EU cuts growth forecast and gives Italy leeway

European finance ministers cut growth forecasts for the euro zone in the wake of the latest surge in oil prices and agreed overnight (NZ time) to give recession-hit Italy two years to knock its public finances into shape.

"The Italian economy has been going through a very prolonged low-growth period," said Jean-Claude Juncker, Luxembourg's prime minister and chairman of talks among the 12 euro zone ministers.

"It seemed fair to give Italy more time."

Juncker told a news conference ministers no longer expected 1.6 per cent growth in the euro zone this year, but 1.3 per cent instead.

"We agreed that the expectations we had at the beginning of the year were not met during spring. But we agreed that the third quarter would be fundamentally better," he said.

The high oil price is eating into euro zone growth but it was also the impact of oil that spared Rome what might have been costly cutbacks ahead of a 2006 election in order to satisfy the deficit rules of the EU's Stability and Growth Pact.

Oil prices eased slightly on Monday after exceeding US$62 ($93.07) per barrel last week but the recent surge has raised concerns because it coincides with a slide in the euro, making Europe pay even more to import oil because it is billed in dollars.

Asked if the European Central Bank should cut interest rates to shore up the economy while crude costs were high, Reynders said there was more room for action on that front than on the budget side.

"There's more room for manoeuvre on the monetary side than on the budgetary side," he said.

European Union Monetary Affairs Commissioner Joaquin Almunia was earlier quoted as saying that high oil prices could lead the Commission to cut its growth forecasts.

"The current price (of oil) is a risk for European growth," Almunia said. The Commission currently forecasts 2005 growth of 1.6 per cent.

Portugal's deficit problems were also discussed by ministers but the focus was on the euro zone's third largest economy, where recession hit in the early part of this year and the Rome government now predicts zero growth this year.

The ministers of both the Eurogroup and the EU were set to endorse the Commission's recommendation to give Italy until the end of 2007 to take its budget deficit to below 3 per cent of gross domestic product, the cap in the EU's Stability Pact.

Italy expects a deficit of 4.3 per cent of GDP this year and was in breach of the rules several years prior to the recent revamp of the Stability Pact.

Juncker insisted that the reformed Pact still had teeth. "The measures are not less tough than they were before the reform of the Pact," he said.

Under the Pact, the ministers will give Italy 6 months to propose concrete tightening measures.

- REUTERS