To me it seemed inevitable, even before last week’s action, that the world economy would weaken in the year ahead. The fact that most economic forecasts did not show this, predicting that global growth would stay close to the 4.3 per cent level achieved last year, is hardly surprising. So-called predictions of future economic activity are usually just “post-dictions”, simply projecting forward the trends of the recent past. Most economists realise this and treat all forecasts with extreme scepticism.

The ECB’s forecasts are no more likely to be accurate than other such rear-mirror predictions. Yet M Trichet, by promising to keep raising interest rates, has dug himself into an indefensible position if the ECB forecasts of economic acceleration turn out to be wrong. And this year an error in the forecasts is even more likely than usual because the prediction of recovery in Europe is based largely on the hope of strong export growth. Exports can grow, by definition, only if the world outside Europe continues to enjoy the exceptionally strong growth seen since 2004, despite the doubling of oil prices and the quadrupling of US interest rates since then.

The ECB’s upbeat view reflects the belief, stated by M Trichet in late January, that the world economy has already survived the increase in oil prices and US interest rates, so better times must surely lie ahead. What M Trichet seems to have forgotten is that changes in monetary policy affect real economic activity with a lag. The same is true of oil prices.

Past experience and economic theory suggest that this lag is about 18 months — and, as it happens, the end of last year coincided exactly with this 18-month “deadline”, since the US Federal Reserve Board started raising US interest rates in July 2004, and this was also around the time when oil prices doubled to $60 a barrel. Thus there was nothing in the least surprising or reassuring about the strength of global growth in 2005 and this strong performance tells us nothing about the prospects for 2006. It was only around the turn of the year that an economic slowdown should have been expected – and a slowdown is exactly what the figures for American and global growth began to indicate at the fourth quarter of 2005 and the first two months of this year.

The ECB’s apparent failure to understand this sequence of events suggests a degree of incompetence that is hard to credit. We must, therefore, seek other explanations.

The most convincing lies in the surveys of German businessmen and exporters, which suddenly became extremely optimistic in the last few months of 2005. These have given media credibility and political cover to the ECB’s shift towards a hawkish monetary policy, even though the hard statistics on economic recovery in Europe actually deteriorated quite sharply between the third and fourth quarters of last year. These surveys may be sending seriously misleading signals about the growth prospects in Germany and (even more) in Europe as a whole.

First, the rise of German business confidence to its highest point since the dot-com bubble seems to be due partly to political rather than economic factors. Angela Merkel, the German Chancellor, has been enjoying a passionate honeymoon with voters. Many German businesspeople hope that another election in the next year or two will produce a convincing right-wing majority, which will allow ambitious structural reforms.

Yet whether or not Frau Merkel emerges as Germany's Margaret Thatcher, the bullish business surveys are inspired by hopes of long-term supply-side improvements. They tell us less than usual about demand conditions now and in the near future. This can be seen in the huge divergence between the confidence indicators and GDP growth shown in the first chart.

Quite simply, the business confidence indicators have ceased to be reliable indicators of German economic conditions. Indeed, the second chart, in which the eurozone Purchasing Managers’ Index is compared with the zone’s composite growth rate, suggests that such indicators of business confidence are actually lagging indicators of economic conditions in the recent past. In light of this, the recent upsurge in European confidence indicators simply reflects the blip in economic activity that most of Europe experienced in the third quarter of last year.

There is a second reason for scepticism about the German confidence on which the ECB has built its case for higher interest rates: this is that strong German exports could be bad news for the rest of Europe. While Germany in theory can enjoy export-led growth, since exports account for more than 30 per cent of GDP, export-led growth is impossible for the European Union as a whole, since the great bulk of European exports go to other European countries. Non-EU exports account for just 10 per cent of EU GDP. In Germany, for example, EU markets account for 63 per cent of total exports. This means that German export gains come largely at the expense of manufacturers in France, Italy and Spain.

The important question for Europe is not whether Germany can keep exporting, but whether the Club Med countries can keep consuming. That will depend on Club Med housing and mortgage markets. Some of these already seemed to be slowing in the second half of last year. And now the bullish behaviour of Club Med property markets has been identified by European central bankers as a potential inflationary problem. Indeed, the desire to deflate an alleged property “bubble” is probably the unstated reason for the ECB’s sudden hawkishness.

Under these circumstances, it is hard to imagine how the European economy could get any stronger this year.

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