German upswing expected to last for 18 months

Germany’s strong economic upswing is set to last at least another 18 months, with economic growth of 2.4 per cent expected both this year and next, Germany’s five top economic think-tanks will predict Wednesday.

The German economy is “expanding exceptionally strongly”, according to the institutes’ six-monthly report, to be presented Wednesday and obtained in advance by the Financial Times Deutschland.

The economists predict that in 2008 Europe’s largest economy is likely to present a balanced budget for the first time in almost 20 years, taking into account federal, regional and social security finances. The budget deficit will fall to 0 per cent in 2008, a sharp decline from 3.2 per cent of gross domestic product in 2005, when Germany was in breach of European Union stability pact rules.

Unemployment, which stood at more than 5m in 2005, will fall to below 3.5m next year, the think-tanks predict.

The government has forecast growth this year of at least 1.7 per cent, and for the budget deficit to fall to 1.2 per cent – compared with the institutes’ forecast of a 0.6 per cent deficit. Growth was 2.7 per cent last year.

The report represents more good news for Angela Merkel, Germany’s chancellor, whose government has benefited politically from the strong economy despite making relatively little progress on economic reforms in recent months.

But the forecasts will pose additional problems for Peer Steinbrück, the finance minister, who is struggling to fend off at least €5bn ($6.8bn, £3.4bn) in extra bids from cabinet colleagues for increased spending in the 2008 draft budget.

Asked on Wednesday whether he agreed with the balanced budget forecast for 2008, Mr Steinbrück urged caution and pointed to budgetary risks in the future. “You must believe me and not various institutes,” he said.

In another awkward twist for Mr Steinbrück, the institutes have called for income tax cuts in the long term. The minister has this month struggled to damp demands from within the ruling coalition for such cuts. Both he and Ms Merkel are committed to further budget consolidation before raising spending or reducing taxes.

The pace of the upswing appears to have surprised the think-tanks, since their most recent forecast, in October, was of growth this year of only 1.4 per cent. This pessimistic view was linked to a value-added tax rise in January from 16 per cent to 19 per cent. But this has been less economically damaging than feared, they argue.

The institutes expect the European Central Bank to increase interest rates by 25 basis points to 4 per cent by mid-2007, but forecast it will then leave this rate unchanged throughout 2008.

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