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Eurozone’s economy shines through in year of political strain

Frankfurt –  Even as Catalonia serves a
reminder that political risks remain, the euro area’s year of living
dangerously is turning out well for the economy.

On track for the strongest expansion in a decade and with consumer
and business confidence at the highest since before the financial
crisis, the

19-nation currency bloc is emerging as fertile ground for dealmakers,
investors and executives.

“The wind is well and truly back in the sails of Europe,” said

Simon Wells, chief European economist at HSBC. “The question for investors I suppose is: can this continue?”

The upbeat economic outcome for 2017 wasn’t at all certain at the
start of the year, when the shockwaves from votes for

Brexit and

Donald Trump were prompting warnings that the euro area would be the
next to witness a populist surge that could splinter the currency bloc.

Catalonia’s illegal independence referendum on Sunday, which could
see separatists make a unilateral declaration as soon as this week to
split the region from Spain, showed that the risks are far from over.

Yet they have abated. German Chancellor

Angela Merkel has to deal with a rise in support for the far right but
she’s still readying for a fourth term in power. At the same time,
newly-elected French President

Emmanuel Macron is pushing a reform program and fellow European Union
leaders are planning deeper integration.

“The period of confusion may cause a dent in Spanish economic
sentiment,” said

Holger Schmieding, chief economist at Berenberg in London. “For the euro
zone as a whole, the possible Catalan impact will probably be too small
to make a noticeable difference.”’

The 

European Central Bank forecasts an economic expansion of 2.2%
this year, enough to persuade President

Mario Draghi to consider slowing the institution’s extraordinary
monetary stimulus. The Governing Council is slated to take that decision
as soon as next month.

Euro-area

unemployment data on Monday will probably show a decline to 9% in
August – the lowest level since early 2009 though still more than
twice as high as the UK or US.

A purchasing managers survey the same
day should show manufacturing activity at the strongest in more than six
years, and

economic confidence is at a decade high.

Mergers & acqusitions

Investors have responded by pushing the Stoxx Europe 600 up more than
7% this year, headed for the strongest gain since 2013. European
takeovers have jumped 41% to $526bn, offsetting a slowdown
in US deals, according to data compiled by Bloomberg.

Consumer transactions – such as French lensmaker Essilor
International SA’s purchase of Luxottica, the producer of
Ray-Ban sunglasses – are leading the increase, reflecting growing
optimism that job creation will boost household demand.

“Confidence is rising,”

Marco Settembri, head of Nestle SA’s European business, said on Tuesday. “People are more confident to spend.”

Politics could still get in the way. Italians will vote to chose
their parliament next year, with the euro-skeptic Five Star Movement set
to make a strong showing. Merkel may have won the German election but
her party still had its lowest share of the vote since 1949 as the
far-right Alternative for Germany made gains.

That might throw a spanner in the works for Macron’s vision for
overhauling the world’s largest trading bloc, where Germany’s
cooperation – from setting up a common eurozone budget to potential
harmonization of corporate taxes – would be essential.

Euro upside

The brighter economic outlook and political stability are also
helping to push up the euro, which has risen 12% against the
dollar this year and almost 6% on a trade-weighted basis. While
the single currency has stabilised in recent weeks – and

fell after the Catalan referendum – options show upside risk.

That’s worrying for the ECB because it depresses import prices and so
curbs inflation, complicating its discussion on whether to start paring
back on its asset-purchase program. It also makes exports less
competitive, an issue for countries such as Italy that rely heavily on
foreign sales and haven’t quite healed the wounds from the recent
crisis.

HSBC estimates for every 10% jump in the trade-weighted euro,
exports fall by 5%, and says net trade is going to be a drag on
growth.

Bloomberg Intelligence predicts the expansion will slow slightly in
the third quarter and decelerate further into the end of the year as the
economy approaches its potential, according to BI economist

Maxime Sbaihi. The ECB itself forecasts a slowdown to 1.8% in
2018 and 1.7% in 2019.

One warning sign? An unexpected decline in German business confidence
for a second month in September. The region’s biggest economy also saw
unemployment fall to a new record low last month – at 5.6% –
but even it is struggling to lift wages and inflation.

“We probably are right around the peak,” said

Jack Allen, an economist at Capital Economics in London. “But that’s not
to say that we don’t think that things will continue to get better.
Unemployment will keep on falling, gross domestic product will also keep
on rising and, at least by euro-zone standards, the economy will
continue to expand at a decent rate.”

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