CONSUMPTION KEEPS FEEDING THE FRENCH ECONOMY

UNCLAS SECTION 01 OF 02 PARIS 005073 SIPDIS SIPDIS PASS FEDERAL RESERVE PASS CEA STATE FOR EB and EUR/WE TREASURY FOR DO/IM TREASURY ALSO FOR DO/IMB AND DO/E WDINKELACKER USDOC FOR 4212/MAC/EUR/OEURA E.O. 12958: N/A TAGS: EFIN ECON PGOV FR SUBJECT: CONSUMPTION KEEPS FEEDING THE FRENCH ECONOMY REF: PARIS 4417 ¶1. SUMMARY. The unexpected rise in French consumption of manufactured products in June confirms solid economic growth in the second quarter. The French Finance Minister said the data supports his 2006 GDP growth forecast of 2.0 to 2.5 percent. However, recovery of consumer spending in Germany and Italy, France's main trading partners, remains fragile, creating doubt about continued growth of French exports. End summary. Consumption was High in Q-2 -------------- ¶2. Consumption of manufactured products (adjusted for workdays and seasonally adjusted) increased for the third consecutive month, up 1.7 percent (excluding inflation) in June compared with May, the highest monthly increase in 2006. The latest numbers surprised many economists, most of whom were expecting a lower increase after good performances in April (a 0.5 percent increase compared with March) and May (a 0.9 percent increase compared with April). Consumption of manufactured products rose 1.5 percent in Q-2, and this on the heels of a significant 1.2 percent increase in Q-1. The effect of the soccer World Cup on consumer electronics purchases (including flat screen televisions) combined with the start of one of two bi-annual sales periods, dynamic real estate investment and special offers on automobiles benefited many different sectors. Other more fundamental factors, such as lower interest rates, higher home prices, and, to a lesser extent, moderate increases in purchasing power and job creation, may explain the strength of consumption in recent months. Consumers Benefit from Prices of Imported Goods -------------- -- ¶3. In recent months, consumption has been focused primarily on imported goods, whose prices have been very competitive. The euro's relative strength also contributed to the increase in imports of consumer goods, offsetting the impact of oil price increases on purchasing power. Eric Dubois, senior economist at the National Statistical Institute (INSEE),confirmed that "the impact of high oil prices on inflation has been offset by the decrease in prices of many other products." Low Interest Rates Encourage Consumption -------------- ¶4. Low interest rates and rising home prices encouraged consumer lending. Consumer loans have surged 32.7 percent since the spring of 2003. The rate of consumer indebtedness (indebtedness as a percent of disposable income) was close to 66 percent in Q-2. Marc Touati, Natexis Banques Populaires's senior economist, stressed that "it is well below rates in the U.S. (133 percent) and in Spain (90 percent),but it is an historical high in France." At the same time, the savings rate continued to decrease, declining from 17.7 percent in 2002 to 14.6 percent in 2006, one of the lowest levels since 2000. Economists Wonder about Durability of Consumption -------------- -------------- ¶5. Manufactured products account for less than one third of household consumption, but economists are now convinced that overall household consumption (including food and services) continued at full speed throughout Q-2. Morgan Stanley's Chief Economist Eric Chaney warned of a consumption slowdown in Q-3, noting that the World Cup's effect would by then be over. He expects any moderate increases in interest rates should decrease demand for consumer loans. The ECB could raise its benchmark rate from 2.75 percent to 3 percent given the pick up in the euro zone economy and record oil prices. Chaney forecast household consumption would increase by 2.4 percent in 2006, "a robust performance by European standards." Touati warned that "despite its apparent vigor, consumption remains fragile; job creation (150,000) and increases in purchasing power (1.7 percent) might be insufficient to maintain the current level of consumption that is so heavily dependent on indebtedness." Natexis Banques Populaires's estimates are lower than INSEE's forecasted 2.6 percent rise in household consumption, itself based on the creation of 196,000 new jobs and a 2.4 percent increase in purchasing power in 2006 (reftel). Government Confirms its GDP Growth Forecast -------------- ¶6. On July 17, before the publication of consumption data, the Bank of France predicted GDP would increase 2.4 percent (annualized) in Q-2 compared with Q-1, when it grew 2.0 percent. The Bundesbank indicated that German economic growth was "markedly faster" in Q-2 than in Q-1, when it was 1.6 percent (annualized). According to the European Commission, economic growth in the euro zone will PARIS 00005073 002 OF 002 accelerate to the fastest level in more than two years by the end of ¶2006. On July 25, Finance Minister Thierry Breton said on Europe 1 that "the French economy picked up very nicely," confirming the government's GDP growth forecast in the range of 2.0-2.5 percent this year. He said that the declining unemployment rate explained "why the French are spending more," and the unemployment rate could decrease to below 9.0 percent by the end of the year, and to 8.7 percent or even 8.5 percent by July 2007. Interestingly, French business confidence increased in July to a five-year high. Comment -------------- ¶7. Household consumption including food and services was certainly more robust in Q-2 than in Q-1. Even if consumption returns to a more moderate pace in the second half of the year, household consumption is likely to post an overall 2.5 percent increase for 2006, which should mean at least a 2 percent GDP growth rate for this year as well. However, according to analysts, consumption growth in France's major partners, Germany and Italy, who also benefited from the soccer World Cup, does not look sustainable and might not boost French exports permanently (ref). Foreign demand from Germany and Italy may even weaken in 2007 due to the implementation of tax increases in the two countries next year. STAPELTON#