Hot and cold: Euro zone grows but inflation slows

EghtesadOnline: Data in the coming week should confirm the euro zone economy is running hot, after the IMF upgraded growth forecasts and Greece returned to the debt market, although inflation figures could throw cold water on ECB plans to start tightening policy.

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31 July 2017

Growth in the single currency area outstripped paltry expansion in the United States and Britain in the first quarter and the pace did not let up in the April-June period, according to Reuters.

The euro zone may not be growth champion in the second quarter, after the U.S. rebounded to an annualized 2.6 percent thanks to consumer spending and business equipment investment. But it should again fare better than Britain, whose economy failed to build momentum.

A forecast expansion of 0.6 percent in the April-June period, equivalent to an annualized 2.4 percent, would be the third consecutive quarter in which the euro zone has grown at or above a half percentage point, for the first time since 2007-08.

"The global economy has been a jumbo jet running on just one engine for the last five, six years, the U.S., but now it seems there's more from the euro zone as well, with encouraging signs from Asia too," said James Knightley, chief international economist at ING.

Data on Friday showed the euro zone's second-largest economy, France, grew by 0.5 percent for a third successive quarter, while Spanish GDP returned to pre-crisis levels with 0.9 percent expansion.

"Momentum is there. We're getting a broadening out of countries in terms of economic performance. It's not just the likes of Germany driving it all forward ... There does seem to be self-sustaining momentum," said Knightley.

Euro zone economic sentiment, as compiled by the European Commission, grew for a third straight month in July to a new 10-year high due to a pick-up of the dominant services sector. And confidence levels in all sectors, as well as for consumers, are far above historical averages.

The International Monetary Fund has hiked outlooks for China and the euro zone, while trimming those for the United States and Britain. The Fund said the euro zone's recovery was firming and becoming broad-based, with stronger domestic demand, although it warned of downside risks.

Stubborn Inflation, Euro Strength

Political risks seen at the start of the year ahead of elections in France and the Netherlands have diminished, while Greece has returned to the bond market after a three-year exile.

Five years ago, European Central Bank President Mario Draghi pledged to do "whatever it takes" to save the euro. His ultra-easy monetary policy is partly behind the robust economic recovery, showing more effect this year as growth in bank loans to the private sector hit a 10-year high in May.

Now the question is when to taper. Strong economic growth should steer the ECB towards reining in asset purchases, but policymakers are still waiting on inflation.

The flash estimate for July, due on Monday, is seen stable at 1.3 percent, well short of the ECB's target of just below 2 percent. Perhaps more significantly, the core figure, without volatile energy and unprocessed food prices, is seen falling.

"The economy is recovering and the labor market is doing quite well, but we think core inflation will be at 1 percent and below for the rest of 2017," said Marco Wagner, economist at Commerzbank. "Except Germany, if you look at France, Italy, Spain or Portugal there are still overcapacities, still relatively high unemployment."

Among the clearest signs of a rebound has been the euro's pick-up to around $1.17, from $1.05 at the start of the year. UniCredit on Thursday raised its forecast for the euro-dollar rate to $1.20 for the end of the year and an "equilibrium" rate of $1.25 for end-2018, from $1.14 and $1.18 respectively before.

"The political risk factor has been taken out," said Vasileios Gkionakis, co-head of strategy research at UniCredit. "It would bring the rate in line with our estimate of fair value and in all likelihood the market will overshoot."

Of course a stronger euro could dampen euro area growth and cap inflation, a further issue for ECB policymakers to consider.

Outside Europe, U.S. monthly jobs data for July on Friday is likely to be the key figure for economists and the Federal Reserve, whose policy-setters next meet on Sept. 19-20.

U.S. job creation surged by more than expected in June and is seen lower but still strong in July, a sign of labor market strength that could keep the Fed on course for a third interest rate hike this year.

More significant may prove to be average wage growth, however. It is seen at 0.3 percent, the highest rate since February, after months of hovering between 0.1 and 0.2 percent.