European Economic Confidence Drops, Inflation Eases

By Fergal O'Brien

Aug. 29 (Bloomberg) -- Europeans' confidence fell more than forecast this month as the economy teetered on the brink of a recession.

An index of executive and consumer sentiment in the economic outlook dropped to 88.8 from 89.5 in July, the European Commission in Brussels said today. That is below the 89.3 median estimate of 26 economists surveyed by Bloomberg News. Inflation unexpectedly eased in August and a measure of consumer-price expectations declined.

The reports signal the slump in economic growth is extending through the third quarter and a 20 percent drop in oil prices from a record $147.27 a barrel last month is easing inflation pressures. Consumer-price increases are still above the European Central Bank's limit, prompting policy makers including Axel Weber to indicate they are in no hurry to cut interest rates even as expansion slows.

``The euro-zone economic situation is deteriorating markedly,'' said Carsten Brzeski, an economist at ING Group in Brussels. ``Therefore, it is somewhat striking that some central bankers still consider interest rates to be accommodative.''

Inflation eased to 3.8 percent from 4 percent, according to a separate report today. Economists had forecast that inflation would remain unchanged at a 16-year high. National data this week showed inflation in Germany, Europe's largest economy, Spain and Belgium eased this month.

Less Chance

European companies and consumers see less chance of prices rising, the commission data indicate. A measure of companies' selling-price expectations fell to 17 in August from 20 in July. Consumers' outlook for prices dropped to 22 from 30, falling below its average reading for the past 18 years.

The euro pared gains after the reports and was up 0.2 percent to $1.4737 against the dollar at 12:40 p.m. in London, having been as high as $1.4767 earlier. The yield on the German 1-year bund fell 4 basis points to 4.13 percent today. It's down 22 basis points since the start of the month.

The ECB, which aims to keep inflation just below 2 percent, raised its key interest rate to 4.25 percent on July 3, a seven- year high. While the central bank left the rate on hold this month, ECB Executive Board member Lorenzo Bini Smaghi said in a Bloomberg Television interview broadcast today that inflation is ``too high'' and must be brought below the bank's ceiling.

The ECB's Weber this week said the central bank may need to raise borrowing costs once the economic outlook ``brightens'' toward the end of the year.

`Too High'

``Inflation has started to slow, but remains too high for the ECB to soften its rhetoric,'' said Marco Valli, chief Italian economist at Unicredit MIB in Milan. He said the ECB may begin cutting rates from the middle of 2009.

The 15-nation euro-area economy shrank in the second quarter while the region's manufacturing and service industries contracted in August. L'Oreal SA, the world's largest cosmetics maker, today reported the slowest profit growth in three years. Bertelsmann AG, Europe's largest media company, yesterday cut its 2008 profit forecast after advertisers slashed marketing budgets.

Confidence among euro-area manufacturers fell more than economists forecast to minus 10 this month from minus 8 in July, while sentiment among retailers also declined, according to today's report from the commission. Consumer confidence rose 1 point from July's minus 20, staying close to a 5 1/2-year low. Spanish retail sales fell for an eighth month in July, while in the U.K., consumer confidence stayed near a record low in August, GfK NOP said today.

In the euro area, unemployment remained at 7.3 percent in July, another report showed.

Most investors have pared bets on the ECB raising rates again as the economic outlook worsens, Eonia forward contracts show. The May contract yielded 4.15 percent today, down from 4.44 percent a month ago.

To contact the reporter on this story: Fergal O'Brien in Dublin at fobrien@bloomberg.net.