Europe Says No Plan to Follow U.S. Taxes, Rate Cuts

By Simon Kennedy

Sept. 12 (Bloomberg) -- European policy makers signaled little intention of pursuing U.S.-style tax and interest-rate cuts to support their stumbling economy.

Meeting for the first time since the 15-nation euro region's economy contracted in the second quarter, finance ministers and central bankers in Nice, France, said restraining inflation and budget deficits remained more important than stimulating expansion.

Spending taxpayers' funds on fiscal programs to spark growth would be ``like burning money,'' German Finance Minister Peer Steinbrueck told reporters. European Central Bank President Jean-Claude Trichet said inflation remains ``much higher than our definition of price stability.''

Europe's economy is struggling even as declines in the euro and oil prices provide some relief amid slowing global demand and the lingering credit squeeze. Payrolls grew at the slowest pace in almost two years in the second quarter and industrial output fell more than forecast in July, reports showed today.

``The situation is not easy,'' Luxembourg Finance Minister Jean-Claude Juncker said after being re-elected chairman of the group of euro-area finance chiefs. ``There is a slowdown in the euro area and it's more marked than we expected.''

Limiting the scope of the ECB to respond is inflation, which held above the 2 percent limit for a 12th straight month in August and close to its highest in 16 years. Interest rates are ``adequate'' and there is no need to change them ``at this very moment,'' ECB Governing Council member Nout Wellink said in an interview today in Nice.

Hands Tied

Governments have their hands tied by EU rules that require budget deficits be kept below 3 percent of gross domestic product.

The European approach contrasts with that adopted by the U.S., where the Federal Reserve has cut its benchmark interest rate by 3.25 percentage points to 2 percent and the government enacted $168 billion of stimulus including tax rebates.

Juncker denied European officials were ``standing by with phlegmatic indifference'' as the economy tumbled, arguing that they were seeking to avoid a repeat of the 1970s and 1980s when sweeping tax cuts failed to stimulate growth. He also questioned whether the U.S. ``has achieved all that was hoped'' amid signs the economy is fading after a second-quarter rebound.

The European Commission this week predicted recessions in Germany and Spain this year and stagnation in France and Italy as it forecast growth of 1.3 percent in the region as a whole, which would be the weakest since 2003. The speed of the downturn has surprised policy makers who had hoped demand from emerging markets and productivity gains in Germany would shield their economy from the U.S. slump.

`Pronounced Fall'

``Everyone was surprised by the contraction in economic activity,'' Juncker said. ``We were expecting a slowdown but not such a pronounced fall in economic activity.''

The chairman of the so-called eurogroup welcomed recent declines in the euro and oil prices as sources of support for the economy. Since reaching a record $1.6038 against the dollar on July 15, the currency has dropped around 13 percent to its lowest in a year, while crude oil has fallen almost 30 percent in the last two months.

Budget deficits are increasing even without tax cuts as so- called automatic stabilizers such as welfare payments kick in. JPMorgan Chase & Co. estimates the euro area's deficit grows 0.5 percentage point for every 1 percentage point the economy grows below its 2 percent trend.

Further Steps

Some governments are already taking further steps. Spanish Prime Minister Jose Luis Rodriguez Zapatero has announced 38 billion euros ($53.5 billion) in additional fiscal stimulus for the next three years as his economy feels the pain of a housing bust. That may push his budget gap close to the 3 percent limit next year, with the shortfalls of France, Italy and Ireland also at risk of breaching the ceiling, according to Citigroup Inc.

EU Monetary Affairs Commissioner Joaquin Almunia urged governments not to let their budgets run out of control even after the Stability and Growth Pact was revised in 2005 to allow for fiscal easing during slowdowns. ``We need to maintain our medium-term policy,'' Almunia said.

The ECB will eventually be forced to cut lending rates as the economy falters, BNP Paribas economist Ken Wattret said today in revising his forecast to show three rate cuts next year. He previously predicted the bank would keep its benchmark at 4.25 percent next year.

``With the economy entering a recession, we believe that the ECB will ultimately capitulate,'' Wattret said.

To contact the reporter on this story: Simon Kennedy in Nice, France, at skennedy4@bloomberg.net.