Euro zone growth hits two-year high of 0.4%, beating expectations

Key Points

• The euro area economy grew 0.4% in the third quarter, ahead of expectations for a 0.2% expansion.
• Spain and Ireland recorded the strongest growth rates, while Europe's largest economy, Germany, avoided a recession.
• The readings come with the European Central Bank expected to cut interest rates four times this year.

The euro zone economy grew 0.4% in the third quarter, flash figures published by the European Union's statistics agency showed Wednesday.

Economists polled by Reuters had expected growth of 0.2%. following the bloc's 0.3% expansion in the second quarter.

Spain saw one of the highest growth rates, increasing 0.8% on the previous quarter, as Ireland — which generally records volatile figures due to the high proportion of international corporations stationed there — rose 2%.

The euro zone's biggest economy, Germany, recorded a surprise growth of 0.2% in the third quarter. That allowed Europe's largest economy to avoid the recession that had been forecast by some economists, as it struggles with a downturn in its key manufacturing sector.

"Although a technical recession was avoided, the German economy remains barely larger than it was at the start of the pandemic," analysts at ING said in a Wednesday note, calling the nation a "magnet for negative macro news."

Analysts say euro zone business activity and consumer confidence should cautiously pick up in the coming months, amid lower interest rates and cooling inflation.

The European Central Bank cut rates for the third time this year at its October meeting, after headline inflation came in at 1.7% in September, according to a final reading. The ECB cited persistent signs of weak activity in the euro area as a key factor in the central bank's decision to enact an October cut.

Markets have fully priced another 25-basis-point cut from the ECB in its last meeting of the year in December. The ECB's key rate, the deposit facility, is currently at 3.25%.

ECB President Christine Lagarde said during her October press conference that the central bank's Governing Council had only debated a 25-basis-point cut.

Nonetheless, the possibility that the central bank could opt for a larger half-percentage-point reduction — as the U.S. Federal Reserve did in September — has been increasingly discussed over the last month. That has come as some ECB policymakers have acknowledged they may soon have to grapple with the ECB's pre-Covid-19 issue of inflation that is persistently below the institution's 2% target.

Franziska Palmas, senior Europe economist at Capital Economics, said stronger-than-expected growth would not deter the ECB from a December rate cut and forecast a reduction of 50 basis points.

Palmas said euro zone GDP growth would slow in the fourth quarter, with Germany still underperforming in manufacturing and with Italy struggling with the end of construction industry tax incentives, while inflation would undershoot the ECB's forecasts for the three-month period.

However, Kamil Kovar, senior economist at Moody's Analytics, said the latest GDP figures would be followed by an uptick in headline inflation which would "shut down any talk about a jumbo sized cut."

Euro zone inflation figures for October are due on Thursday.

"The report puts to rest any questions of whether the euro zone is currently in recession — it is not, and such worries were always overblown," Kovar said, calling growth "splendid in Spain and solid in France," due in part to the summer Olympics.

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