European Investment, Spending Drop as Economy Shrinks

By Fergal O'Brien

Sept. 3 (Bloomberg) -- European company investment, consumer spending and exports declined in the second quarter, dragging the economy into a 0.2 percent contraction and pushing it to the brink of a recession.

Investment by companies fell 1.2 percent, the first decline in five years, and household expenditure dropped 0.2 percent after stagnating in the previous three months, the European Union statistics office in Luxembourg said today. The 0.2 percent decline in overall gross domestic product matched an initial estimate published on Aug. 14.

The euro fell today, extending its 7 percent decline over the past month as evidence of Europe's economic slump mounts. Separate figures today show retail sales unexpectedly fell in July and services contracted for a third month in August. The downturn has yet to prompt the European Central Bank to drop its inflation-fighting stance and policy makers will probably keep interest rates at a seven-year high tomorrow.

``The ECB did the minimum last month and it would make sense for them to acknowledge the downturn a bit more this week,'' said Laurent Bilke, an economist at Lehman Brothers in London, who expects the economy to shrink again in the current quarter. ``But I think they can claim they need a bit more insurance that the price of oil will drop more for them to say inflationary pressures have eased.''

Company Investment

The overall contraction in the economy is the first since the introduction of the euro almost a decade ago. The decline in company investment followed a 1.5 percent surge in the first quarter, when mild weather prompted the construction industry to bring forward building projects.

``If an abrupt GDP slowdown in second quarter had to be expected, the most recent developments certainly suggest that growth weakness goes beyond a technical correction,'' said Aurelio Maccario, chief euro-zone economist at Unicredit MIB in Milan. ``Growth momentum has virtually come to a halt.''

The euro fell as much as 0.9 percent to $1.4385 today, its lowest since Jan. 22, and was at $1.4432 as of 12:50 p.m. in London. European government bonds advanced. The yield on the two-year note fell 2 basis points to 4.07 percent and the yield on the 10-year German bund, the region's benchmark government security, also declined 2 basis points, to 4.11 percent.

The 0.4 percent drop in retail sales followed a 0.9 percent fall in June. Economists had forecast a 0.1 percent increase, based on the median of 25 estimates in a Bloomberg News survey.

Government Spending

Government spending rose 0.5 percent in the three months through June after a 0.3 percent gain in the previous quarter, according to today's report. Exports fell 0.4 percent. From a year earlier, the economy expanded 1.4 percent, less than the 1.5 percent initial estimate.

Bertelsmann AG, Europe's largest media company, on Aug. 28 cut its 2008 profit forecast after advertisers slashed marketing budgets to reduce costs amid the slowdown. L'Oreal SA, the world's largest cosmetics maker, a day later reported the slowest profit growth in three years.

The economic backdrop ``remains difficult across Europe,'' said John Browett, chief executive officer of U.K. consumer- electronics retailer DSG International Plc, which has operations in countries including France, Spain and Germany. Its sales fell 7 percent in the 16 weeks through Aug. 23, DSG said today.

Even with the weaker economic growth, the ECB in July raised its key rate to 4.25 percent to curb price growth. While inflation eased in August to 3.8 percent from 4 percent, it remains almost twice the ECB's 2 percent limit. The ECB staff projections for inflation in 2008 and 2009 may be raised tomorrow after the governing council meeting, according to Lehman's Bilke.

Benchmark Rate

All but one of 53 economists surveyed by Bloomberg News predict the Frankfurt-based central bank will leave the benchmark rate on hold tomorrow and only five expect a cut this year.

The economic slowdown isn't confined to the euro area. The U.K. economy unexpectedly stagnated in the second quarter, ending the nation's longest stretch of expansion in more than a century, and Japan's economy contracted on an annualized basis. While the U.S., the world's largest economy, grew faster than forecast in the second quarter, the nation's leading economic indicators suggest growth is likely to weaken this quarter.

While the stronger euro against the dollar and record oil prices threatened growth this year, those pressures may be fading. The euro, whose gains eroded export competitiveness, has fallen 7.5 percent versus the dollar in the last month, while crude oil has dropped around 25 percent since reaching a record $147.27 a barrel on July 11.

Still, an index of consumer and executive confidence in the economy dropped more than forecast last month, according to the European Commission. Europe's manufacturing and service industries contracted for a third month in August, according to reports this week.

``The euro-zone economies are continuing to struggle in the third quarter,'' said Howard Archer, chief European economist at Global Insight in London. ``We expect this to remain the case for some time to come.''

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