May 3 (Bloomberg) -- German Chancellor Gerhard Schroeder wants to spur growth in Europe's largest economy by boosting investment in education and innovation, a step that may mean Germany breaking European budget rules for a fourth year in 2005.

``For a limited period of time, the economic recovery must take priority without bidding farewell to structural reforms,'' Foreign Minister Joschka Fischer, 56, told today's edition of the weekly magazine Der Spiegel. ``Cost cuts alone won't yield the necessary economic growth.'' Fischer's spokesman, Walter Lindner, confirmed the remarks.

Schroeder fears that continuing with a cost-cutting program to ease the deficit may choke Germany's recovery from three years of stagnation and dent his popularity ahead of 13 more elections at local, regional and European level this year. The economy will expand no more than 1.5 percent this year and next, the six main state-funded economic institutes said last week, lowering their growth forecast for 2004.

Along with France, Germany has since 2002 been breaking the European Union deficit limit of 3 percent of gross domestic product that it designed to protect the euro. Two of the institutes said last week the government should ease its budget cuts to prevent the recovery from stalling.

Schroeder, Fischer and Finance Minister Hans Eichel met in Berlin Wednesday to discuss ways out of the impasse. The budget is already facing unforeseen revenue shortfalls of about 18 billion euros ($21.5 billion) this year and 15 billion euros in 2005, said Joachim Poss, a lawmaker and deputy parliamentary leader of Schroeder's Social Democratic Party, in an interview.

Lack of Confidence

The government last week also lowered its forecast for economic growth this year as the euro region's third-highest unemployment rate crimps consumer spending. The jobless total has risen for three straight months and consumer confidence stagnated for a seventh month in April.

``In such a fragile economic environment, it's perfectly appropriate to refrain from pursuing draconian cost cuts,'' said Michael Mueller, another SPD lawmaker, in a separate interview.

Schroeder hopes that steps to increase government outlays on research projects, education and innovation may encourage consumers to resume spending. The rising unemployment rate and last year's decisions to cut jobless benefits, reduce tax breaks for commuters and homebuyers, raise doctors' fees and retirees' costs have heightened people's fears about their future income, leading them to save rather than spend.

Tax Cuts

The German Savers' Association said household savings totaled 151 billion euros last year, compared with 146 billion euros in 2002. Poss said that even the income-tax cuts worth 15 billion euros introduced at the start of this year may fail to spark greater household spending.

``The Maastricht Treaty accord on deficit limits is a fair- weather treaty and not one for lengthy periods of stagnation,'' said Poss. ``We've reached a point where we've got to take every step to overcome the economic lull.''

Norbert Walter, chief economist of Deutsche Bank AG, said today Germany should only allow its deficit to swell if it sought to cut taxes and labor costs and planned to boost asset sales and public investments at the same time.

``Holding up reforms and carrying on the comfortable old way with subsidies and social transfers would be fatal for the economy,'' Walter, representing Germany's BDB banking association, told reporters in Berlin.

Opinion polls show Schroeder's Social Democrats would lose national elections if they were held now. A survey by the market research company Forsa published last week put the Social Democrats on 27 percent, compared with 47 percent for the opposition Christian Democrats and Christian Social Union. Forsa surveyed 2,509 voters for the poll, which has a margin of error of 2.5 percentage points.

The next test of Schroeder's popularity among the electorate will be on June 13, when the country votes for representatives to the European parliament. Regional elections will be held on the same day in the eastern state of Thuringia and local polls in six of Germany's other 15 states.

To contact the reporter on this story: Andreas Cremer in Berlin at acremer@bloomberg.net.

Last Updated: May 3, 2004 08:33 EDT