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Europe confidence unexpectedly rises; inflation slows

Confidence in the European economy unexpectedly rose in February for the first time in four months as unemployment fell to a record low and inflation slowed.

An index of sentiment among executives and consumers in the euro area increased to 109.7 from 109.2 in January, the European Commission in Brussels said today. Economists had expected a decline to 109.1, according to the median of 23 forecasts in a Bloomberg News survey. Unemployment fell to 7.4% in January and the inflation rate unexpectedly declined to 1.8% from 1.9% in December, separate reports showed. The euro-area economy may maintain momentum this year after growing at the fastest rate in six years in 2006. The pace of expansion and declining unemployment may fuel wage demands and increase pressure on the European Central Bank to keep raising interest rates even as inflation remains below its limit of 2%. „The main story is inflation is benign, below 2%, and perhaps next month as well,” said Martin Van Vliet, an economist at ING Bank in Amsterdam. „But the ECB are clearly more focused on growth because they are concerned about a pickup in underlying inflationary pressures.”

Economists had forecast that inflation in January would remain at 1.9%, which would have matched a provisional figure on January 31. Eurostat, the European Union's Luxembourg-based statistics office, will publish an initial estimate for February tomorrow. The euro was little changed, remaining down 0.4% to $1.3184 against the dollar. Bonds rose, partly as a slump in global equity markets attracted investors to the safety of fixed-income debt. The yield on the German two-year notes fell 3 basis points to 3.85% at 11:05 a.m. in Brussels. The European Commission February 16 raised its growth forecast for this year to 2.4% from 2.1%. Europe's manufacturing expansion probably accelerated in February, a survey due tomorrow may show.

Continental AG, the world's fourth-largest tiremaker, last week reported that Q4 profit surged 64% and said it plans to double the dividend. Volkswagen AG, Europe's biggest carmaker, on February 26 said its commercial-vehicle unit's profit rose 5.4% last year and forecast further growth in 2007. There are signs that the euro area's expansion is easing from the 2.7% pace recorded last year. European retail sales fell for a second month in February after the German government's January 1 increase in value-added tax, a sales levy, to 19% from 16% discouraged shoppers in Europe's largest economy. Germany's Ifo index of business confidence fell more than expected, according to a report last week.

European confidence may weaken if a global slump in stocks that began yesterday becomes a prolonged decline. The slide started in China amid concern the government of the fastest-growing major economy will tighten controls on investment. The Dow Jones Industrial Average fell 3.3% yesterday and the Morgan Stanley Capital International Asia-Pacific Index fell 2.8% today. Europe's Dow Jones Stoxx 50 fell 1.9% today, extending yesterday's 2.6% drop. Declines were compounded by a survey of economists that forecast that the US economy grew 2.3% in the Q4, less than the 3.5% the government initially reported.

Investors have pared bets on the ECB raising its key rate to 4% after March, futures trading shows. The implied rate on the three-month Euribor futures contract for September dropped 3 basis points to 4.06% today, compared with 4.13% on February 26. Still ECB policy makers have warned that the pace of growth may fuel wage increases and fan inflation. The 7.4% unemployment rate for January reported today marks the lowest since the data were first collated in 1993. The Frankfurt-based central bank has signaled it will raise its benchmark interest rate to 3.75% from 3.5% on March 8, which would be the seventh increase since late 2005. ECB council member Nicholas Garganas said this week that economic growth may prove stronger than the ECB forecasts and inflation risks are increasing. „I would expect that the growth outcome for this year would turn out to be higher than it had earlier been expected,” Garganas said in an interview in Athens. „The risks to inflation are clearly on the upside, and are growing.” (Bloomberg)