FRENCH GDP STAGNATES IN THIRD QUARTER

UNCLAS SECTION 01 OF 02 PARIS 007477

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E.O. 12958: N/A
TAGS: EFIN ECON PGOV FR
SUBJECT: FRENCH GDP STAGNATES IN THIRD QUARTER



1. SUMMARY: Based on a French National Statistical Agency
preliminary estimate (which may be subject to revisions),GDP growth
stagnated in Q-3. The results disappointed the government, which
was counting on growth to reduce unemployment ahead of the April
2007 presidential elections. However, the government is sticking to
its 2.0-2.5 percent range forecast for GDP in 2006. Weak export
growth, affecting output and employment, is a growing concern,
prompting the GoF to call for an EU strategy on the euro. END
SUMMARY.

GDP Stagnates in Q-3 after a Spurt in Growth in Q-2
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2. Based on the National Statistical Agency's (INSEE) preliminary
estimate, GDP (seasonally and workday adjusted) was unchanged in Q-3
compared to Q-2 (when it increased at a 4.8 percent annualized rate,
its fastest pace in five years). The zero Q-3 GDP growth rate, the
worst performance since Q-2 of 2005, was much worse than expected by
INSEE and the Bank of France, which had forecast growth of 2.4
percent (annualized) and 2.0 percent respectively for Q-3. The
consensus forecast of private-sector economists is for 2.0 percent
GDP growth in 2006. Emmanuel Ferry, Chief Economist at broker
Exane, ascribed the sharp Q-3 slowing to "a normalization" after a
second quarter that was "disconnected from reality," also noting
that quarterly results were not good indicators of future
performance. Chief Economist Marc Touati at Banques Populaires
Natexis similarly stated the Q-2 was "an anomaly." Both underscored
that preliminary GDP growth estimates might be subject to change as
more economic data becomes available.


3. Household consumption (not trade or industrial output) was
still the driving force for economic growth in Q-3, increasing 2.4
percent (annualized) compared with 3.6 percent in Q-1 and 2.8
percent in Q-2. There are indications that a portion of household
consumption, fueled by buoyant sales of electronic and IT goods, was
supplied by increased imports rather than domestic output.
Industrial production fell 2.0 percent (annualized) in Q-3 compared
with Q-2, led by a decline in the automobile and consumer good
sectors, while imports increased to 104.7 billion euros (134 billion
dollars) in Q-3 from 103.8 billion in Q-2. The trade deficit
deteriorated due to the increase in imports and a decrease in
exports to 97.4 billion euros from 97.6 billion euros in Q-2.
Interestingly, exports to the EU increased 4.0 percent (annualized)
compared with Q-2, but exports to the U.S. and the Middle East
decreased. Corporate investment growth was weaker in Q-3 (3.2
percent annualized compared with 9.0 percent in Q-2),and a strong
positive inventory contribution reported in Q-2 was reversed in Q-3.


GDP would increase at least 1.9 percent in 2006
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4. INSEE calculated that GDP would grow at least 1.9 percent in
2006 based on the first three quarters. Finance Minister Thierry
Breton said "Q-3 GDP growth data was not good," but reaffirmed the
government's forecast for 2006 to be 2.0-2.5 percent. He said he
saw a "very good fourth quarter" with GDP increasing 2.4-3.2 percent
(annualized). French private-sector economists forecast 2006 GDP
growth to be nearer the bottom of the range predicted by the
government. In early November, the IMF revised upward 2006 French
GDP growth to 2.5 percent from 2.4 percent, but recommended the
French government pursue reforms, notably to reduce the overall
budget deficit and make the labor market more flexible by reducing
the gap between permanent labor contracts and limited-duration
contracts. In a recent analysis, the EU Commission projected that
the French budget deficit would decrease to 2.6 percent of GDP in

2006. However, the Commission stressed that France was on the road
to register long-lasting durable current account deficits. The
Commission revised downward 2006 French GDP growth to 2.2 percent
from 2.3 percent.

Fears about U.S. Slowdown Spreads to Europe
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5. The lack of French economic growth in Q-3 cast doubt on the
strength of growth in the rest of Europe, prompting Citigroup Inc.,
JPMorgan Chase & Co., Royal Bank of Scotland Group Plc, as well as
Commerzbank economists to immediately cut their estimates of
European growth. Other analysts waited for the November 13
economic-growth estimates for Germany and Italy to see if the U.S.
economic slowdown in Q-3 had spread to Europe. Economists worry
whether a hard landing of the U.S. real estate sector could impact
France and Europe, since U.S. consumption is essential in global
economic growth. Nonetheless, solid economic growth in Germany in
Q-3 reassured many economists about the solidity of EU economic
growth. Bank of France's economists said Q-3 zero GDP growth was "a
pure accident," forecasting 2006 GDP to increase 2.0 percent,

PARIS 00007477 002 OF 002


including a 2.4 percent annualized GDP growth in Q-4.

GDP Data Mask Positive Aspects of the French Economy
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6. Disappointing Q-3 economic growth did not affect the CAC 40
blue-chip index. Instead, the CAC 40 continued increasing, hitting
new highs of 5,502 on November 13, and of 5,511 on November 15.
Investors felt healthy French company profits, decreasing oil prices
and increases in U.S. stock prices were good signs for the French
economy.


7. The inflation rate decreased in September and October to 1.2
percent and 1.1 percent, respectively, mainly due to a sharp decline
in oil prices, which was beneficial for the purchasing power of
households.


8. The unemployment rate decreased to 8.8 percent in September.
Labor Minister Jean-Louis Borloo attributed the improvement to his
Social Cohesion Plan. Job creation in the non-farm private sector
only edged up 0.4 percent annualized, the lowest increase since Q-3
2005, prompting economists to say that disappointing economic growth
has dragged down hiring. Borloo said he would unveil a package of
new measures "to go quickly toward full employment" in January.
However, despite the improvement, the unemployment rate of the youth
remains above 20 percent, and the labor situation in disadvantaged
suburbs remains problematic. Quizzed about the introduction of new
"flexisecurity" measures inspired from the successful Danish
experience, Borloo said that the new hire contract ("Contrats
Nouvelles Embauches - CNE) was "already" an example of
flexisecurity.

Government Calls for an EU strategy on the Euro
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9. A few days after the release of Q-3 GDP data, De Villepin
asserted "we cannot allow the European Central Bank (ECB) to act
alone on rates," urging Europe to acquire "a currency policy taking
account the objectives of growth strategy, protection of industry,
and of course employment." He acknowledged that the euro allowed
the creation of a stable environment between all European partners,
but "its current level hurts some of French exports." In September,
Finance Minister Breton suggested he did not want the euro exchange
rate to rise further against other currencies such as the U.S.
dollar or the yen, saying "the euro was fully valued."

Comment
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9. The unexpected lack of growth in Q-3 is bad news for Prime
Minister De Villepin's government, which was betting on a
consolidation of economic growth in 2006 to reduce further
unemployment and bolster its position ahead of the May 2007
presidential elections. The new package of measures in favor of
employment is likely to include further measures in favor of the
youth (living in or out of disadvantaged suburbs),but unlikely to
include "flexisecurity" measures, except if the political situation
permits. Lower inflation coupled with GDP stagnation in Q-3 has
prompted the government to speak out even more forcefully against
ECB plans to hike interest rates in December, suggesting France's
primary fear is weak export growth, but the ECB has given no sign of
changing course.

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