PARIS, May 26 (Reuters) - Germany needs to cut spending to consolidate a budget balance that is set to deteriorate markedly in 2010, the Organisation for Economic Co-operation and Development (OECD) said on Wednesday.
Berlin's deficit is expected to widen to over 5 percent of gross domestic product (GDP) this year, partly due to tax cuts introduced by Chancellor Angela Merkel's new government at the start of 2010, the Paris-based organisation said.
That was in line with the government's own forecast.
"When choosing options for consolidation going forward, priority should be given to expenditure cuts and reductions in tax expenditures, rather than tax increases," the OECD said in its twice-yearly Economic Outlook.
Earlier this month, Merkel ruled out further tax cuts for 2011 and 2012 due to a tight budget situation, effectively abandoning one of the main platforms of her coalition deal.
The government wanted to implement the tax cuts to stimulate the economy, Europe's largest, which emerged last year from its deepest recession since World War Two.
The OECD said the underlying growth momentum in Germany was intact, although it had slowed over the winter months due to "a significantly negative contribution from stock-building" and adverse weather conditions.
"Growth is expected to pick up strongly from the second quarter onwards as the improvement in world trade continues and firms gradually raise their investment expenditures," it said.
"In 2011, both private consumption and investment are expected to return to past positive growth trends."
Recent economic indicators have beaten forecasts, with industrial output and orders surging in March, while exports rose at their fastest rate in nearly 18 years, surpassing even the most optimistic predictions.
Downside risks to growth were the development in world trade, as exports continued to be Germany's growth motor, and the robustness of the banking sector, the OECD said. However, if the labour market proved more resilient than expected, private consumption could rise, boosting the economy.
German unemployment fell far more than expected in April, declining for a 10th consecutive month, and the Economy Minister and analysts have spoken of a "job miracle". [ID:nLDE63S0SF]
"The labour market continues to be exceptionally robust given the magnitude of the output contraction," said the OECD, forecasting the jobless rate to rise to 7.6 percent in 2010 from 7.4 percent last year, and to hit 8.0 percent in 2011.
"Nevertheless labour hoarding has left some enterprises with excess employment and some increase in layoffs and in unemployment is expected," the think tank said. (Reporting by Sarah Marsh; editing by Patrick Graham)