The Economist Hits the Right Tone on The Eurozone

I have long advocated that we were not going to see any real sustainable recovery in the Eurozone and thus gone against many an article from The Economist and the FT. A couple of days back in connection with the recent ECB raise I also mentioned an article from the new Eurozone Watch which very well summarizes the argument. Now the recent data coming out of the Eurozone sure does seem to merit a more optimistic view of the Eurozone's immediate future but remember that all things are interconnected and a slowing US economy coupled with tough fiscal tightening cycles in the big Eurozone countries are not furthering the economy as well as aren't a hawkish ECB.

Although The Economist has been very inconsistent in their position on the Eurozone economy I am reminded this week why I am a (happy) subscriber. Of course there are things in the article which I feel could be more precise and emphasized more clearly but all in all it lies very close to my take on this. Exceptionally and because the article is free for all I have chosen to paste it in its full length here with blod parts signifying where to read closely as usual.  

'Don't get your hopes up too high about growth in the euro area

IN A field as error-strewn as economic statistics, caution is always wise. This week's data, though, leave little room for doubt. If the initial estimate for the second quarter of 0.9% is right—and adjustments to Europe's numbers, unlike America's, have tended to be upward—the euro area's GDP grew at an annual rate of 3.7%, its fastest for six years. For the first time in seven years, the zone outran America, Britain and Japan.

Does continental Europe, becalmed for so long, at last have the wind in its sails? It would be convenient for the world economy if it did, because America, the powerhouse for so long, seems to be slowing. But do not expect this summer's rate of knots to be maintained in the euro zone. That is partly because of a series of short-term changes in the economic winds that will make it harder for the euro economies. But the main speed limit remains the same familiar problem: the reluctance of governments, especially in France, Germany and Italy, to embrace bold structural reform.

Tougher sailing ahead

There are three short-term reasons to expect slightly choppier waters in the euro zone. The easiest one to exaggerate is the slowdown in America, where growth tumbled to (an annualised) 2.5% in the second quarter and where consumers will surely be less willing to snap up German plastics and French perfumes. In fact, the euro area's growth increasingly seems to be being pushed along by its own consumers' spending rather than exports. The zone as a whole depends on exports much less than its individual countries do: the 43% of Germany's exports going to other members of the club count as domestic demand at the level of the euro area. And America is less important as an export market for the zone than you might expect. Britain counts for more; so, combined, do other European Union countries. And when it comes to recent additions to exports—which is what really matters for growth—China is buying an ever bigger share. On the other hand, a slowing America is plainly no help to Europe's exporters.

The second reason to expect a slowdown is that some euro-area countries, notably Germany and Italy, are due to tighten their budgets. That their public finances need repairing is not disputable; the timing and style of the repairs is, especially in Germany. Just when German consumers seem to have recovered their confidence, after years of low wage-growth and worries about jobs and pensions, the government wants to raise value-added tax by three percentage points next January. Paradoxically, this may boost growth in the second half of this year, as spending is brought forward to beat the tax increase. But it will surely hold the economy down at the start of 2007.

Third, the European Central Bank (ECB) is providing less of a following wind than it did. It started raising interest rates last December and is expected to keep doing so at least until the end of this year. So far, there is little sign that these rate increases are holding the euro zone back, but eventually they will have an effect. And the second-quarter spurt makes further rises in interest rates more likely.

Not feeble, but slower than it could be

You may wonder why, if demand is likely to ease, the ECB is so eager to raise rates. The reason lies not with demand, but supply. No one knows for sure how fast the economy can grow without causing inflation to rise appreciably; but the ECB thinks that anything much faster than 2% looks dangerously quick. In the second quarter the euro zone seems to have grown at almost twice its sustainable pace.

Next to America, all this looks pretty feeble. In fact, it is mostly to do with Europe's slower population growth. Kevin Daly, an economist at Goldman Sachs, points out that in terms of GDP per head the euro zone has grown almost as fast as the United States in the past decade. And Europe's speed limit may be rising: inflation, although above the ECB's target, has been stable even though the unemployment rate has fallen.

That said, there is plenty that governments should do to make faster growth sustainable, by raising the proportion of people in work and by helping to make those with jobs more productive. This would be a good time to do it: those who balked at reform in sluggish times, worrying at the pain it might cause, now have less excuse. Competition in service markets is one area from which politicians have often shied away. And in several countries too many people are encouraged to quit work in their 50s. With the number of older workers bound to rise, this is a waste Europe cannot afford.'