Hopes rise for euro zone revival

Italy staged a strong rebound from recession during the second quarter, underpinning growing hopes that Europe as a whole will gather strength during the second half of the year.

The Italian economy, the euro zone's third-largest, beat expectations and posted a 0.7 per cent quarter-on-quarter rise in gross domestic product (GDP), after two quarters of decline, according to data released yesterday.

This, combined with a surprisingly strong reading in the Netherlands, helped compensate for a flat reading in Germany, and produced overall euro zone GDP growth of 0.3 per cent.

The figure was more than analysts' expectations, and means growth in the euro zone is only slightly behind the UK, which registered 0.4 per cent increases in the first and second quarters.

The European Commission and European Central Bank (ECB)yesterday expressed confidence that growth in the 12-nation euro zone was set to accelerate.

The commission forecasts 0.2-0.6 per cent growth in July-September, and yesterday projected 0.4-0.8 per cent for the fourth quarter, citing "lagged effects of favourable exchange rate developments and an improved international environment".

These factors have already produced a string of early indicators showing that business confidence has picked up since July, easing pressure on the ECB to lower interest rates.

In its August monthly bulletin, the ECB said it expected the euro zone to "expand in a sustained, albeit gradual, manner". Previously, the ECB had said: "There are no signs as yet that a more sustained recovery in economic activity has already started." This prompted economists yesterday to project that the ECB's governing council might harden its language at its next policy meeting in September.

"Although there is nothing to suggest a major shift from the ECB, elements of the bank's hawkish rhetoric seen at the end of last year are starting to re-emerge," said Neville Hill at Credit Suisse First Boston. "Given that the slowdown in GDP growth in the second quarter was less substantial than expected, it is possible that this modest toughening up in the ECB's rhetoric will continue [ in September]." At the same time, the ECB is still warning the recovery will be gradual. High oil prices, in particular, represent a potential risk, as does consumer confidence, which, unlike business sentiment, remains hampered by high unemployment.

In Germany sentiment is unlikely to have been boosted by news that the economy was stagnant in the second quarter. In addition, the German statistics office yesterday revised first-quarter growth to 0.8 per cent from 1.0 per cent, a move economists said could jeopardise growth forecast of 1 per cent for 2005 thus reducing tax revenues.