The European Commission has cut back its 2005 growth forecast for the euro zone to 1.6 per cent - down from a previous forecast of 2 per cent.

It said that the over-estimated forecasts had mainly been due to the hike in oil prices and the strength of the euro.

"The second half of 2004 was very bad, very low growth rate, so the carryover for 2005 was not strong", said Economic Affairs Commissioner Joaquin Almunia presenting the Spring Economic Forecasts.

However, the report suggests that the economy is showing moderate signs of recovery as consumer demand slowly picks up.

"A return to potential" is expected for the 12 countries that use the euro with gross domestic product (GDP) rising to 2.1 per cent next year, while for the 25 member states, the commission expects a growth rate of 2 per cent this year (down from a predicted 2.4 per cent).

This contrasts with an expected growth rate of 3.6 per cent for the United States.

Speaking about the general loss of competitiveness in the EU when compared with other regions in the world, such as the US, Mr Almunia pointed out that it was important not to lay the blame entirely at the door of the exchange rate between the euro and the dollar.

"The loss of competitiveness starts in 2002," he pointed out, adding that the dollar's depreciation against the euro started in 2004.

He said that another reason for Europe's slow competitiveness was an "increase in the presence of emerging countries" - of which China is the most important.

The commission also gave warnings to Germany, Greece, Italy and Portugal - countries it predicts will break the euro zone budgetary rules by running public deficits of over 3 per cent of GDP.

France, which, along with Germany, has repeatedly breached the Stability Pact, is not likely to do so this year, said the commission.

Italy received particular criticism as its growth rate is among the slowest in the EU and it has one of the highest debt levels.

Mr Almunia said the situation in the country is "very difficult" and that the commission "will need to adopt measures in the case of Italy".

Italy's growth is only predicted at 1.2 per cent this year.

Speaking about the other economic giants in the euro zone - France and Germany - the commission was slightly more positive.

France's economy is expected to grow by 2 per cent in 2005 rising to 2.2 per cent next year, while growth in Germany which has been suffering from post-World War II unemployment highs, is expected to double from 0.8 per cent this year to 1.6 per cent next year.

In Britain growth is likely to stay at 2.8 per cent for 2005 while the majority of new member states have very strong growth prospects for this year.

Latvia leads with 7.2 per cent, followed by Lithuania (6.4 per cent ), Estonia (6 per cent) and Slovakia (4.9 per cent).