Euro-zone economy on track of strong recovery

Yearender: Euro-zone economy on track of strong recovery

BRUSSELS, Dec. 11 (Xinhua) -- Despite a surging euro, the European Central Bank raised its benchmark interest rate near the year-end, the sixth time in 12 months.

The exceptional move was no surprise considering the inflation danger resulting from an accelerating economy in the 12-nation region sharing the same currency.

After an unexpected downturn in 2005, the euro-zone economy started picking up at the end of last year. A strong recovery was underway throughout 2006, and set to continue into the next two years.

"BEST IN THE DECADE"

In the latest autumn forecasts released in November, the European Commission raised its estimates of the euro-zone economic growth in 2006 to 2.6 percent, i.e. more than 1 percentage point above last year's growth and 0.5 percentage point higher than the forecast made six months ago.

The upward revision of the forecasts was mainly justified by the better-than-expected outcome of the first half of 2006. Real GDP rose by 0.8 percent quarter-on-quarter in the first three months and by 0.9 percent in the second quarter of 2006. This was the strongest pace of expansion in six years.

Although GDP growth slightly slowed down to 0.5 percent in the third quarter, dragged down by poor performance in France and Germany, the two largest economies in the euro zone, it was widely regarded as remaining solid. Economists expect the positive trend to have continued into the last months of the year.

Robust economic growth was also evident in the whole European Union, whose growth rate was estimated to be 2.7 percent this year, up from 1.4 percent in 2005.

"After years of disappointing results, the European Union economy in 2006 will be at its best since the beginning of the decade," said Joaquin Almunia, the EU Economic and Monetary Affairs Commissioner.

DOMESTIC DEMAND IMPROVING

Peaking price of oil had been blamed for the sluggish growth of the euro zone in 2005. It is true that lower oil price did help economic recovery this year, but it is not the main driver.

According to the European Commission, the economic growth was mainly supported by robust domestic demand, in particular investment that rose at an annual rate of 6 percent in the first half of 2006. Investment in equipment, especially, is set to grow by more than 5 percent in 2006. Consumer spending is expected to pick up more gradually, mirroring an improved labor market. Exports, on the other side, continue to be supported by the strong world economy.

Domestic demand and exports are regarded as the two engines of the euro-zone economy, but weak domestic demand has always been the Achilles' heel before.

Reflecting the economic activity, employment growth has also increased more strongly since the last quarter of 2005. In October, the euro-zone jobless rate kept declining and stood at 7.7 percent, much lower than 8.5 percent registered in the same period last year.

Meanwhile, inflation has remained remarkably stable this year at an expected 2.2 percent. Core inflation, which excludes energy prices and unprocessed food, remains subdued, indicating that the oil price hikes have not had any significant second-round effects.

Inflation expectations also remain relatively contained. The ECB recently cut its forecast for 2007 inflation to 2.0 percent from 2.4 percent and its projection for 2008 inflation to 1.9 percent, which will be in line with the ECB's target of a rate below but close to 2.0 percent.

BRIGHT FUTURE WITH CERTAIN RISKS

The positive mood is set to spread over the next two years. Looking ahead, economic activity in the euro zone is projected to moderate to 2.1 percent growth in 2007 and 2.2 percent in 2008.

The economic sentiment indicator (ESI), based on business and consumer surveys, leapt from 109.3 in September to 110.3 in October, the highest level since February 2001. This shows that manufacturers and consumers are both positive about the economy.

However, economists fear the euro-zone economy may hit turbulence in 2007 as the German value-added tax hike hits growth, the effects of higher interest rates feed through and further oil price hikes can not be ruled out.

The impact of the U.S. slowdown also remains uncertain. A more marked slowdown in the United States may have a negative impact on the euro-zone growth, which could be seen from the recent rise of the euro against the dollar.

With the euro hitting a 20-month high against weakening dollar earlier this month, many euro-zone countries are worrying a stronger euro will hurt their exports. It is concluded from experience that a 10 percent appreciation of the euro, on a trade- weighted basis, knocks roughly a percentage point off growth in the following year.

Source: Xinhua