The euro zone economy is on track to recover this year but uncertainty about its short-term outlook has increased recently, the European Commission said on Monday. Its quarterly report on the euro zone economy predicted the economy of the dozen-member bloc would gather further momentum during the second half of the year despite the mixed signals sent by recent business confidence soundings. While buoyant world demand was offsetting the damage done to exports by the strength of the euro, risks persisted and the persistent weakness of consumption was a source of concern. "Downside risks are mainly related to the persistent sluggishness of consumer spending in the euro area," the EU executive said, adding that consumption was weaker than might be expected against the current economic backdrop. "Household confidence has probably been dented by concerns related to deteriorating public finances in some member states, an increasing awareness of the challenges posed by population ageing and an excessively slow structural reform process. Distortions between perceived and actual inflation may have played a role." It said the impact of the Madrid bombings was difficult to assess at this juncture. It cited a further sharp rise in the euro's value on the foreign exchanges and the sustainability of the U.S. economic recovery as other possible sources of downside risk.
EXPORTS AFFECTED BY DEMAND
While the Commission warned of the risks of further euro gains, it said the currency had risen only slightly above its long-term value and that euro zone exports were more sensitive to swings in world demand than to changes in exchange rates. "As a result, a surge in world demand is currently more than offsetting the negative impact on exports of losses in competitiveness. Overall, the impact on the euro area should be modest." It said euro zone exporters had squeezed profit margins to contain losses in their price competitiveness suffered as a result of the euro's rise in the past two years. There was also some evidence to suggest that euro zone exporters specialised in products that were more sensitive to changes in income than to changes in prices, it said. Moreover, the strong euro would help dampen inflation in the months ahead and help boost households' purchasing power. "The positive effects of the strong euro on households' purchasing power are to a large extent still in the pipeline and can be expected to gain importance over the coming months," European Monetary Affairs Commissioner Pedro Solbes said in the introduction to the report.
Core inflation would be much less volatile than headline inflation and only decrease gradually in the months ahead, it added. The Commission said euro zone monetary conditions were accommodative despite the euro's appreciation and said its model was expecting quarterly euro zone growth to come in between 0.3 and 0.7 percent in the first and second quarters. However, governments could shore up business and consumer confidence by maintaining sound macroeconomic conditions and implementing structural reforms that would boost employment and productivity growth, Solbes said.///