The Eurozone's 'Goldilocks' Recovery?'

If there is one thing to be mindful of these days as the news role in from economic reports from Japan and Europe is that you are wise to read beyond and bewteen the (head)lines. Edward Hugh showed us how to do this with Japan and now I shall attempt to do the same thing in terms of Europe. I am not trying to talk Europe down in a hole but it still seems that the optimists are forgetting to hedge their bets on 2007.

The upbeat sentiment goes something like this ...  

'The eurozone economy is for now enjoying a “Goldilocks” recovery – not too hot, not too cold. Inflation has fallen to the lowest for more than two years, while business and consumer confidence has soared to a fresh five-year high, official figures indicated on Friday.

Tumbling energy prices led to eurozone inflation falling from an annual rate of 2.3 per cent in August to 1.8 per cent in September, according to Eurostat, the European Union’s statistical union. That was the lowest since March 2004 and the first time since January 2005 that inflation has been within the European Central Bank’s target range – “below but close” to 2 per cent.'

So this is what we have; headline inflation is falling because energy prices is going down which might in fact mean that the ECB will hesitate to raise rates, probably not next time around but as we move into 2007. So is the Eurozone enjoyning a broad base recovery with no inflation pressures? Some think so ..

'The eurozone is enjoying a resilient and broad-based economic upswing that is not generating any major inflationary tensions,” said Holger Schmieding, economist at Bank of America. Italy saw a particularly sharp rise in confidence, taking its index to the highest since June 2000.'

Well if the ECB was ever stuck in a dilemma it is now as inflation seems to be waning. However, as far as I am concerned the inflation predictions at the moment are in limbo since markets are unsure. And don't believe headline inflation won't go up again either ... So in a time of uncertainty where we are getting aligned for what is up next we might want to look at the fundamentals which despite the future course of the ECB have not changed much.

A telling quote comes from the FT linked initially above ...  

'(...) economists fear fiscal tightening in Germany and Italy, a possible slowdown in the US and a stronger euro could soon spoil the current upbeat mood.'

So there seems to be some bumbs on the road ahead; I would particularly point to the fiscal tightening process in Germany and Italy which is very like to out a damper on growth. In terms of the stronger Euro ... well I am not so sure actually. Both the Fed and the ECB are slowly stopping the hike and when the ECB stops to raise the Euro might actually fall agains the dollar especially if the Eurozone economy declines on the back of a US slowdown and fiscal tightening. In short; at some point the ECB just cannot defend to raise the rates anymore. Now, at the moment many attribute this to the fact that the headline inflation has dipped a bit but another point is that the Eurozone economy amidst the previous mentioned fiscal tightening process and now also the slowing USA perhaps just is not strong enough to merit all that vigilance against inflation ... in fact it never was. I guess 'Goldilock' perhaps is a fitting adjective after all ...