor states, including France, Germany, the UK, Sweden, the Netherlands and Austria, and the net recipients plus the Commission over the size of the EU budget (between 1% and 1.14% of gross national income) has more recently been complicated by the renewed flare-up of the argument over the UK's budget rebate. This special rebate of £3bn (€4.5bn), which the UK has received since the early 1980s, has long been a matter of ongoing discontent among all the UK's partners. Although the UK can argue that France as a major recipient of payments under the common agricultural policy (CAP) is treated even more favourably, other countries whose economies are now in greater difficulty than the UK, such as Germany and the Netherlands, are paying twice as much as the UK and helping to fund the UK rebate. UK ministers have counter-attacked over what they argue is the distortion of the EU budget by the fact that 40% of it is still spent on agriculture, which accounts for only 2% of GDP. However, there have already been major reforms of the CAP, and it will not be easy for any French government to accept additional reforms; moreover, some other countries may back French resistance to further change.
The political scene: Opposition to enlargement was also behind no votes
The "no" votes in France and the Netherlands have had an impact on prospects for the future enlargement of the EU, to which they have dealt a double blow. First opinion polls suggest that an important reason (though by no means the only one) for the "no" votes was opposition to future EU enlargement, because of the perceived threat to jobs through extending the area of free movement of labour as well as encouraging moving manufacturing and other facilities to new member states. Despite these concerns enlargement to Romania and Bulgaria will almost certainly go ahead, probably in 2007, and it would be difficult to place permanent obstacles in the way of the accession of the western Balkan countries, which would then be an enclave within the EU. However, prospects for Turkey and Ukraine, although not completely destroyed, have been adversely affected. Turkey will start accession negotiations in October 2005, but these will be "open-ended", meaning that even if Turkey meets the requirements for EU membership, actual accession (which is in any case not feasible before 2015) cannot be guaranteed if political opposition in the EU remains strong. Despite the victory of Viktor Yevtushenko in the contested presidential election in Ukraine at the end of last year, which has strengthened the country's democratic credentials as seen by the EU and shifted its orientation westwards, the country is bound to remain behind Turkey in the accession queue. The setback for Turkey is therefore also a setback for Ukraine, to the extent that its possible accession, though not ruled out, cannot be regarded as defining Ukraine-EU relations over the next few years.
The political scene: Potential importance of ENP increases
The impact on EU policy towards Ukraine and other countries to its east is considerable. The record of EU enlargement reflects a very successful foreign policy, which has played an important role in encouraging the development of stable, democratic countries respecting the rule of law and freeing their economies in the neighbourhood. If the EU wants to pursue the same objectives with its new neighbours, it must find new policy instruments to do so. This is precisely what it has attempted with its European Neighbourhood Policy (ENP), which the previous Prodi Commission tried to promote in its last two years. The main objective of the ENP as defined by the Commission is to offer the EU's neighbours to the south and east incentives for taking meaningful steps towards democracy, the rule of law, human rights, and good governance. The trouble is that the policies to put in place such incentives, and the financial resources allocated to them, remain feeble, and the call for more financial or other resources for this purpose has been almost absent from ongoing debates on the future EU budget or other policies.
The political scene: Some improvement in Ukraine-EU relations
Even so, there have been some moves towards closer EU-Ukraine relations. For nearly a decade relations had been marred by the EU's unanswered appeals for reform and Ukraine's empty rhetoric, but the new government's commitment to the rule of law, freedom and justice have sparked a more co-operative spirit between the EU and Ukraine. The two sides recently signed a civil aviation agreement that grants access for European airlines to the Ukrainian market from any member state. In addition, Ukraine reached an agreement with the EU to participate in the EU's Galileo satellite navigation system. Ukraine has a highly developed space industry and is a world leader in the design and production of launchers and Global Navigation Satellite System (GNSS) components. Ukraine is the third non-EU country to join the programme after Israel and China, and the agreement is the first step towards Ukraine having a stake in the Galileo Joint Undertaking.
On May 18th Ukraine adopted the Mine Ban Treaty, which will allow the European Commission to launch a project for the destruction of anti-personnel landmines in Ukraine, of which the country inherited more than 10m following the break-up of the former Soviet Union. In addition, Ukraine and the EU recently signed an Agreement for Co-operation on Peaceful Uses of Nuclear Energy, which outlines, among other things, co-operation to promote safety in Ukraine's nuclear power stations (although this may be subject to financial constraints). The EU is also increasing European Investment Bank funding and has promised to work towards the facilitation of visas.
