Europe's economy lost steam in the second quarter of 2007 as growth slowed more sharply than had been expected in Germany, France and Italy, prompting economists to challenge the logic of European Central Bank (ECB) plans to increase interest rates.
Growth in gross domestic product (GDP) slowed to 0.3 per cent in the euro zone, less than half the pace of the first quarter and a lot weaker than the minimal slide economists were forecasting, an official EU report showed.
The slowdown, combined with turmoil in the financial markets over the past week, has raised doubts about the likelihood of an interest rate rise in September, which the ECB pre-announced earlier this month.
But economists concluded that on balance, the ECB would be unlikely to backtrack on the flagged September rate increase unless the fallout from the US mortgage crisis brings further turbulence in the money markets.
Bank of Ireland chief economist Dan McLaughlin said the probability of a September hike in interest rates had fallen from about 95 per cent to 65 per cent.
"The more significant factor is what happens with the markets. If another large European bank was to announce surprise losses, it would probably set the whole thing off again," he said.
But in that event, it would be more likely that the ECB would postpone its decision to increase its base rate to 4.25 per cent, up from 4 per cent, rather than scrap its plans completely, he said.
Monthly economic indicators had already suggested that the euro-zone economy is past peak momentum, Dr McLaughlin said. But the data issued yesterday makes it more likely that the current cycle of interest rate increases will soon end.
Mortgage holders have faced eight quarter point hikes in interest rates since December 2005, taking the ECB base rate from 2 to 4 per cent and adding more than €200 to the cost of a mortgage for a typical first-time buyer.
IIB Bank chief economist Austin Hughes said the ECB would probably go ahead with its September rate rise, although the market turbulence may have given the ECB some wiggle room.
"But if they were to say that they won't put up rates because their view of the economy had changed, it would make them look very stupid."
The economic growth data yesterday should not have come as a complete surprise to the ECB, he added.
"Where they may have been disappointed is that the slowdown was so broadly based. It's not just a rogue development in one country," Mr Hughes said.
German GDP rose 0.3 per cent in the April-June quarter versus the first three months of the year, Germany's Federal Statistics Office said. Exports were still strong, but investment in the construction sector fell.
French GDP also rose less than forecast, up 0.3 per cent, according to the statistics offices of mainland Europe's second largest economy. Growth in business investment slowed to a trickle and the trade deficit squeezed GDP too.
Italy, next in size after Germany and France, said GDP barely budged in the second quarter, rising 0.1 per cent. The Netherlands disappointed too, reporting second-quarter GDP growth of 0.2 per cent, versus forecasts of 0.7 per cent.
Bank of America's chief European economist said the ECB moved too fast when it flagged another rise in euro zone interest rates for September.
"The clear loss in growth momentum, mirrored in France, Italy and the Netherlands . . . makes the ECB decision to pre-announce a September rate hike look premature, to put it mildly," Bank of America economist Holger Schmieding said. - (Additional reporting, Reuters)
