EUROZONE GDP EXPANDS, BUT RETAIL SALES DON'T.

European Central Bank leadership predicts that the strong euro will boost household consumption, but retail sales data show that the turnaround will be slow in coming.

The fourth quarter of 2003 got underway with minor year-on-year retail sales losses. Sectors that showed the highest rate of loss included TXiles, clothing, and footwear, as well as specialized food products. Weakness in those sectors underscores the unwillingness of eurozone households to engage in high-end discretionary spending.

The recovery in sales of goods and services originating in the eurozone will come slower than that for imports. The more than 15 percent increase in the value of the euro against the dollar last year gave a cost-competitive edge to goods originating in the United States and China, which has a loose currency link with the U.S. dollar.

Several factors portend increased eurozone household expenditure as 2004 progresses. One is the determination of the European Central Bank to maintain both low interest rates and low inflation. Near record low interest rates will make it possible to offer attractive terms of financing on high-end goods. Real household income is on the rise. Since most eurozone households already have more than enough income to cover the basic necessities of life, discretionary expenditure should rise this year.

Eurozone business confidence showed signs of improvement during the second half of 2003 and that bodes well for gradual upward momentum in job creation and capital spending. Although the level of unemployment will probably not drop significantly during the first half of this year, consumer confidence should begin to improve slightly by the second quarter.

Sales of non-durable goods are poised for modest growth ranging from 1 to 2.5 percent through the first half of this year. However, growth in sales of high-end durables will be spotty throughout most of this year, with overall growth for the first half of the year unlikely to exceed 3 percent.

Expenditure on high-end services should begin to gain upward momentum during the second quarter of this year, driven by a gradual increase in tourism activity. Strongest growth should be noted in sales for the hotel and restaurant sectors. However, it is important to bear in mind that year-on-year growth data will reflect statistical lag from periods of unusually low tourism activity registered in 2003.

Capital expenditure on the part of eurozone industry will recover faster than household spending. A modest increase in demand both at home and abroad for finished goods from the eurozone should contribute to year-on-year growth in capital goods orders approaching 5 percent. Throughout most of this year, capital expenditure will primarily be aimed at acquiring production equipment in order to remain internationally competitive.

Most eurozone businesses will keep plant expansion projects on hold throughout 2004 and into 2005 as they struggle to occupy installed capacity. Another factor that will limit growth of production facilities in the medium to long term is the trend toward shifting production plants to nations with more cost-competitive labor forces.

Demand for business services will pick up this year. Orders for telecommunications and logistical services should achieve slight upward momentum during the first half of 2004, and year-on-year gains ranging from 5 to 10 percent after that. Cargo transport hubs will benefit from increased trade this year.