European recovery too fragile for rate rise says OECD

The Organisation for Economic Cooperation and Development (OECD) yesterday joined the clamour of voices urging the European Central Bank to put off its first increase in interest rates for five years for fear of choking off the eurozone's fragile economic recovery. The west's leading economic think-tank also warned that Gordon Brown may soon have to raise taxes or cut spending to rein in Britain's budget deficit.

The ECB is 99% certain to raise the cost of borrowing by 0.25 percentage points tomorrow to 2.25%, the first change in rates for 30 months, after Jean-Claude Trichet, its president, this month signalled such a pre-emptive move. But with eurozone finance ministers, business leaders and unions stepping up pressure on the central bank to desist, the OECD said rates should be left unchanged until the autumn of 2006.

The French and German finance ministers, Thierry Breton and Peer Steinbrück, are reconciled to a rate rise tomorrow but the fear is growing that the ECB will follow the lead of the US Federal Reserve by ushering in a series of increases over the next 12 months, which would bring a halt to economic recovery.

After a poor first half, the eurozone recovered in the third quarter of this year with 0.6% growth but there are signs that this could prove another false dawn, with consumer demand in France and Germany still weak and unemployment in both countries close to or above 10%.

The OECD's chief economist, Jean-Philippe Cotis, said a rate rise now could prove either inconsequential or counterproductive. "It's worth waiting a little bit. We would raise rates next autumn ... What we want to avoid is a situation where you have some tightening at a stage which may prove premature."

Mr Breton said a rise "would not be legitimate to fight against an inflation that does not exist", while Jean-Claude Juncker, Luxembourg's premier and head of the eurogroup of finance ministers, said a rise was "not particularly necessary".

The bank's critics say that eurozone headline inflation - at 2.2% barely above the ECB's 2% target - is unduly influenced by energy costs. Core inflation is near to 1.5% and falling, and wage deals are low.

The OECD is forecasting eurozone inflation of 2.1% next year, falling to 1.6% in 2007. The OECD and the European commission expect growth to recover to 2.1% in 2006 and 2.2% in 2007 but this is well below forecast levels for the United States and for world trade. Mr Cotis said: "The problem is that we've had several episodes of aborted recovery."

Mr Trichet has signalled that tomorrow's rate increase will not follow the Fed's model of a steady flow of rises but some economists expect them to rise in stages to as high as 3%.

With less than a week to go until the chancellor's pre-budget report, the OECD said it was concerned there could be a structural deficit in Britain's public finances, which would require slower spending or tax rises to put right.

The OECD, the International Monetary Fund, the CBI and the Institute for Fiscal Studies all think Mr Brown will have to raise taxes or, more likely, rein in the rate of growth of public spending, to ensure he meets his golden rule that current spending should be covered by tax receipts over the ups and downs of economic cycles.

Mr Brown thinks the economy is growing faster than official data suggest and that tax receipts will continue to recover in line with his budget predictions, proving his critics wrong.

The Nationwide said yesterday house prices had stagnated last month after rising 1.3% in October. The lender said the annual rate of increase fell to 2.4% from 3.3% the month before. Bank of England data, however, showed new mortgage approvals at a 17-month high in October.