Economic recovery in the euro zone is proceeding as expected, according to a quarterly economic report by the European Commission.

The news came as the euro fought back against last week's dollar gains to make another bid for parity with the US currency.

With support from a strengthening Japanese yen, the euro was trading at $0.993 last night, down from an earlier high of $0.995. As the stream of negative US corporate news continues, most analysts suggest the definitive test of parity is close at hand.

But the Economic Affairs Commissioner, Mr Pedro Solbes, has warned that EU governments are becoming too lax about national budgets. "It is worrying that the latest information available on the implementation of budgets confirms a weakening of budgetary positions in several member-states. The budgetary slippages which accumulated over the 2001-02 period mean several member-states, particularly those with a significant deficit, will have to make further adjustment efforts to meet their commitments," he said.

The Commission's second quarterly report was published yesterday as Eurostat figures showed that gross domestic product (GDP) grew by 0.3 per cent in both the euro zone and the EU15 during the first quarter of 2002.

"The euro area has experienced gradual recovery since the beginning of the year, which gathered pace during the spring and is set to accelerate as the year progresses," Mr Solbes said.

Despite its upbeat tone, the Commission's report acknowledges that the anticipated improvement of domestic demand has not yet materialised. But it suggests the stronger-than-expected global economic environment has largely compensated for the weakness in domestic demand.

Inflation is falling after an unexpected rise at the beginning of the year and the report predicts the appreciation of the euro against the dollar will contribute to containing inflationary pressure.

The Commission's upbeat message contrasted with economic setbacks suffered yesterday by German chancellor Mr Gerhard Schröder two months before election day. German unemployment rose to its highest level in four years in June, while a leading economic institute predicted the euro zone's largest economy would only begin to recover in the fourth quarter.

There were 4.092 million Germans out of work in June when seasonally adjusted, according to official data released yesterday, a rise of 39,000 on the previous month, and over 260,000 on a year ago.

The German Institute for Business Research added that the Germany economy would grow by only 0.6 per cent this year and 2.0 per cent next year. The German government anticipates growth of 0.75 per cent and 2.5 per cent respectively. Yesterday the finance ministry said industrial output fell in Germany by 1.3 per cent in May.