The political scene: Barcelona Process nears tenth anniversary
The Euro-Mediterranean Partnership (Barcelona Process), which was established in October 1995 as a framework for political and economic relations between the EU and the countries of the southern and eastern Mediterranean, was in 2004 brought into the ENP. A high-level conference is planned for November this year to mark the tenth anniversary. During meetings in Luxembourg on May 30th-31st foreign ministers agreed to develop targets in the areas of peace, stability, good governance and democracy, sustainable economic development and reform, education and socio-cultural exchanges, and security, migration and social integration. In this respect, the EU is attempting to bring these states closer to the EU not through membership, but through aligning policies and legislation and moving towards a free-trade zone with a target date of 2010, although it is unlikely that this will be achieved for all the Mediterranean countries. At the political level, the two main current policy objectives are progress towards a solution to the Israeli-Palestinian conflict and the establishment of an independent, stable and democratic Lebanese state.
The political scene: Relations with Russia may become more strained
Attempts by Russia and the EU to establish a framework for their relations continued in May. In a summit held on May 10th, after much diplomatic stalemate, Russia and the EU adopted a package of programmes for the creation of the four Common Spaces—economic integration, freedom and justice, external security, and research, education and culture—agreed in St Petersburg in 2003. The goal of economic integration is to move towards a free-trade area, including increased competition, decreased barriers to investment, and aligned regulatory standards. In particular, the agreement examined ways to increase co-operation in the transport, energy and space sectors and opened discussion on issues surrounding the achievement of the Kyoto Protocol benchmarks. On the issue of the second Common Space—freedom and justice—the EU, in response to Russian requests, agreed to co-operate to achieve easier access to visas. With respect to external security, both sides agreed on the importance of multilateralism and expressed their desire to strengthen the role of the UN and the Organisation for Security and Co-operation in Europe (OSCE), but avoided discussion of more difficult issues involving Georgia, Moldova and Chechnya.
Even if the agreement was more symbolic than substantial, it came as a relief to diplomats and marked some improvement in bilateral relations after more than a year of stagnation. It came on the day after the Russian president, Vladimir Putin, and the US president, George W Bush, together with EU leaders had participated in ceremonies to mark the 60th anniversary of the allied victory at the end of the second world war. During the celebrations leaders ignored Mr Putin's comment that the greatest tragedy of the 20th century was the fall of the Soviet Union, a statement which not only signalled his distance from both the US and EU, but also indicated a reluctance to accept the full independence of other former Soviet states. EU leaders also downplayed disagreements over human rights issues in Chechnya and the recent sentencing of Mikhail Khodorkovsky, the former head of the Yukos oil company, allegedly for tax evasion, but more credibly as a punishment for political opposition, given the more favourable treatment of other leading businesmen. A change of policy towards Russia could result from the probable election in September of a German government led by the Christian Democrats, who have called for more explicit criticism of Russia on these issues.
The political scene: Improvements in EU-US relations maintained
The improvement in the climate of transatlantic relations, which took place before and during President Bush's visit to Europe in February, when he became the first US president to visit the EU institutions, has been broadly maintained. The Commission has recently adopted a communication entitled "A Stronger EU-US Partnership and a more Open Market for the 21st Century", which is aimed at bolstering economic integration and strengthening the framework and profile of EU relations with the US. Although coverage of EU affairs is generally minimal in the US, the referendums in France and the Netherlands were widely reported in the US media. At the moment, relations have not been affected by the EU's internal problems.
Although important differences remain, there has been some convergence on EU and US policies with regard to the Israeli-Palestinian conflict, Iran and Iraq. Generally, the US has been less critical than the EU of Israeli government policies such as settlements in areas that might in an agreement become a Palestinian state. This remains the case, but Mr Bush has explicitly urged Israel to freeze its settlement policy, and he met with—and showed some willingness to support—the leader of the Palestinian Authority, Mahmoud Abbas.
At the request of the new Iraqi transitional government, the US and the EU will co-host an international conference in Brussels on June 22nd. The conference is intended to serve as a forum for the transitional government to present its goals and strategies for the transition period, to mobilise support for the transitional government, and to co-ordinate support for the reconstruction of Iraq. The conference reaffirms the EU's willingness to work with the US in collaboration with the UN and to refrain from focusing on disputes from the past. Nonetheless, tensions still arise from the refusal of those EU states that opposed the war to send troops and personnel into Iraq. Furthermore, Poland and the Netherlands are set to withdraw their troops, and Italy is likely to follow suit if a new centre-left government takes over in 2006.
