Europe set for sustained expansion, says IMF

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Europe's upswing is showing momentum, creating bright prospects for 2007 and 2008, according to Michael Deppler, head of the IMF's European Department. "The situation in Europe, which improved markedly last year, is set for a sustained expansion," he told journalists at an April 14 press briefing during the IMF-World Bank Spring Meetings. Europe as a whole is expected to see growth of 3.4 percent in 2007, against 3.7 percent last year (see table). The euro area is set to expand by at least 2.3 percent this year.

Deppler noted that "part of this strong outlook is due to good policies. Monetary policy has been appropriately conducted, fiscal policies have gotten back on track, and countries have undertaken significant structural reforms." In Europe's advanced economies, continuing job creation, falling unemployment, and low inflation are providing the basis for stronger private consumption. In emerging-or perhaps more aptly named converging-Europe, business investment has been boosting production and export capacity, leading to strong growth. More broadly, growth has also benefited from the synergies between east and west, rooted in the general cyclical upswing as well as in more structural developments, such as enlargement.

Europe may well surprise on the upside

While external risks to Europe's economic outlook are tilted to the downside, mainly because of the uncertainty surrounding the U.S. economy, Deppler thought that "it would take a very large negative external shock to significantly derail recovery in Europe." In fact, short-term indicators inspire confidence that the cyclical upswing may exceed expectations.

But there are still risks. A stronger-than-expected slowdown in the United States or a disorderly unwinding of global imbalances is possible, but the impact on Europe would likely be muted relative to the experience in 2001-02, when the bursting of the dotcom bubble dealt a shock both inside and outside Europe. Most important, the very large cross-border financial flows into central and eastern Europe could push convergence past its speed limits.

While these flows have been used productively in most of converging Europe, financial convergence may be running ahead of fundamentals in some countries. Rapid credit growth could sow the seeds for trouble in the event of a generalized retrenchment from risky assets or a...