Euro zone growth to slow sharply in '08 but not inflation

LONDON (Reuters) - The euro zone economy probably stagnated in the second quarter this year, and will struggle to recapture its past solid growth momentum for some time, a Reuters poll found.

A promising start to the year is fast slipping from economists' minds as the euro zone economy shows signs of weakening even though recession seems unlikely.

The growth outlook contrasted with a familiar picture of surging price rises across the euro zone, forcing analysts to upgrade yet again their forecasts for inflation this year and next.

The poll of over 80 economists, carried out July 16-22, showed they forecast no growth in the quarter just ended in June after a rosy 0.7 percent quarter-on-quarter in the first three months of 2008.

This was the lowest GDP forecast since a Reuters poll in February 2002 when a 0.1 percent contraction was predicted for the fourth quarter of 2001.

Altogether 11 of 45 economists reckon a contraction is more likely, with the most pessimistic forecast showing a 0.4 percent decline in the second quarter this year. For the year as a whole they have penciled in 1.6 percent growth, the fifth time in nine months that they have cut their estimates in the poll.

Fast cooling growth, combined with high inflation means the European Central Bank is unlikely to change interest rates from 4.25 percent for some time.

"The constellation of negative factors for the euro zone is unchanged or even getting worse looking at the oil price, euro exchange rate and ongoing financial crisis," said Claudia Broyer at Allianz Dresdner.

She predicted stagnant euro zone GDP in the second quarter with downside risks as the German economy would very likely slide into contraction.

The euro hit a new record high above $1.60 in July, hurting European exporters trying to sell their goods.

A slowdown in global activity and continued turbulence in financial markets will prove a drag for some time. Median forecasts show euro zone growth will slow to just 1.2 percent next year.

The chances of a euro zone recession also increased to 30 percent this month from only 15 percent last month.

ECB President Jean-Claude Trichet said last week that growth would be weak in the second and third quarters before making a return to more moderate levels.

But for rampant inflation will prevent the ECB from contemplating cutting rates at least for a while. The poll showed rates remaining on hold until next year, with a cut coming by the end of the third quarter.

"The ECB will leave rates on hold for some time. Their latest communication still sounds hawkish with a tightening bias, but they can't raise rates looking at the economy," said Broyer.

OIL PUSHES INFLATION

Oil continues to push euro zone inflation ever upwards and make analysts re-think how high it will go.

Inflation is forecast to average 3.6 percent this year -- the eighth time in the last 10 polls forecasts were upgraded -- and up on the 3.4 percent seen last month and 2.5 percent back in January.

That comes as oil prices rose as high as $147 a barrel by mid-July only to retreat back to around $126, though that is still around a 30 percent rise this year.

Official euro zone inflation hit a record 4.0 percent in June and is likely to edge even higher throughout the summer as energy costs hit consumers.

"We expect the Bank to raise its 2008 inflation forecast again in September. This could lead the Bank still to raise interest rates to 4.50 percent in the fourth quarter," said Kenneth Broux at Lloyds TSB.

Despite a rapidly cooling economy, employment is expected to hold up well in the euro zone. This year unemployment is forecast to average 7.2 percent, where it currently stands, only edging up marginally in 2009 to 7.5 percent.

(Polling by Bangalore Polling Unit; Editing by David Stamp)