Reduction
The budget deficit in the eurozone will continue to decline, reaching 2% of GDP in 2006. For 2008, we even expect a ratio of only just above 1%. Indeed, Germany’s deficit will fall below the Maastricht ceiling of 3%in 2006 for the first time in five years.
Tailwind
Support is coming primarily from higher revenues generated by the continuing upswing in the eurozone. But even the EMU's structural deficit, which is adjusted for cyclical influences, is being reduced gradually.
Impact
While fiscal tightening will dampen economic growth over a short-term horizon, it will not endanger the upswing. If budget consolidation continues, there will even be positive medium-term growth effects. Lower net borrowing requirements are at the same time supporting European bond markets. But it will be not enough to fully compensate for the upward pressure on yields resulting from higher ECB interest rates and again rising US yields later next year.
US
Unlike in the eurozone, the US budget deficit will deteriorate again in 2007 because the economy is still slowing, led by a recession in the housing sector. Consequently, a supportive pillar of labor market strength so far will disappear in the future.
Further topics:
- Weekly Comment: Time to give thanks and cross your fingers.
- Italy: Consumer price inflation to slow next year.
- Currencies: Australian and New Zealand currencies overvalued.
- Data outlook: Purchasing managers in the eurozone remain confident, their US counterparts, in contrast, are skeptical.
- Market outlook: USD bears and bond bulls are back.
