German, French business buoyant despite U.S. gloom

BERLIN (Reuters) - Business confidence in the euro area's two biggest economies unexpectedly improved in March, suggesting the region is eluding damage from a sharp U.S. slowdown and quashing hopes for a swift ECB interest rate cut.

The buoyant sentiment readings from Germany and France eclipsed news that Italian business confidence fell to its lowest level in over 2-1/2 years, and propelled the euro higher as expectations of a rate cut receded.

The robust French and German morale confounded the sense of doom and gloom in financial markets, which was compounded on Wednesday when Germany's biggest lender Deutsche Bank (DBKGn.DE) said credit market aftershocks could hit its 2008 profits.

Belgian business confidence, often seen as a bellwether for the euro zone, also unexpectedly rose in March, climbing for a third month running as sentiment improved among retailers and manufacturers.

"Today's figures suggest that, although slowing, manufacturing activity in the euro area is looking more resilient than expected so far, albeit with emerging differences across countries," said Lavinia Santovetti at Lehman Brothers.

"These numbers will likely give some comfort to the ECB as the impact of the financial market turmoil appears, so far, limited overall," Santovetti said in a research note.

The Ifo economic research institute's German business climate index rose to 104.8 in March from 104.1 in February, bucking expectations for a fall and hitting a seven-month high.

The survey was marked by a rise in its manufacturing sector component. German industry has made productivity gains in recent years and enjoys strong demand from emerging markets.

European Central Bank President Jean-Claude Trichet noted that the Ifo reading was "better than expected". He also told the European Parliament he saw upward risks to price stability in the medium term, denting expectations for a rate cut soon.

FRANCO-GERMAN AXIS

In France, business morale hit its highest level this year as firms reported fuller order books.

"There is an improvement in foreign orders and my hunch on this is that it might be a consequence of quite strong industrial activity in Germany which is filtering through to France," said Bank of America economist Gilles Moec.

Germany is France's top trading partner. Together, the two account for around half of the euro zone's economic output.

The upbeat sentiment surveys contrasted with reports from the United States on Tuesday, showing consumer confidence in the world's largest economy plunged to a five-year low this month.

"It is clear that the risk factors which are rattling the (German) economy -- concerns about a recession in the United States, the exchange rate and other things -- are leaving little trace on industry," said Dresdner Kleinwort's Rainer Guntermann.

German industry is managing to withstand the troubles in the U.S. economy by tapping growth in emerging markets.

The president of Germany's BGA exporters' group, Anton Boerner, told the Handelsblatt daily on Tuesday that expansion in markets like Russia and China meant foreign trade would contribute positively to German economic growth this year.

"Companies in Germany are unsettled, but they are not yet feeling direct effects," he said, with regard to the euro's strength, the high oil price and the weakened U.S. market.

The European Commission nonetheless expressed concern about the euro's rise, saying it added to the headwinds facing euro zone growth. The euro hit a record high of $1.5905 last week.

A European Union source said the Commission would almost certainly cut its euro zone 2008 economic growth forecast of 1.8 percent next month, but not below 1.5 percent.

SOFT UNDERBELLY?

The deterioration in Italian business confidence was mainly due to a contraction in order books, the ISAE think-tank said.

"This underlines that Italy, along with Spain, ahead of the other euro zone economies, is experiencing a cyclical slowdown," said Luigi Speranza of BNP Paribas.

The data was the latest in a stream of gloomy economic news for Italy, the euro zone's third largest economy. Consumer confidence hit its lowest since May 2004 in March. Spain is also facing a slowdown as its property market stumbles.

"If you take Spain and Italy together, that's about one third of the euro zone," said Bank of America's Moec. "If Spain and Italy get into nasty territory, which is very likely in 2008, then it would have an impact on the euro zone data."

(Additional reporting by Swaha Pattanaik in Paris, Robin Pomeroy in Rome and Dave Graham and Iain Rogers in Berlin, editing by Stephen Nisbet)