Growth prospects for the German economy remain favorable even though expansion could slow because of tighter taxes and higher interest rates, the country's state-funded top research institutes predicted on Thursday.

In their traditional spring report, the country's five leading economic research institutes sharply upgraded their forecasts for German growth this year and next year to 2.4 percent, predicting that Germany, the eurozone's biggest economy, would achieve a balanced budget by 2008.

"The current upturn will continue, but the pace of expansion will be slower than last year," the institutes said. "A key reason for this is restrictive fiscal policy, which is likely to knock around half a percentage point of gross domestic product (GDP) growth. And the European Central Bank, too, is switching to neutral in its monetary policy."

Optimism

The five institutes -- DIW in Berlin, Ifo in Munich, IfW in Kiel, IHW in Halle and RWI in Essen -- expected the ECB to raise its benchmark "refi" refinancing rate by a further 0.25 percent this summer to 4.0 percent.

Nevertheless, the tighter monetary conditions would not hamper "robust economic expansion, since long-term interest rates remain comparatively low," the report said.

Contributing to GDP growth of 2.4 percent this year -- in their previous report last autumn, the institutes had projected growth of 1.4 percent for 2007 -- would be strong domestic demand, the institutes said.

"Household consumption will gradually improve as result of higher disposable income," the think tanks predicted. "Investment remains strong. And exports will continue to support the economy."

Reduced unemployment

The strong economic performance would lead to an improvement on the labor market, with the annual average jobless total set to fall below four million for the first time since 2001.

The jobless total would fall to 3.77 million in 2007 from 4.49 million in 2006 and then decline to further to 3.47 million in 2008, the institutes said.

The jobless rate, which measures the total number of unemployed as a proportion of the working population as a whole, was projected to decline from 10.3 percent in 2006 to 8.7 percent in 2007 and 8.0 percent in 2008.

The robust economy would also have a positive effect on German debts, pushing the public deficit down from 1.7 percent of GDP in 2006 to just 0.6 percent of GDP in 2007. Germany was expected to achieve a balanced budget, or a deficit ratio of zero, in 2008, according to the report.

Under the terms of the European Stability and Growth Pact, eurozone members are not allowed to run up public deficits in excess of 3.0 percent of GDP.

But Germany, the main architect of the pact, was in breach of the 3.0-percent rule every year between 2002 and 2005.

On the inflation front, German inflation was projected to pick up only fractionally to 1.8 percent in both 2007 and 2008 from 1.7 percent in 2006, the institutes said.

The ECB defines price stability as inflation rates close to but just below 2.0 percent.