WRAPUP 1-Europe warns Iraq war could trigger recession

reuters.com Mon March 17, 2003 10:33 AM ET By Alister Bull, European Economics Correspondent

FRANKFURT, March 17 (Reuters) - A second Gulf War could trigger recession in the euro zone, European officials said on Monday as markets braced for an imminent invasion of Iraq.

Central banks in Germany and Italy warned that the global economy was being harmed by the tension and the European Commission said a lasting spike in oil prices could heap more damage on the spluttering euro zone economy.

"A stagnation or even a recession in the euro area cannot be excluded," the Commission said in its 'worst-case' assessment of what a U.S.-led attack on Iraq could mean for the euro zone.

It has also almost halved its estimates for euro zone growth in 2003 and says hopes for a recovery next year depend on the uncertainty around Iraq being dispersed.

As a result, the Commission now expects only around one percent growth this year, from 1.8 percent forecast back in November, and that is before the fallout of a war is felt.

Countdown to the conflict is being figured in hours, not days after U.S. President George W. Bush told Iraq on Sunday it faced a 'moment of truth' and the United Nations was advised to pull its weapons inspectors out of the country.

The Bundesbank said in its monthly report on Monday that the tensions were taking a heavy toll and the Italian central bank said a prolonged fight would hit the industrial world hard.

"The rhythm of growth in the principal industrial economies could end up falling, even significantly," it said in a twice-yearly assessment of economic conditions.

Oil is the main channel through which the war will make itself felt in the pockets of the industrial world by cutting consumer spending power, although lower business and household confidence and international trade can make matters worse.

SHORT WAR GOOD

Klaus Regling, head of the European Commission's economics department, told a news conference in Brussels that a swift war would have only relatively mild implications for growth.

Outlining this benign scenario, the Commission reckoned oil prices would peak at $50 per barrel during a quick war, but be back to around $26 per barrel by the third quarter of 2003 and this would cost less than 0.1 percentage points in GDP growth.

This mirrored the experience of Gulf War One, when allies evicted Iraq from Kuwait in January, 1991 in ground fighting which was over in a matter of days and oil prices fell under $20 per barrel after peaking around $40/barrel.

Unfortunately, this time around the euro zone economy is in a much more fragile state. Germany is tilting towards another recession and business and consumer confidence has already been mauled by the steepest stock market losses for 70 years.

LONG WAR BAD

"Given that the political and economic situation currently appears more precarious than in 1990-1991, a more substantial and lasting impact on confidence is also possible," the Commission said in its quarterly economic report.

Plus, the state of world oil supplies is also much tighter following a strike in Venezuela and recent cold weather, which could prevent a repeat of 1991.

As a result, if the damage done to world oil supplies turned out to be more serious, oil prices could spike to $70 per barrel and stay high for much longer.

If this translated into a more or less permanent increase in the price of oil, the Commission estimates that the damage to growth could be up to 0.8 percentage points of GDP over the next two to three years.

"In the worst-case scenario we assume a sharp deterioration of confidence, a higher risk premium and further declines in equity markets. A negative impact on world trade, global capital flows, investment and tourism also cannot be excluded," he said.