Europe growing faster than U.S. -- Is your portfolio?

August 23, 2006

European GDP growth in Q2 2006 was 2.6%. (This is for the Euro 25 area, which includes all the members of the European Union.) This was slightly faster than the U.S. growth rate of 2.5%. Europe’s performance was driven by .9% growth in Germany (the fastest in five years) and an unprecedented 4.4% growth in France. Underlying these results were strong exports to Asia, increased domestic consumption, and higher industrial activity.

The looming cloud comes from the potential effects of increasing interest rates, a higher euro and a 19% Value Added Tax (VAT) proposed by Germany for January 2007. Interest rates are currently at 3%, and could rise to 3.5% by the end of the year. As the dollar declines, thanks to the huge U.S. current account deficit, the Euro will increase. This will make European exports to the U.S. more expensive, possibly reducing demand. The VAT will be applied to all German imports, reducing consumption in Europe's largest economy. However, Chancellor Merkel insists it is necessary if Germany is to reduce its budget deficit to comply to EU standards.

What It Means:
Europe’s economic recovery has been slower than that in the U.S., but is speeding up while America's is slowing down. This is because Europe’s growth has been built on more stable fundamentals. While the U.S. has borrowed money from the Chinese and Japanese (who have invested heavily in U.S. Treasuries ) to finance its recovery, Europe has built its strength on encouraging exports and domestic consumption. Although the VAT tax and inflation could lead to lower GDP growth rates in the future, Europe still has a more stable economy than does the U.S.

Action Steps:
Make sure you have European mutual funds in your portfolio. This will protect you from both U.S. stock market volatility and the decline of the dollar.

Source: Eurostat, Insee, U.S. Commerce Dept.