Euro zone economy shrinks despite German growth

Reuters: The euro zone’s debt-ravaged economy shrank in the second quarter, having flatlined in the first, despite continued German growth which economists said could soon be snuffed out.

The 17-nation currency bloc contracted by 0.2% on the quarter, data showed on Tuesday. Germany eked out growth of 0.3%, marginally beating forecasts, but its forward-looking ZEW sentiment index slid for a fourth month running, undercutting even the lowest estimate in a Reuters poll.

Economists said worse is likely to come and even Europe’s largest economy is unlikely to defy gravity for long unless decisive action is taken to tackle the bloc’s debt crisis.

“Growth turned out to be pretty solid. But this could be the last positive piece of news out of Germany for some time,” said Joerg Kraemer at Commerzbank. “The German economy could contract in the summer. It is fundamentally in good structural shape, but can’t decouple from the recession in the euro zone, plus the global economy has also shifted down a gear.”

Aside from a downward blip in the last three months of 2011, the euro zone has posted pretty consistent, albeit anaemic, growth over the past three years although some of its debt-laden members have been in recession for some time.

“It was a touch better than we expected, but I think overall it confirms the idea that the euro zone is in a recession phase,” Aline Schuiling, economist at ABN AMRO, said of Tuesday’s data.

“What we see is a vicious circle of budget cuts, high interest rates in the periphery and sovereign debt rising,” she said. “Policymakers are moving very slowly. There are limited prospects for growth in the euro zone. We expect another contraction in Q3.”

For France, it was the third consecutive quarter of zero growth. The central bank has already said it expects a mild contraction in the third quarter.

“These figures are not excellent, but at the same time France is not in recession while the majority of its European partners are,” Finance Minister Pierre Moscovici told Europe 1 radio.

Safe-haven German Bund futures fell and European stocks rose after the slightly stronger than expected German and French GDP reports but the euro dipped against the dollar after the ZEW survey came in worse than expected. The think tank’s monthly poll of economic sentiment slid to -25.5 from -19.6 in July. ZEW economist Christian Dick said the German economy would slow due to weak growth in its main export markets, but would not deteriorate sharply. Austria and the Netherlands almost matched Germany’s performance, each posting growth of 0.2%. Economists surveyed by Reuters had expected the Dutch economy to shrink 0.3%.

Finland, one of Germany’s northern European allies in pushing for austerity, suffered a 0.7% year-on-year fall in GDP.

Southern pain

For the currency bloc’s members at the sharp end of its debt crisis, the picture is bleaker still and as economies shrink, so do tax revenues, making deficit-cutting even harder to achieve.

That has fostered a growing debate inside and outside Europe about the sense of austerity drives.

Bailed-out Portugal’s recession deepened with GDP diving by 1.2% on the quarter and Cyprus contracted by 0.8%.

Figures released on Monday showed deficit-cutting measures helped to shrink Greece’s economy 6.2% year-on-year in the second quarter. Economists say the slump will persist as the government scrambles to secure billions in additional cuts to keep bailout funds flowing.

Italy’s second quarter data last week showed the economy contracted 0.7% quarter-on-quarter, compounding the difficulties for Mario Monti’s technocrat government as it tries to avoid a bailout.

Spain’s economy shrank 0.4% over the same period, pushing it deeper into recession, according to figures out two weeks ago.

The big unanswered question is whether a weakening economy will make Germans, the EU’s paymasters, less likely to support government rescue efforts for the broader euro zone.

German Chancellor Angela Merkel has said repeatedly over the past year that she will do everything to save the euro, most recently after the European Central Bank signalled it would intervene in the bond market to lower Spanish and Italian borrowing costs.

Not all Germans support that course and the chancellor’s room for manoeuvre appears to be shrinking at a time when both Greece and Spain may soon require new rescues. However, if ordinary Germans start to feel real economic pain, their response could be to demand their leaders sort out the crisis that is now finally knocking at their door.

Spanish and Italian bond yields have steadied since ECB President Mario Draghi promised to do whatever it takes to save the euro zone. It is quite possible that Madrid and Rome will seek help from the euro zone’s rescue funds and the ECB before the year is out.

“It remains decisive whether the euro crisis can be controlled. We expect that the ECB has initiated a turning point with its signal of bond purchases,” said Christian Schulz, economist at Berenberg Bank. “After a weaker summer the German economy will be able to grow faster again from the fourth quarter.”