FRANKFURT (MNI) – The European Central Bank should not begin
raising interest rates until early 2012, while continuing its exit from
non-standard measures as market conditions allow, the Organization for
Economic Cooperation and Development said in its latest Economic
Outlook, published Thursday.

The Paris-based OECD warned that the Eurozone’s “public finances
are in poor shape” and that the weakness in the fiscal position of some
member countries could still “lead to wider financial tensions.”

These remarks come against the backdrop of the most recent flareup
in the euro area’s sovereign debt crisis, as talks begin in Dublin today
on a possible bailout for Ireland or its banks, or both. Spreads on
Irish sovereign debt rose sharply in recent weeks, and Portugal followed
suit as markets lumped the two fiscally troubled nations together.

There is increasing concern among policymakers of contagion to
other high-deficit or high-debt EMU states such as Spain and Italy.

“Provided that the recovery remains on track, and given the
weakness of inflation pressures and the expected fiscal consolidation,
monetary policy stimulus should largely remain in place during 2011 and
non-standard measures should continue to be wound down as conditions
allow,” the OECD said.

“The main refinancing rate should gradually be increased from the
early part of 2012, unless higher than expected inflationary pressures
emerge,” it added.

The OECD’s baseline scenario sees no such inflationary pressures.
Inflation is expected to “remain subdued in view of the remaining
slack,” while inflation expectations remain well anchored, the report
said.

The OECD forecasts HICP to stay well below the ECB’s price
stability target of close to but below 2% throughout the forecast
horizon — at 1.5% in 2010, 1.3% in 2011 and 1.2% in 2012.

The economic recovery should continue although it is likely to
remain moderate and uneven, the report said. It projects GDP growth of
1.7% for both 2010 and 2011, with a slight acceleration to 2.0% in 2012.
For the final quarter of 2010, it forecasts GDP growth of 1.3%.

While private consumption is expected to pick up further, “the
necessary fiscal consolidation will be a drag on the recovery,” the OECD
warned. The contribution from exports will thus largely hinge on world
demand in the context of “fading support from the weaker effective
exchange rate,” it added.

“The overall pace of recovery will be held back by continued
rebalancing needs, the near-term weakness of potential output and
underlying structural growth trends. The recovery will also be uneven,
as large imbalances and lost competitiveness are gradually repaired in
the countries with large debt overhangs and current account deficits,”
the OECD said.

It also noted that while credit to the nonfinancial sector, notably
households, “is increasing and equity prices have risen,” the strength
of the banking system and its ability to provide credit as demand picks
up remain of concern.

The organization sounded a stark warning on the weak state of
public finances, calling for ongoing consolidation. And it joined the
ECB in putting pressure on European governments to further strengthen
the Stability and Growth Pact and national fiscal institutions.

“Detailed medium-term consolidation plans should be set out in all
euro area countries to increase the credibility of the consolidation
process,” the report said. “The commitment to consolidation would be
further enhanced by reforms to strengthen market discipline, the
Stability and Growth Pact, and national fiscal institutions.”

The OECD cited the state of public finances and associated market
tensions as a key downside risks to its economic outlook.

“Markets remain sensitive to the weakness in the fiscal position in
some countries and this may lead to wider financial tensions, although
the creation of the European Financial Stability Facility (EFSF)
provides an important near-term crisis management mechanism,” it said.

Overall, the OECD said that “substantial risks remain around the
strength and pace of the recovery, although they are broadly balanced.”

The report said, “the quality of bank balance sheets and its impact
on credit growth is another risk for growth and public finances.” And it
cited international trade as another risk. On the upside, “domestic
demand may strengthen more rapidly than anticipated, as business
investment may recover more strongly than projected,” the OECD said.

–Frankfurt newsroom +49 69 72 01 42; e-mail: jtreeck@marketnews.com

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