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European Commission forecasts
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Moderate growth along with high uncertainty
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European Commission forecasts increase in economic activity in 2006 giving way to moderate slowdown in 2007…
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In its Spring forecasts, the European Commission has come out with its pronouncement: the often looked for but much delayed economic recovery in Europe is finally happening. According to the EU executive, this year the European Union (EU-25) will grow by 2.3% year-to-year (1.6% in 2005) to later decrease its drive slightly with a projected rise in gross domestic product (GDP) of 2.2% in 2007. The Euro Area will follow this cycle with growth of 2.1% in 2006 and 1.8% in 2007. In 2005, growth recorded in the Euro Area was 1.3%.
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…thanks to better state of investment and foreign demand.
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What will be the engines of this growth? The same as those showing up in recent months: investment will increase and exports are moving into a stage of higher growth. Following this drive we should see a recovery of private consumption although the growth rate will be more contained.
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So far we have looked at the good news. Now we shall examine some less promising factors. The first threat to carrying out this relatively benign scenario is the much-mentioned upturn in oil prices. The European Commission, in an effort to make amends for previous predictions, this time around is assuming that the energy picture will continue to be complicated in coming years. For this reason, its forecasts for the per barrel price of Brent quality oil are 69 dollars in 2006 and 71 dollars in 2007.
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Foreign risk (oil) and domestic risk (uncertainty about German economy) key factors.
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In spite of this, the European Commission estimates that the inflationary effect will be negligible. Harmonized inflation for the Euro Area at annual average will hold at 2.2% in 2006 and 2007. While it is true that up to now evidence of «second round» effects (that is to say, of the shift of increases in energy prices to other types of prices) is lacking, the European Commission forecasts look a little like wishful thinking.
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A second disquieting factor the EC executive raises is the impact of the tax package Germany has adopted. The uncertainty arising from the carrying out of a broad range of budgetary consolidation measures could change the expected pattern of recovery with effects not only restricted to the German economy.
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Recovery of Euro Area confirmed with growth of 2.0% in first quarter.
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This look ahead is especially relevant if we take into consideration that under the umbrella of recovery of the European Union as a whole we may find hidden substantially different national situations. In the group of the four countries in the Euro Area to grow below the average in 2006 we discover the three large economies, namely Germany, France and Italy, along with Portugal. This adds a factor of disquiet, given that, if the «big boys» should perform below expectations, it will be difficult for the other economies to avoid the downward drift of the whole group. It is in this context of a lack of counterweights to a potential slack in these three economies that we can understand concern in the EC with regard to Germany.
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Euro area
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Euro Area: inflation showing its teeth
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Europe’s ability to greatly increase rate of economic activity limited due to low growth potential.
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From the figures now available, everything suggests that in the first quarter of 2006 the results in terms of growth have been satisfactory but the disappointment that came in the fourth quarter urged prudence. Events confirmed those favourable predictions. In the first quarter, the Euro Area GDP grew by 2.4% quarter-to-quarter annualized, practically twice the rate in the fourth quarter, which put the year-to-year rate at 2.0%. No higher rate had been recorded since the second quarter of 2004.
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Given the main figure, a less favourable factor must be mentioned. The upward stage still remaining for recovery will in all likelihood be limited. The forecasts point to a high quarterly growth scarcely above the current 2% year-to-year. In fact, the economy will grow less as we come close to the end of the year. How can we explain this short life? The low growth potential of the Euro Area economy, which both the International Monetary Fund and the European Central Bank put at levels of the order of 2%, is precisely the rate currently showing up.
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Industry, services and even faltering construction industry now showing better state.
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The monthly indicators, mainly those for the end of the first quarter, show a scenario of continuing growth. In this respect, the prospect for supply is gathering increased evidence of the growth pattern. Industrial production grew by close to 4% year-to-year in March and the strong recovery in the portfolio of industrial orders suggests maintenance of the good state of the secondary sector. After promising something of a recovery in March, confidence in services fully showed up in the upward trend in April. Even prospects in construction are the best in recent months.
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Demand indicators are less definite in pointing to growth. Consumption has scarcely begun to recover, as reflected in the fact that retail sales in the first quarter grew at a rate practically identical to that in the fourth quarter. On the other hand, investment is shining more brightly and exports are showing a positive trend (growth of 16% year-to-year between January and March).
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Nasty surprise from inflation with rise in April not caused only by increased price of oil.
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With things as they are, the negative player of the month was inflation. Apart from the rise in the general index in April to 2.4% year-to-year (2.2% year-to-year in March), what is troubling is the performance of the underlying core. Discounting energy, tobacco and food, the resulting rate rose for the second consecutive month to stand at 1.5% year-to-year, two decimals more than in March. As a result, we are seeing a more complex scenario in prices than in previous months. Things have gone from one situation in which, apart from more costly energy, there were no pressures to another offering a wider range of sources of inflationary trends.
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In turn, the labour market is continuing to appreciably improve. While the unemployment rate dropped by one decimal in March (to 8.1%), job creation continues to be disappointing. In the third quarter of 2005, employment was barely 0.8% higher than that recorded one year earlier. In view of these figures, we can understand the reluctance of the European consumer to spend more recklessly.
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Germany
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Germany: taxpayers, to the payments counter!
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Further increase in German taxes, this time affecting highest wage earnings.
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Following approval of the 3-point increase in the ordinary value added tax (VAT) for the coming year, the Grand Coalition headed by Angela Merkel has also decided to raise the tax rate on wage incomes by three points as of 2007. Both measures have been justified by the government because of the increase in tax collections but the critics of this restrictive turn in fiscal policy argue that the increase in economic activity will in itself raise collections and that the heavier tax load could affect future growth and raise prices.
