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Euro area economy gains momentum despite clouds on the horizon

 
Reference:  IP/05/1230    Date:  06/10/2005
 
 
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IP/05/1230

Brussels, 6 October 2005

Euro area economy gains momentum despite clouds on the horizon

After a modest acceleration in the first quarter of the year, GDP growth in the euro area slowed slightly to 0.3% in the second quarter, but there are signs that the recovery in the euro area is gathering momentum in the second half of 2005. Business confidence is strengthening, industrial production has picked up and the world economy has emerged from the soft patch of the beginning of the year. Still, high oil prices have taken their toll on the economy and remain a major source of uncertainty in the short-term, reads the third Quarterly Report on the Euro Area. In its focus section, the report highlights the case for further structural reforms, arguing they would help the euro area prepare itself for a long-feared disorderly unwinding of the global current account imbalances besides increasing the growth potential.

After an economic growth of respectively 0.4% and 0.3% of gross domestic product (GDP) in the first and second quarters – which is an improvement on the last quarter of 2004, but still modest– there are signs of acceleration in economic activity in the second half of 2005, notes the European Commission’s Quarterly Report on the Euro Area.

Strengthening business confidence, an increase in industrial production and continued favourable financing conditions are amongst the factors suggesting that the recovery in the euro area is gaining momentum.

However, the risks remain tilted to the downside, in particular due to surging oil prices. Compared to the beginning of this year, the price of the Brent has increased by close to 70% in euro terms and is likely to stay high due mainly to strong demand. Indeed current future prices indicate that the price will remain above 60 dollars in the medium to longer term. This also increases risks of inflationary pressures although core inflation (i.e. excluding energy and unprocessed food) has remained unchanged since June and price increases in the transport sector, for example, are offset by decreases in other consumption categories such as clothing and recreational services.

On the bright side, imports by oil exporting countries are on the rise to the benefit of euro-area exporters, which have seen their sales to OPEC, Norway and the Community of Independent States increase by more than 50% since the beginning of 2003. In the meantime, total euro-area exports have increased by 25%.

On the consumer side, hard data point to continued weak momentum, judging from the retail sales data. But car sales (not included in the data) give reason for more optimism as registrations in June reached their highest level since April 2001. The unemployment rate also edged slightly down from 8.8% in April to 8.6% in July.

As the third quarterly report also highlights, global current account imbalances are an additional risk factor for the euro-area economy. In 2004 the United States had a current account deficit of $670 billion, or 5.7% of GDP, matched by surpluses in East Asia and the Middle East while the current account of the euro area is roughly balanced.

A disorderly unwinding of such a deficit, which is unprecedented in its magnitude and duration, could trigger a sharp depreciation of the dollar and a recession in the US with possible substantial knock-on effects on world growth. The report shows that the euro area can make only a limited contribution to reducing global imbalances. Instead, it ought to pursue further structural reforms in order to strengthen the economy’s capacity to absorb external shocks as well as to improve its own growth performance.

Finally, the report also notes that government bond yields and risk premiums on corporate bonds have declined to historical lows. As equity prices have increased and bank lending conditions improved, the overall picture is one of further easing of long-term financing conditions in the euro area which has been associated with early signs of a pick-up in corporate demand for external funding and continued rapid expansion in loans to households.

Full document available on:

http://europa.eu.int/comm/economy_finance/publications/quarterly_report_on_the_euro_area_en.htm