Euro zone economic sentiment rose strongly in July, buoyed by figures from Germany that point to a recovery as the currency area overcomes the sovereign debt crisis, but the outlook remains uncertain.

The European Commission said its economic sentiment indicator for the 16-nation currency area rose to 101.3 in July, a 28-month high, from an upwardly revised 99.0 in June. Economists polled by Reuters expected the index to stay at 99.0.

Economic morale is the latest in a string of indicators that have shown the currency area continues to recover from the worst economic crisis in decades, despite turbulence on its sovereign debt market and uncertainty about the health of banks.

July's improvement in the (euro zone) consumer and business surveys adds to the evidence that the euro-zone is performing surprisingly well, but with stark divergences between countries, said Jennifer Mckeown, senior European economist at Capital Economics.

Martin van Vliet said: It confirms the spillover effect of the debt crisis to the real economy was limited. But the euro zone economy is bound to lose steam in the second half of the year. For now, let's enjoy it while it lasts.

OUTLOOK GLOOMY

Growth may falter because of fiscal austerity measures ordered by many governments to prevent the sovereign debt crisis from spreading from Greece to other countries. Foreign demand for European goods is also expected to diminish.

Howard Archer, chief European economist at IHS Global Insight, noted that the index measuring consumers' willingness to make major purchases over the next 12 months fell as the did the figure showing consumers' willingness to make major purchases at present.

This raises question marks as to whether improved consumer confidence will translate into significantly higher spending. We have our doubts on this given that the euro zone unemployment rate is currently at a near 12-year high of 10.0 percent, he said.

The Commission said economic sentiment improved thanks to an increase in the index for the export-driven industrial sector to -4 from -6 and improvement in services to 6 from 4.

Morale of consumers, whose demand is crucial for making economic growth self-sustaining, rose to -14 from -17.

The increase was driven by strong figures in Germany, the euro zone's biggest economy, where economic sentiment rose to 110.1 from 106.1. The figure also increased in France and Italy, but fell in Spain.

In the wider 27-nation European Union, economic sentiment grew to 102.2 in July from 100.3 in June.

The Commission's separate business climate indicator for the euro zone increased more than expected, rising to 0.66 in July from 0.40 in June. It was the highest reading since March, 2008.

It has forecast that the euro zone will register growth of 0.9 percent this year after gross domestic product contracted 4.1 percent in 2009.

The Commission survey also showed that euro zone inflation expectation remained muted.

Selling price expectations in industry fell to 5 in July from 6 in June, while consumers' assessment of price trends over the next 12 months remained unchanged at 11.

The European Central Bank, which watches the indicators closely, is expected to leave its main interest rate at 1.0 percent well into 2011.

(Editing by Luke Baker)

Germany