Firms Turning Still More Pessimistic – Unemployment Rising Further

Firms' judgements on the current order situation are still signalling no improvement of business conditions. Output expectations for the months to come have become still more pessimistic. In addition, the flood disaster has led to huge losses in private wealth and considerable shortfalls in production, which the ongoing repair works will take time to make up for. According to the regular WIFO business survey conducted in co-operation with the EU, the overall judgement on the current order situation has hardly changed in August from the previous months. However, production expectations have weakened further, even if the sample was largely taken ahead of the flood disaster. Only a small number of firms were able to include an assessment of the consequences of the floods in their late response. The floods have damaged private dwellings, commercial buildings and public infrastructure such as roads and railway tracks. Still, latest information suggests that the losses in private and public wealth may remain rather at the lower end of the range given in WIFO's early estimate, i.e., 2.5 to 3.5 percent of GDP). The impact on economic growth deriving from production shortfalls on the one hand, and from repair works on the other, may be altogether small (see box). Most negatively affected are the tourism and the insurance sectors, whereas the construction business will benefit from reconstruction efforts. The business surveys conducted in Austria convey a message that is similar to those in Germany. The latest survey among German companies carried out by the ifo Institute in Munich suggests that the recovery has stalled, if not reversed: the monthly index for the business climate has gone down for the third time in a row in August. The business cycle weakness is putting heavy strain on German public finances. Hence, it will be difficult for the authorities to keep the general government deficit for 2002 below the ceiling of 3 percent of GDP, as provided for by the Stability and Growth Pact. Balancing the budget by 2004, as foreseen, would require a distinctly restrictive fiscal policy stance, which may weigh on economic activity not only in Germany, but also in Austria and Europe as a whole. The delay in the EU recovery is giving the ECB more leeway in steering interest rates. Headline inflation in the euro area is close to 2 percent and should abate further over the coming months. While the growth of money supply has clearly exceeded the reference value in recent periods, this can largely be explained by a number of one-time influence factors. The weaker dollar exchange rate will, via cheaper imports, facilitate the deceleration of inflation in the euro area, but may also reduce export opportunities for European goods. The negative real effects of currency appreciation typically show up with a lag of between two and three quarters. Such dampening effects constitute a risk factor at the present juncture, the external contribution being currently the major growth-supportive element in the face of sluggish domestic demand. Indeed, the euro area trade surplus rose to a total € 42 billion for the first half of 2002, compared with just € 4.3 billion in the year-earlier period.