Although the US continues to refuse to join in negotiations between France, Germany and the UK and Iran, it has given a little support to the EU's diplomatic efforts by declaring itself willing to make concessions to Teheran if it renounces its nuclear programme. It has, for example, suggested that it could end its objections to Iran's membership of the World Trade Organisation (WTO). France, Germany and the UK, with the support of the EU high representative for foreign policy, Javier Solana, have continued their efforts to persuade Iran to abandon its nuclear enrichment activities. In a meeting on May 25th Iran agreed to continue its freeze on uranium conversion and enrichment until early August, when it is awaiting new proposals from the EU. A crucial period will then follow after a new government should have been formed in Iran. If negotiations fail, Iran has threatened to resume enrichment activities, and the EU has warned that it would refer the issue to the UN Security Council (a move that the US has repeatedly called for), which would be likely to result in sanctions.
Relations with the US have also been aided by the EU's decision to delay its plans for the lifting of the arms embargo on China. Although trade tensions have increased over US claims that the European aircraft manufacturer, Airbus, is unfairly subsidised in relation to its US counterpart, Boeing, with both parties filing suits with the WTO, EU and US politicians have managed to keep this commercial dispute separate from political relations.
The political scene: US and EU co-operate in Lebanon
Last February the murder of Lebanon's former prime minister, Rafik Hariri, in a bombing exacerbated public anger and resulted in massive demonstrations that forced Syria to withdraw its troops and led to the toppling of Omar Karami's pro-Syrian government. The US and the EU, and France in particular, have been in complete agreement regarding their desire for a Lebanese state that is fully democratic and free of Syrian influence. In this respect, the EU has welcomed the formation of a new government on condition that the elections were free, fair and transparent and without outside interference. To help in the democratic process, the EU sent an electoral observation mission for the first free elections in 29 years, scheduled for May 29th and June 5th, 12th and 19th. The first round of elections, on May 29th, was given a positive evaluation by EU observers and was won convincingly by candidates endorsed by Saad Hariri, the son of Rafik. However, just four days later a prominent Lebanese journalist opposed to pro-Syrian politicians was killed in a car bombing. France and the US have both sent teams to investigate the attack.
The political scene: EU retreats from lifting China arms embargo
In the 30th year of partnership between the EU and China, relations continue to be dominated by the arms embargo that resulted from the violent repression of a pro-democracy protest movement in Tiananmen Square in 1989. In December 2004 the European Council set June 2005 as the deadline for lifting the embargo. This move was pushed forward mainly by France and Germany, which view the embargo as outdated and believe that relations with an emerging economic superpower outweigh human rights violations. The plan was strongly opposed by the US, because of the possibility that such arms might be used in a conflict with Taiwan. At the time it appeared as though the embargo would be lifted this month, yet several factors have come into play since then.
In April EU foreign ministers failed to reach a consensus on the issue, as the UK, the Netherlands and Sweden remain concerned about human rights violations and the conflict between China and Taiwan. The movement for the removal of the embargo had been weakened by China's adoption in March of an anti-secession law that could be used to justify force against Taiwan. Also in March, China failed to ratify the UN Convention on Civil and Political Rights that was signed in Beijing in 1998.
On May 11th the EU urged China to commit itself to refrain from using force in Taiwan, but this seemed to fall on deaf ears. The EU had plans to accompany the removal of the embargo with a strict code on the conduct of arms sales, but officials were not able to reach a consensus regarding the details of the code or whether it should be legally binding. The US had also stepped up its complaints and threatened restrictions on transatlantic defence co-operation and the transfer of technology if the EU lifted the embargo. In April and May relations between the EU and China were strained by EU complaints about massive increases in exports of some categories of textiles and clothing, following the lifting of import quotas in January. However, in early June an agreement to restrain the rate of increase was reached.
Economic policy: Policy remains unchanged
Economic policy over recent months has not changed significantly, despite the fact that economic conditions have deteriorated as a result particularly of weakening consumer confidence, while the results of the two referendums in France and the Netherlands have led some commentators to question the long-term viability of the single-currency project. The French debate made little reference to the euro as such, but in the Dutch debate it did feature, and there was clearly unhappiness about the perceived impact on inflation and economic performance of the introduction of the euro.
