High oil prices, a slow recovery and growing fear of war in the Middle East have led to gloomy forecasts from European airlines, with KLM and British Airways warning that the market remains difficult.

KLM says that "deteriorating economic conditions [and] geopolitical instability" mean it will probably make an operating loss of over c150 million ($156 million) for the full year to March 2003.

Last month the airline, which said traffic was "lower than expected" in the last quarter of 2002, was ordered to pay c150 million in compensation for the termination of its tie-up with Alitalia. KLM now says it will make an operating loss even before paying this fine. BA has also warned that it faces "challenging" trading conditions, but still expects to report a net profit this year.

Independent aviation analyst Chris Tarry expects more bad news from European carriers, saying: "The outlook remains extremely tough... we haven't seen enough capacity come out."

Oil prices have risen to over $32 a barrel, higher than at any time since the peak immediately after the 11 September attacks. Although KLM - like most major carriers - is highly hedged against a rise in aviation fuel costs, high oil prices translate into slow economic growth, and thus a slower recovery in passenger numbers (see graph).

The rise has been blamed on a five-week strike by oil workers in Venezuela and on rising tension in the Middle East. Although the Organisation of Petroleum Exporting Countries was last week debating a modest increase in production, this is unlikely to have much effect on prices in the short term and may well be outweighed by the effects of a war in Iraq.

Both business and leisure traffic have been hit. The UK Civil Aviation Authority points out that holiday travel during the 2002-3 winter season from the UK is expected to be 4% down on the previous year, which is significant considering that 12 months ago the world was already into a post-attack downturn.

KLM has the disadvantage that its home market is far smaller than those of its rivals Air France, BA and Lufthansa. And economic growth in the Netherlands is forecast to remain slow this year, even by European standards. Growth is not expected to pick up before the end of the year, remaining at the 0.2-0.5% quarterly level of late 2002.

The US recovery is more rapid, but more bad news from the markets or from the international arena could put it just as rapidly into reverse.

Source: Flight International