Eurozone looks strong but weak as economy powers on in 2018

Frankfurt - The eurozone is set to start the new year the way it ended the old: the economy is strong but inflation is weak.

The region’s fastest growth in a decade will be confirmed this week in a burst of data that should also show economic confidence at the highest since the currency bloc’s early days, unemployment at a post-crisis low, and manufacturing continuing to boom.

Yet inflation, the key metric for the European Central Bank (ECB), will probably be the slowest in six months.

The readings will cement the 19-nation region’s transformed reputation from an economic black spot to a pillar of the global upswing, an opinion expressed frequently at the World Economic Forum last week in Davos, Switzerland.

They will also underpin ECB President Mario Draghi’s argument that it’s still too soon to consider winding down the unprecedented monetary stimulus that sparked the recovery.

First out of the block will be reports for gross domestic product and confidence at 11 am Luxembourg time on Tuesday. A Bloomberg survey of economists predicts fourth-quarter GDP growth of 0.6%, the 19th straight expansion. Economic confidence this month was probably the strongest since 2000.

Data on Wednesday will likely show inflation in January weakened to 1.3% from 1.4%, with underlying price growth picking up slightly to 1%. Neither is enough - the ECB’s goal is for price growth to average just under 2% over the medium term without monetary support.

Governing Council member Klaas Knot renewed his hawkish push in an interview on Dutch television on Sunday. He said that the ECB should end asset purchases as soon as possible, arguing that the “program has done what could realistically be expected of it.”

What Bloomberg economists say...

“Economic growth is vibrant - Bloomberg Economics expects a reading of 0.6% to be recorded for the region as a whole in 4Q. Yet there’s not much life in underlying inflation, and the headline rate for the monetary union should slip at the start of the new year.”- Jamie Murray, Dan Hanson, David Powell, Maxime Sbaihi.

Currency volatility is complicating the ECB’s job. The Governing Council revived language in their statement last week saying exchange-rate swings are a “source of uncertainty” that need to be monitored for the impact on inflation.

Draghi partly attributed the euro’s climb to a three-year high against the dollar to the economy’s performance, but also to currency talk “not by the ECB but by someone else.” Markets were whipsawed as US Treasury Secretary Steven Mnuchin appeared to endorse a weak dollar, before President Donald Trump spoke up for a “strong” greenback.

Still, for now the omens are auspicious. A Purchasing Managers’ Index due on Thursday should confirm that while factory activity slowed a little this month, it’s still doing well. Policy makers may also find comfort in the fact that manufacturers are finally raising their prices as demand outstrips supply for many goods.

Anyone searching for signs that economic strength is finally generating inflation pressures might also want to keep an eye on wage talks in Germany, where the nation’s largest union, IG Metall, is trying to win a 6% pay hike and more-flexible working hours for 3.9 million employees.

ECB Executive Board member Benoit Coeure has expressed confidence that higher wages may finally be around the corner in the euro area, and with them also a pick-up in inflation.

“We are now at the point where we are starting to see wages ticking up in a very tentative way, also core inflation ticking up in a very limited way in the eurozone,” he told a panel in Davos on Friday. “It’s happening at different paces across the region, but we are moving to the point where we see wages going up.”

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