Nevertheless, there have been no prominent demands in the Netherlands for the break-up of the euro, probably because it is seen that this would cause further disruption with no evident benefit. In Germany there is also considerable discontent over the perceived benefits of the euro, but again there has been no strong move to bring back the D-mark. Politicians, aware that the result would probably be a stronger currency that would make Germany less competitive, have refrained from casting doubts on the viability of the euro. Only in Italy, where relatively high unit labour cost increases have led to a loss of competitiveness vis-à-vis other euro area countries, have there been calls for the reintroduction of the lira from members of the government's small coalition partner, the Lega Nord. These are unlikely to be echoed by mainstream parties, because the costs of servicing Italy's large public debt would be enormous.
A wide range of factors was involved in producing the "no" victories (see The political scene), but most commentators would agree that poor recent economic performance had an impact. The implication is that continued poor performance could lead to increased discontent. However, there are no easy answers. Monetary policy remains expansive, but increased money supply has not pushed up demand, and the European Central Bank (ECB) is reluctant to reduce interest rates further—its scope for doing so is in any case limited, with intervention rates at just 2%. Fiscal policy remains heavily constrained by the poor condition of most member states' government finances, and even without the Stability and Growth Pact (SGP) it is very doubtful whether the stimulatory effects of an expansionary fiscal policy by the larger member states, leading to even bigger deficits, would not be counteracted by the loss of consumer confidence resulting from the knowledge that the higher deficits would have to be paid for by higher taxes or lower pensions in the future. Member states are constantly being told by the European Commission, the ECB and international institutions that reforms, particularly to labour markets, would lead to better performance. However, the political obstacles to such reforms are considerable, and their benefits would probably only emerge some years later—and even then their impact is uncertain. In several euro area countries there has already been a sharp switch in income from labour to profits, but so far without positive results (other than avoiding a probably even worse scenario if profitability had remained poor).
Economic policy: ECB remains unpersuaded of case for lower interest rates
As expected, the latest meeting of the Governing Board of the ECB on June 1st ended with a confirmation of interest rates at their current levels, which have now been maintained for two years. Expectations for a rate cut had increased over the past few months, following the release of a string of disappointing economic indicators. At his press conference on June 1st Jean-Claude Trichet, the ECB president, acknowledged the more pessimistic growth environment but claimed that monetary policy conditions were generous and hence conducive to growth, and that reforms—not monetary policy—were the key to economic dynamism. However, he did not make clear how such structural reforms would increase demand, which is currently growing clearly below the potential of supply. In fact, the ECB has not entirely ruled out the possibility of a rate cut at some point in the future, and it was noted that, in reply to questions, Mr Trichet did not, as he had at early press conferences, say that a cut in interest rates had not been discussed. Despite the fact that everything else Mr Trichet said was arguing against a rate cut, this has left market actors on the verge of pricing in the expectation of a rate cut later this year. Such a cut would be more likely if the recent moderate decline of the euro against the US dollar were reversed, since a declining euro does in fact bring extra money into the economy through the increased euro value of export earnings. The impact of a rate cut to 1% would be likely to have only a marginal impact on growth prospects in 2005-06.
Growth of M3 money supply remained high in March with an annual rate of 6.5%, slightly down on its recent peak of 6.8% in January. The three-month moving average rate (January to March) was 6.7%, still well above the desired 4.5% rate of expansion. The ECB has stressed that some normalisation in the asset allocation process has taken place in recent months, as economic agents have shifted from more liquid assets into longer-term investment forms, such as bonds, equities or real estate. However, the ECB remains concerned about the slow pace of this process and the risk of a rapid price increase in certain markets, especially real estate, although it has also said that this is at present only of concern for some hot spots, not for the euro area as a whole.
Economic policy: Stability and Growth Pact is amended
At the Brussels summit on March 22nd-23rd the EU heads of state approved a reform of the Stability and Growth Pact (SGP) previously agreed by finance ministers. The reform contains amendments in three areas: improving governance, strengthening the preventive arm, and altering the criteria for the activation of the excessive deficit procedure. It is the last which has attracted most attention.
* Improved governance comprises demands for better co-operation between governments, a greater involvement of national parliaments (eg, in discussing additional fiscal measures), more reliable macroeconomic forecasts, and better statistical methods. The last is indeed important. In 2004 Eurostat seemed haphazardly to verify figures revised by the present Greek government for past years, despite having earlier endorsed the figures and methods of the previous government, and it has allowed some highly dubious accounting procedures by Belgium, Germany and Portugal.
