Under the rules of the EU's Stability Pact, eurozone countries are not supposed to run budget deficits above 3% of GDP (gross domestic product).

But the Commission said it expected both France and Germany still to be running deficits above this level in 2005.

The Commission also cut this year's growth forecast for the eurozone to 0.4%, from its previous estimate of 1%.

Growth is expected to rise to 1.8% in 2004 and 2.3% in 2005, but, despite the pick-up, the Commission said unemployment is set to rise next year.

Budget battle

Last week, France escaped EU sanctions for breaking the 3% deficit rule. French officials admitted the eurozone's second biggest economy would break the rules for three years in a row but said the deficit would be back within limits by 2005.

FORECAST BUDGET DEFICITS France 2003: 4.2% of GDP 2004: 3.8% 2005: 3.6% Germany 2003: 4.2% 2004: 3.9% 2005: 3.4% Source: European Commission

The Commission gave France a further year to get its finances in order, recommending that it make cuts in government spending.

Paris has insisted that boosting economic growth should take precedence over cutting the deficit.

While Germany is also set to break the 3% level next year, it has taken a less confrontational approach with the EU.

The Commission also said that Italy and Portugal are set to break the 3% deficit limit unless they make changes.

"Public finances are not in a good shape," said Pedro Solbes, European monetary affairs commissioner.

'Encouraging' growth signs

The meagre growth seen this year in the eurozone was put down by the Commission to the uncertainty surrounding the Iraq war, the "prolonged stock market decline", and poor confidence among consumers and business.

"However, there are encouraging signs that the worst is behind us," Mr Solbes said.

But he warned that governments needed to push through reforms aimed at making Europe more competitive.

"Our major challenge during the upturn will be to raise our growth potential," he said.

Despite the upturn in growth expected next year, unemployment is expected to keep rising.

The eurozone's unemployment rate is expected to hit 8.9% this year and rise to 9.1% in 2004, before edging back to 8.9% in 2005.