France posts surprise Q3 GDP growth, outlook still weak

France's economy unexpectedly grew in the third quarter as households splashed out on clothing and trade data turned positive, though high unemployment and rising taxes make for a gloomy outlook.

Preliminary data showing the economy expanded 0.2 percent on a seasonally adjusted quarterly basis confounded fears that France might slip into recession by year-end.

There was further good news as investors piled into a French government bond auction on Thursday, sending two-year yields to a record low as they sought a safe alternative to ultra-low returns on German debt.

Economists cautioned though that with unemployment running at a 13-year high and 30 billion euros ($38 billion) in additional taxes on households and businesses set to kick in next year, the bounce in the euro zone's second-biggest economy was unlikely to be maintained.

"A positive figure for the third quarter does not mean the crisis is over," said Philippe Waechter of Natixis Asset Management. "Private demand - both consumption and capital investment - are still very low. There's no momentum."

Prime Minister Jean-Marc Ayrault said the GDP figures did not take the pressure off the government to turn around the economy, which had stalled for three quarters until the third-quarter uptick.

"These indicators are promising but they're not enough," Ayrault said as he arrived in Berlin to meet German Chancellor Angela Merkel and defend the Socialist government's economic policies in the face of German concerns about France's flagging exports.

"The battle for growth is on and we absolutely must not ease up on this," Ayrault said.

Second-quarter gross domestic product was revised down to show a 0.1 percent contraction instead of being flat, according to data from the INSEE national statistics office.

Growth in the third quarter beat a Reuters poll forecast for zero growth quarter-on-quarter.

Household spending rebounded as spending on clothing rose strongly in the quarter, while consumers also spent more on health and services, the data showed.

The unexpected growth may provide a boost to President Francois Hollande who has launched a drive to turn around France's flagging competitiveness and lower unemployment. The weak economy has been a key factor in driving down his approval ratings since he took office in May.

Broken down by sector, household consumption, the engine of France's 2 trillion euro economy, grew by 0.3 percent in the third quarter after contracting 0.2 percent in the previous three months. Destocking by French firms, particularly in the transport sector, and falling investment were a drag on growth.

After two quarters of mild contraction, manufacturing output also crept up 0.1 percent, lifted by a rise in sales of transport materials and refining and coking.

Growth in exports accelerated to 0.5 percent from 0.3 percent in the second quarter. Crucially, volatile import demand declined 0.6 percent after strong growth of 1.6 percent in the second quarter.

GLOOMY OUTLOOK

Still, while France performed better than expected in the third quarter the outlook is gloomy as separate data on Thursday showed the euro zone as a whole slipped into its second recession since 2009.

France's unemployment rate of 10.2 percent is weighing on its 2-trillion euro economy and weak industrial production and business sentiment surveys, as well as looming tax rises, suggest it may end the year on a down note, economists say.

"We expect the French economy to contract again in the final quarter of this year," said Joost Beaumont of ABN Amro.

Hollande's government unveiled a plan last week to boost the competitiveness of French industry, including 20 billion euros a year in tax credits to lower labor costs. However, German government sources have expressed concern the measures do not go far enough.

($1 = 0.7856 euros)

(Additional Reporting by Alexandria Sage in Paris and Elizabeth Pineau in Berlin; Editing by Catherine Bremer and Susan Fenton)