* The strengthening of the preventive arm is to result from a transformation of the general concept of a budget close to balance or in surplus to country-specific targets, which are less strict for low-debt countries (-1% of GDP) than for high-debt countries (0% of GDP). Governments are committed to undertake more than 0.5% of GDP consolidation efforts in good times, defined as output above potential, and to use unexpected revenue for budget consolidation. Deviations are to be explained, and the Commission may issue recommendations, although there is no possibility of sanctions.
* Changes to the excessive deficit procedure include a substantial increase in the causes that may be taken into account when assessing whether an overshooting of the 3% of GDP deficit limit is excusable, from two (natural disasters and negative growth) to 14 (including sluggish growth over an accumulated period; implementation of the Lisbon Agenda; expenditure on research, development and innovation; public investment; burdens resulting from financial contributions to fostering international solidarity; and burdens arising from achieving European policy objectives and pension reform, among others). However, despite these large numbers of factors that can be taken into consideration, the pact continues to insist that the deficit remains near to the reference value and that the excess must be temporary.
The ECB has launched a strong attack against the revisions. In its April Monthly Bulletin it stated: "The new rules severely weaken the Stability and Growth Pact. They diminish both the incentives to pursue a sound budgetary policy and the binding impact of the rules... By differentiating between countries, the pact will become less transparent, more complex and, therefore, ultimately even more difficult to enforce." Nonetheless, the ECB has vehemently expressed the need for the rigorous implementation of the reformed SGP rules and procedures.
Economic policy: Netherlands' fiscal position improves, Italy's deteriorates
The reform of the SGP is, in fact, unlikely to have a marked impact on fiscal policy. The Economist Intelligence Unit has only made minor alterations to its fiscal forecasts for France and Germany for 2005 and 2006 to take account of the impact of lower growth forecasts. In one country, the Netherlands, a substantial downward revision in June to the estimated 2004 deficit has improved prospects for 2005 and 2006. Having taken major and painful corrective measures, the Dutch government balance remains comfortably below the 3% of GDP benchmark. As a vociferous critic of the laxity of the larger countries, the Dutch finance minister, Gerrit Zalm, is now in a stronger position to argue his case. By contrast, Italy has experienced a significant deterioration in the public finances. In May various developments highlighted that the country's growth and fiscal problems were worse than feared. On May 12th first-quarter GDP data showed that the Italian economy was in recession. On May 17th the Italian finance minister, Domenico Siniscalco, responded by revising down the official growth forecast for 2005 from 1.2% to 0.6%, thereby not ruling out stagnation. He concluded that a budget deficit in 2005 of up to 4% of GDP rather than the officially projected 3% was possible. On May 23rd Eurostat published budget deficit data for 2003 and 2004 that had been revised upwards and showed an increase from just below or in line with the 3% of GDP ceiling to 3.1% of GDP in both years. Debt levels were also revised up slightly, to 106.5% of GDP in 2003 (before: 106.3%) and 106.6% of GDP in 2004 (before: 105.8%).
The Italian government's response has not eased concerns. The admission of worse than previously reported budget deficit data for 2003-04 and of the prospective breach of the 3% of GDP deficit ceiling in the current year did not prompt any announcement of corrective measures, which is not surprising, given that the next election is due in early 2006. As a result of the government's fiscal record and failure to take measures to tackle it, Italy has become the first country to face disciplinary action under the SGP's new rules. On June 7th the European Commission issued a report on Italy, highlighting its use of faulty statistics to conceal its breach of the deficit rules in 2003 and 2004. The report also pointed out that according to the rules of the SGP, the excessive Italian budget deficit is neither temporary (it has been above the EU's target of 3% of GDP since 2003) nor warranted (it is not the result of circumstances outside the control of the government). The Commission's report will soon be scrutinised by finance ministers in Brussels, although given their past record, sanctions are not expected unless there is a further deterioration. Nevertheless, the fact that disciplinary action has been taken so soon after the adoption of reforms to the SGP is a positive sign for the pact's continuing relevance as a way of putting some pressure on governments.
Currency and bond markets have so far virtually ignored the gradual deterioration of fiscal positions in the euro area as a whole or in specific countries. Yields on Italian government ten-year bonds, at 3.40 on June 13th, were only 21 basis points above German bonds and well below yields of US or UK bonds. Average bond rates in the euro area are at exceptionally low levels.
posted by Marko at 12/10/2005 09:05:00 AM
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