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Paradoxically, the first criticism has received support from the half-yearly forecasts of tax collections put out by the government itself. At the beginning of May, the estimate for revenues in 2006 was revised upward by 8.1 billion euros, an amount equivalent to 0.4% of the GDP. Criticisms of the fiscal adjustment and its effect on growth and inflation would seem to have less basis given that available estimates point to a temporary and rather limited effect.
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Growth of 1.4% in first quarter slightly below expected level but consumption taking off again.
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The battery of figures recently becoming available, although these may be open to various interpretations, has not served to temper the debate. The GDP grew by 1.4% year-to-year in the first quarter thus losing some of its previous drive (advance of 1.7% in the fourth quarter). Nevertheless, the composition of that growth incorporates some new factors. In the first place, what stands out is the rise in private consumption which made it possible to compensate for the sharp drop in the previous quarter. A second factor, which is less positive, was the slowdown in investment, the result of the poor performance of construction investment. The other components have gone long expected lines. Public consumption is tending to stabilize and exports and imports continue along an upward course.
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Figures at the point between the end of the first quarter and start of the second are also positive. In May, the IFO index held close to the 106 points level, a milestone not see for 15 years, while the consumer confidence indicator that month marked up its highest figure since September 2002.
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Drive in industry remains excellent, as proved by both figures recorded and business executive expectations.
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Other indicators, however, were less definite. In spite of the good figure in the first quarter, the hesitation in consumption still remains, if we are to go by the drop in passenger car registrations in April. Industrial activity has been surprising because of some slowing down in March when it grew by 3.9% (6.3% in February). Overall, it would seem that the basic trend is still for recovery but the truth is that the second quarter could be definitive in giving a feeling of the real strength of the German economy.
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In turn, inflation rose moderately going to 1.9%, but this level is not alarming. Meanwhile, the unemployment rate continues to move within the range of values above 11% of the labour force (11.3% in April).
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France
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France: comme ci comme ça
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First-quarter recovery in France fails to dissipate lack of general confidence in country’s economic future.
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While the French economy partially recovered in the first quarter with growth of 1.5% year-to-year (1.1% in the fourth quarter), the sensation of a country that is inward looking and rudderless is not going away.
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Underlying core of CPI increasing while unemployment rate holds close to all-time high levels.
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Figures for national accounting in the first quarter clearly indicate that the pattern of French growth continues to lean basically on private consumption. As a result, with a rise of 2.2% year-to-year (as against 1.9% previous), this macroeconomic figure has more than compensated for the slowdown in investment and the higher negative contributions to GDP growth coming from the foreign sector and the change in inventories.
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With regard to the latest available monthly indicators, the most significant concerns industrial recovery. Along with the rise in industrial production (growth of 1.9% year-to-year in March, nearly two percentage points above the February rate), we should mention the improvement seen in industrial orders. In addition, both the trend in unemployment and in consumer prices are similar to that seen in most of the large European economies. The unemployment rate is being maintained in spite of a reduction of one decimal in March, at levels still high (9.5% in that month), while inflation is rising (1.7% year-to-year in April), the result not only of higher-cost energy but also of the underlying core (which does not include the more volatile components).
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Italy
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Italy taking off
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Italy grows by 1.5% in first quarter (more than expected) thanks to drive in exports and investment.
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Finally, Italy has come up with positive economic news. In the first quarter of the year the GDP grew by 1.5% year-to-year, thus going above the forecasts and beating the slim results in the fourth quarter (0.5% year-to-year). In spite of the fact that we still have no breakdown by component, the trend in the monthly indicators, especially for consumption and foreign trade, indicate that the foreign sector and investment must have been the sources of the rise in the first quarter.
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What can we hope for the second quarter? Two favourable factors dominate the economic scenario. In the first place, once doubts about the election were cleared up, the country’s confidence moved clearly into an upward phase.
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Country’s confidence benefits from end to electoral uncertainty…
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A second positive factor is the better performance in industry which, after too many months reporting drops or with practically no growth, since the end of 2005 has broken with this negative trend. To be specific, industrial production went from growth of 0.2% year-to-year in November to 3.2% year-to-year in March.
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…while industry puts on best face in many months.
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Finally, we may end this review with a reminder that inflation showed moderate growth in April (2.2% year-to-year compared with 2.1% in March), while the unemployment rate again reported 7.7% in the fourth quarter, with no change from the level reported in the second and third quarters in 2005.
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United Kingdom
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United Kingdom: consumption under scrutiny
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While United Kingdom undergoes substantial improvement in first quarter…
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With announcement of growth in the first quarter (2.2% year-to-year, an increase of four decimals over the fourth quarter), the main doubt about the state of the British economy remains the real state of private consumption. Available indicators, especially industrial production of consumer goods and the figure for retail sales in March, suggest that household consumption has improved as the first quarter has advanced.
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…worsening of labour market takes away from strength of economic recovery at beginning of 2006.
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Immediate prospects are for a continuation of recovery, if we are to go by the increase in consumer confidence in April. Nevertheless, the slowdown in employment (a drop of three decimals in the fourth quarter to 0.6%) and stagnation in the unemployment rate (3.0% in April with no change over March) make it clear that the final bases for a consistent recovery of consumption are still not settled.
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Industry may be leaving behind stage of lack of strength seen in recent quarters but inflation troubling Bank of England.
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With regard to other matters of interest, we should point out that, without stepping out of the present crisis stage in activity, industrial production marked up an advance of 0.3% year-to-year in March, the first positive figure since December 2004. On a less positive note, the rise in inflation in April (2.4% year-to-year as against 2.1% in March) was troubling, something that explains the signs recently given out by the Bank of England of a more restrictive turn in monetary policy.
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