Euro zone growth beats projections but headwinds mount

By Balazs Koranyi

FRANKFURT, Oct 30 (Reuters) - The euro zone economy grew faster than predicted last quarter, displaying exceptional resilience to headwinds from expensive energy, even as surging borrowing costs and rapid inflation cloud the outlook.

The euro zone economy has beaten most estimates this year, expanding steadily on the back of robust investment and consumption, confounding expectations for a downturn as energy price rises sap incomes.

The economies of the 21 nations sharing the euro grew by 0.4% in the third quarter, a slowdown from an exceptionally strong 0.6% three months earlier, but far above expectations for 0.2% in a Reuters poll of economists.

Compared with a year earlier, the bloc's economy grew by 1.3%, beating expectations for 1.1%, as heavy spending on AI, defence and infrastructure boosted investment, robust foreign demand helped industry, and households kept on spending, reducing their already high savings rate.

Among the euro zone's biggest economies, Germany expanded by 0.2% on the quarter, Spain and the Netherlands by 0.6%, while Italy was unchanged and the French economy contracted by 0.1%.

While the bloc's growth rate is less than half of the expansion produced by the United States, the figure far exceeds the gloomy projections made after the start of the Iran war. 

Europe is a net energy importer and oil price surges immediately reduce growth, compress corporate margins and worsen the bloc's terms of trade.

AMPLE RISKS ON THE HORIZON

This strength may not last, however.

The European Central Bank has warned that the balance of risks is tilted towards weaker readings as the recent surge in borrowing costs is bound to weaken the bloc.

Indeed, German borrowing costs — the bloc's benchmark — surged to their highest in decades this month, partly mirroring similar moves in US markets and partly on investor unease about debt sustainability around the world.

Meanwhile, the premium that euro zone countries need to pay to borrow has jumped, particularly for France, as investors doubt it will sort out its finances before next year's presidential election. 

Inflation is likely to add to this pain.

Price growth accelerated in most of the euro zone's biggest countries this month, suggesting that annual inflation for the bloc as a whole could jump to 3.9% or above, far above the ECB's 2% target.

Such a figure would solidify already widespread bets for another rate hike in December, a move that would further dampen growth.

An ECB survey published on Friday showed a big rise in inflation expectations and suggested that the rate of price growth may not return to target until 2028.

Fabio Panetta, Italy's central bank governor, said further increases in policy rates could be needed.

Still, data suggest that high inflation is not yet generating dangerous second-round effects, likely because the labour market is relatively soft.

Unemployment was steady at 6.5% in August but has been inching up for most of the past year and now stands well above the record-low 6.2% hit in late 2024.

(Additional reporting by Francesco Canepa; Editing by Toby Chopra and Hugh Lawson)