February 26, 2017 / 12:14 PM / 6 months ago

Euro zone economy: real recovery or another Sirens' song?

FILE PHOTO:Fireworks explode next to the Quadriga sculpture atop the Brandenburg gate during New Year celebrations in Berlin, Germany, January 1, 2017.Fabrizio Bensch/File Photo

LONDON (Reuters) - Over the years, euro zone economic growth has been a bit like the Sirens in Homer's Odyssey: singing a song of promise, only to end up pulling you onto the rocks. Will it be different this time?

The strong growth registered in numerous data releases and surveys at the beginning of this year has surprised many.

One eye-opening example was the release of flash purchasing managers indices for France, Germany and the euro zone on Feb 21. Of nine indexes, eight registered growth and six did so at a higher level than any economist polled by Reuters had imagined.

Not surprisingly, economists and policy-makers are now looking for firm proof that the euro zone's apparent rebound this year is sustainable, as well as noting a variety of potentially destructive economic and political hazards ahead.

There has not been, they say, a specific inflexion point at which it can be said that the euro zone has recovered and is off on a growth tear. Rather it has been a slow simmer.

"The euro zone has been recovering steadily for three years now, helped by monetary policy stimulus, an end to fiscal austerity and a healthier financial sector," said James McCann, OECD economist at Standard Life Investments.

"(It's) a steady recovery which has been trundling on."

The numbers confirm this. The European Commission notes that real GDP in the euro zone has grown for 15 consecutive quarters - a sign of steady improvement.

But putting aside some of the latest data, it has been steady rather than spectacular. Economic growth is still running at only around 1.6 percent annually, and most forecasters - from economists polled by Reuters to the Commission itself, reckon it will be about the same this year.

So the question is whether the recent data has turned this on its head. Even before considering whether Greece's debt problems will come back to bite the euro zone, there are two main strands: inflation and elections.

OF POLITICS AND INFLATION

While the repetition of positive January and February data in the month ahead - for example, German industrial orders soaring again - would fuel the euro zone takeoff story, inflation may hold the key.

"The risk of disappointment is that higher headline inflation decelerates real income growth and consumption," said Paul Mortimer-Lee, global head of market economics at BNP Paribas.

The preliminary reading of February euro zone inflation, to be reported on Wednesday, is expected to come in at 2.0 percent year-on-year, rising to the European Central Bank's target on the back of monetary stimulus and economic growth.

While far from hyper, such a level has not been seen for four years, and there has been a strong inverse path taken between inflation and retail sales over the last five years.

In other words, rising prices can hurt consumer spending, which in turn drives economies.

Unemployment during the financial crisis accounts for some of the dive in retail sales seen on and off since 2008. But joblessness, though improved, is still twice that of, say, the United States.

So if euro zone inflation were to overshoot in the coming year, it may well stifle the very growth that engendered it.

Economists, however, also see a growth killer in the bloc's politics.

Many have long argued that the euro zone cannot compete as a leading economy without substantial structural reform - particularly in the number two and three economies after Germany.

"It comes down to France and Italy stepping up a gear," said Florian Hense, European economist at Berenberg private bank.

But it is exactly in those two countries where politics is threatening to delay or derail the type of pro-growth structural reforms advocated by the European Central Bank and many private sector economists.

In Italy, the chances of an election this year have diminished, but the political turmoil surrounding the resignation of prime minister Matteo Renzi is likely to set back major reforms until an election takes place.

It is France, however, that is seen providing the biggest risk. Two of the top three candidates are viewed as economic reformists, but they are up against Marine Le Pen, the far-right National Front candidate whose pledge to put France's EU membership to a referendum could de-stabilize the region's economy for years.

Le Pen is not supposed to win, according to polls. But neither was U.S. President Donald Trump or those in Britain wanting to leave the Europe Union.

"If a rising France joins a still strong Germany at the core of Europe, the economic and political outlook for the euro zone as a whole could improve considerably," Berenberg economists told clients.

"(But) a President Le Pen would spell the end of reform hopes for France and the EU for the next five years."

Click tmsnrt.rs/2kYYW2A for graphic on Euro zone economy.

Editing by Mark John

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