ECB fears stability pact will fuel inflation

A deal to loosen the euro's rule book came in for sharp criticism from the European Central Bank yesterday after EU finance ministers clinched an agreement giving countries including Germany new get-outs from rules on public deficits.

A deal to loosen the euro's rule book came in for sharp criticism from the European Central Bank yesterday after EU finance ministers clinched an agreement giving countries including Germany new get-outs from rules on public deficits.

In a statement, the governing council of the ECB said it was "seriously concerned about the proposed changes" to the so-called Stability and Growth Pact, which EU leaders are expected to rubber-stamp tonight.

Although eurozone nations will still have to abide by a budget deficit ceiling of 3 per cent of gross domestic product, new clauses will allow more flexibility, particularly for Germany, to escape sanctions.

The Frankfurt-based central bank, which is the guardian of price stability and has long opposed a relaxation of the rules, is concerned that changes will fuel inflation requiring an increase in interest rates. It argued that alterations must not "undermine confidence in the fiscal framework of the European Union and the sustainability of public finances in the euro area member states".

Yves Mersch, of the ECB governing council warned: "If there is a relaxation on the fiscal side, it will not remain without consequence on the monetary side." Germany's Bundesbank, which played a key role in setting the original regulations, said "the pact will be decisively weakened by the new rules".

But while the central bankers argued the new pact was too lax, the Treasury suggested that a separate change over medium-term deficit targets would make the pact too much of a straitjacket.

Under this rule, budget deficit ceilings calculated over a 5 to 6 -year period will be under 1 per cent. Gordon Brown argued that to achieve this would force the UK to cut investment in infrastructure and education, and Britain and other countries outside monetary union won an opt out. Since that concession applies only to non-euro countries, the measure might act as a further obstacle to British membership of the euro.

Mr Brown said yesterday: "We insisted that we would not allow the UK's plans for investment in the long-strength growth of our economy to be undermined or jeopardised by new Commission guidelines or rules. And we defeated a plan from the European Commission to take greater control over the monitoring of member states' public finances. We have won both those arguments, and have protected our investment plans."

The biggest victor in yesterday's deal was Germany, whose deficit has been in excess of 3 per cent of output for the past three years. It won the right to invoke the huge subsidies it is paying to the eastern portion of the country after unification in 1990.

Under the new agreement, spending on the "unification of Europe" can be used to excuse excessive deficits "if it has a detrimental effect on the growth and the fiscal burden of a member state". Another part of the same clause could suggest that big net contributors to the EU could get special leniency.

Under existing rules, countries could expect leniency only if their economies contracted by an annual rate of 2 per cent. Finance ministers said that was "too restrictive" and instead agreed that exceptions could include "a negative growth rate" or "a protracted period of very low growth".