Cablegate: Consumption Keeps Feeding the French Economy

VZCZCXRO1867
RR RUEHAG RUEHDF RUEHIK RUEHLZ
DE RUEHFR #5073/01 2071434
ZNR UUUUU ZZH
R 261434Z JUL 06
FM AMEMBASSY PARIS
TO RUEHC/SECSTATE WASHDC 9824
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUCNMEM/EU MEMBER STATES

UNCLAS SECTION 01 OF 02 PARIS 005073

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PASS FEDERAL RESERVE
PASS CEA
STATE FOR EB and EUR/WE
TREASURY FOR DO/IM
TREASURY ALSO FOR DO/IMB AND DO/E WDINKELACKER
USDOC FOR 4212/MAC/EUR/OEURA

E.O. 12958: N/A
TAGS: EFIN ECON PGOV FR
SUBJECT: CONSUMPTION KEEPS FEEDING THE FRENCH ECONOMY

REF: PARIS 4417

1. SUMMARY. The unexpected rise in French consumption of
manufactured products in June confirms solid economic growth in the
second quarter. The French Finance Minister said the data supports
his 2006 GDP growth forecast of 2.0 to 2.5 percent. However,
recovery of consumer spending in Germany and Italy, France's main
trading partners, remains fragile, creating doubt about continued
growth of French exports. End summary.

Consumption was High in Q-2
----------------------------
2. Consumption of manufactured products (adjusted for workdays and
seasonally adjusted) increased for the third consecutive month, up
1.7 percent (excluding inflation) in June compared with May, the
highest monthly increase in 2006. The latest numbers surprised many
economists, most of whom were expecting a lower increase after good
performances in April (a 0.5 percent increase compared with March)
and May (a 0.9 percent increase compared with April). Consumption
of manufactured products rose 1.5 percent in Q-2, and this on the
heels of a significant 1.2 percent increase in Q-1. The effect of
the soccer World Cup on consumer electronics purchases (including
flat screen televisions) combined with the start of one of two
bi-annual sales periods, dynamic real estate investment and special
offers on automobiles benefited many different sectors. Other more
fundamental factors, such as lower interest rates, higher home
prices, and, to a lesser extent, moderate increases in purchasing
power and job creation, may explain the strength of consumption in
recent months.

Consumers Benefit from Prices of Imported Goods
--------------------------------------------- --
3. In recent months, consumption has been focused primarily on
imported goods, whose prices have been very competitive. The euro's
relative strength also contributed to the increase in imports of
consumer goods, offsetting the impact of oil price increases on
purchasing power. Eric Dubois, senior economist at the National
Statistical Institute (INSEE), confirmed that "the impact of high
oil prices on inflation has been offset by the decrease in prices of
many other products."

Low Interest Rates Encourage Consumption
----------------------------------------
4. Low interest rates and rising home prices encouraged consumer
lending. Consumer loans have surged 32.7 percent since the spring
of 2003. The rate of consumer indebtedness (indebtedness as a
percent of disposable income) was close to 66 percent in Q-2. Marc
Touati, Natexis Banques Populaires's senior economist, stressed that
"it is well below rates in the U.S. (133 percent) and in Spain (90
percent), but it is an historical high in France." At the same
time, the savings rate continued to decrease, declining from 17.7
percent in 2002 to 14.6 percent in 2006, one of the lowest levels
since 2000.

Economists Wonder about Durability of Consumption
--------------------------------------------- ----
5. Manufactured products account for less than one third of
household consumption, but economists are now convinced that overall
household consumption (including food and services) continued at
full speed throughout Q-2. Morgan Stanley's Chief Economist Eric
Chaney warned of a consumption slowdown in Q-3, noting that the
World Cup's effect would by then be over. He expects any moderate
increases in interest rates should decrease demand for consumer
loans. The ECB could raise its benchmark rate from 2.75 percent to
3 percent given the pick up in the euro zone economy and record oil
prices. Chaney forecast household consumption would increase by 2.4
percent in 2006, "a robust performance by European standards."
Touati warned that "despite its apparent vigor, consumption remains
fragile; job creation (150,000) and increases in purchasing power
(1.7 percent) might be insufficient to maintain the current level of
consumption that is so heavily dependent on indebtedness." Natexis
Banques Populaires's estimates are lower than INSEE's forecasted 2.6
percent rise in household consumption, itself based on the creation
of 196,000 new jobs and a 2.4 percent increase in purchasing power
in 2006 (reftel).

Government Confirms its GDP Growth Forecast
-------------------------------------------
6. On July 17, before the publication of consumption data, the Bank
of France predicted GDP would increase 2.4 percent (annualized) in
Q-2 compared with Q-1, when it grew 2.0 percent. The Bundesbank
indicated that German economic growth was "markedly faster" in Q-2
than in Q-1, when it was 1.6 percent (annualized). According to the
European Commission, economic growth in the euro zone will

PARIS 00005073 002 OF 002

accelerate to the fastest level in more than two years by the end of
2006. On July 25, Finance Minister Thierry Breton said on Europe 1
that "the French economy picked up very nicely," confirming the
government's GDP growth forecast in the range of 2.0-2.5 percent
this year. He said that the declining unemployment rate explained
"why the French are spending more," and the unemployment rate could
decrease to below 9.0 percent by the end of the year, and to 8.7
percent or even 8.5 percent by July 2007. Interestingly, French
business confidence increased in July to a five-year high.

Comment
-------
7. Household consumption including food and services was certainly
more robust in Q-2 than in Q-1. Even if consumption returns to a
more moderate pace in the second half of the year, household
consumption is likely to post an overall 2.5 percent increase for
2006, which should mean at least a 2 percent GDP growth rate for
this year as well. However, according to analysts, consumption
growth in France's major partners, Germany and Italy, who also
benefited from the soccer World Cup, does not look sustainable and
might not boost French exports permanently (ref). Foreign demand
from Germany and Italy may even weaken in 2007 due to the
implementation of tax increases in the two countries next year.

STAPELTON#

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