•  Strong. Eurozone's real gross domestic product reaccelerated this summer and posted growth of almost 3% annualized in Q3. The main driver was brisk investment activity. But private consumption also made a tangible contribution to the growth.

  • Downward. But all signs point to a slowdown. The pace of growth is already decelerating appreciably in the current quarter and should almost halve by Q1 2008. Strains are coming from the strong EUR, record-high oil prices and the aftershocks of the financial market crisis. Leading indicators already point clearly south (pages 2-3 & chart below).

  • ECB. For a forward-looking central bank, the strong Q3 is yesterday’s news. The prospects for growth are deteriorating, and the risks are skewed to the downside. Since, however, inflation dangers are increasing at the same time, the ECB’s hands are tied for months to come.

  • US. The swing in growth momentum will be much more pronounced in the US. Third quarter growth should be revised up to 5%, but Q4 should see growth of at best 1½%. The risks that the Fed could ease again after all are, therefore, substantially higher than for the ECB.

  • Further topics:

    – Germany: GDP growth has already peaked (page 4).

    – Japan: Economic recovery still on track (page 6).

    – Global economic slowdown pressuring metal prices (page 8).

    – Data outlook: European purchasing managers to become more skeptical; downturn in the US housing market continues (page 11)

    – Market outlook: EUR to look for new record highs; bonds to remain well supported (page 17).


Eurozone: GDP rebounds in Q3, but momentum is slowing

  • In Q3 2007, Eurozone GDP growth reversed the disappointing performance of the second quarter and rose to an above-trend 0.7%.

  • Though details are not yet known, we suspect that investment was the main driver of the acceleration. Consumption probably performed nicely, while net trade is unlikely to have been a major swing factor.

  • However, the solid Q3 figure is not representative of the underlying GDP trend heading toward year-end. Business surveys point to a significant loss of momentum in Q4 2007 and the beginning of next year.

  • ECB implications: on hold for long. With GDP growth set to ease moderately below potential in coming months and inflation sharply on the rise, a prolonged period of unchanged rates seems the most likely outcome.


GDP up nicely in Q3, as expected

Eurozone GDP growth picked up in Q3 to an above-trend 0.7% q-o-q, lifting the yearly growth rate to 2.6% from the previous 2.5%. The outcome was in line with our expectation, and was the result of growth rebounds in all the Big Three (cf. chart), with Germany and France recording a solid 0.7% q-o-q, and Italy a more moderate 0.4%. Spain expanded 0.7% - a respectable performance, which however remains the slowest quarterly rate in almost three years, confirming that the GDP boom in the fourth biggest economy of the area has started to fade. The Netherlands was the real positive surprise, with a stunning 1.8% q-o-q advance.

No breakdown for the eurozone has been released yet, but high-frequency data and national account details so far available at country level suggest that domestic demand was the main driver of the GDP pick up. In particular, there is little doubt that investment spending has re-gained considerable traction after the soft patch hit in Q2 2007: we think the rebound involved capex and, probably to a lesser extent, also construction. Private consumption is also likely to have performed nicely, mostly on the back of solid retail spending and car registrations. Our model based on monthly data points to an acceleration in the 0.7% area from the 0.5% recorded in Q2 (cf. chart). Hoverer, while national account details released in France and the Netherlands are consistent with such a pick up, the indication of moderate spending growth in Germany and our forecast for a consumption slowdown in Italy suggest that the area-wide performance could have been a bit softer than implied by our model. Evidence so far available suggests that net exports’ contribution to growth probably was negligible.

If our working assumptions are correct, the overall picture for Q3 will look rather solid once Eurostat releases the expenditure breakdown. However, our view is that the growth strength seen in the third quarter is going to prove short lived. We have very good reasons to believe that Q3 2007 will be the strongest quarter for quite some time.


Less favorable times ahead

To be perfectly clear, we are not envisaging any abrupt slowdown down the road, and recession fears seem definitely overdone. But it’s evident to everybody (including the ECB) that the Q3 number overstates the underlying GDP trend heading toward year-end for two reasons:

First of all, even though the 0.7% outcome is broadly in line with survey indications – in particular our Composite PMI – the growth rebound was in part helped by the unwinding of technical factors that artificially depressed GDP in Q2. We refer in particular to the industrial and construction sector, with the former marking a whopping 1.5% quarterly gain after adverse calendar effects held back production during the spring months, and the latter sending signals of recovery following the abrupt correction seen in the previous quarter.

Secondly, and certainly more important, business surveys point to a clear loss of momentum in coming months. This is true especially in manufacturing, where the PMI is approaching the no-growth threshold and no stabilization seems in sight. We usually tend to rely on the OECD leading index as a good gauge of two-month-ahead developments in both the manufacturing PMI and industrial output. As can be seen from the chart, the OECD index is in a free fall, and we would not be surprised if the factory PMI were to slip into contraction territory within the next few months.

Clearly, the mix of slowing global growth, appreciating currency, skyrocketing oil prices and tighter credit standards have not come without pain for euro-area manufacturers.

Therefore, we think a significant GDP deceleration has to be already expected in the current quarter. We forecast that growth will ease slightly below trend between Q4 2007 and Q1 2008, and recover only gradually thereafter. While we confirm our long-held confidence in the soundness of euroarea fundamentals, risks to our relatively benign GDP scenario are on the downside, and could materialize if the services sector – so far decently resilient to the financial shock – - were to show more signs of weakness.


ECB: hands are tied

There is not much the ECB can do to counter slowing GDP momentum: given the steep rise in spot inflation and inflation expectations, a rate cut is not an option, also because the central bank is still convinced that any sign of softness will prove temporary (in so doing, it is very much aligned with our baseline scenario). Accordingly, the bar for monetary easing is definitely very high, and awful survey numbers are required for them to seriously start considering rate cuts. On the other hand, the spike in headline inflation is unlikely to trigger any policy reaction as long as core price dynamics remain well behaved. Wait and see will therefore remain the name of the game for the next several months.