Global Insight

August 16, 2011 5:21 pm

Eurozone economic engine gives nasty jolt

Ralph Atkins weighs Germany’s unexpectedly poor growth figures

Like the high performance cars it produces, Germany’s economy can roar ahead of others. It can also screech to a halt, giving passengers serious jitters.

Unexpectedly poor second-quarter growth figures were a nasty jolt for the eurozone. At the start of this year, Germany was Europe’s economic powerhouse; the surging confidence of its industrial sector infecting neighbouring economies – offering hope that debt crisis-hit southern Europe might be swept along for the ride.

By the time Angela Merkel, chancellor, started talks on Tuesday in Paris with President Nicolas Sarkozy of France on fresh measures to restore confidence in Europe’s monetary union, that story had changed. In the three months to June, German quarter-on-quarter growth had slowed to just 0.1 per cent – even more anaemic than in the US or UK.

With worries rising about global growth and even double-dip recessions in some countries, Germany’s growth performance is crucial. The slowdown will make Berlin still twitchier about extending financial help to distressed eurozone countries. On top of moral objections towards helping the imprudent will be worries increasing contingent liabilities as public finances become more stretched.

The risk is of a vicious circle: that Germany’s perceived fiscal rectitude escalates further the eurozone debt crisis, resulting in shock to economic confidence that hits investment and job creation across the region – and beyond – weakening growth further in months to come.

As such, the German-led eurozone slowdown has made life even less comfortable for the European Central Bank in Frankfurt. While the US Federal Reserve and Bank of England have looked for fresh ways to stimulate growth, the ECB has raised interest rates twice this year – most recently in July – to head off inflation. Higher official borrowing costs have hit hardest in interest-rate sensitive eurozone countries such as Spain and Ireland, hardly helping their plight. Rather than the hoped-for rebound in confidence, the ECB has found itself buying the bonds of crisis-hit countries on an ever larger scale – including, most recently, those of Italy.

At least outside Germany – where the ECB is usually criticised for being too soft on inflation threats – Tuesday’s growth data were seen as proof that those interest rate increases were a mistake on a par with the ECB’s July 2008 rate rise, just weeks before the collapse of Lehman Brothers investment bank. Financial market speculation about an ECB rate cut could gain momentum.

Jean-Claude Trichet, president, would, of course, reject any criticism. Official borrowing costs were raised when growth appeared robust and price pressures were clearly mounting, he could point out. Even at 1.5 per cent, the ECB’s main policy rate remains at a historical low; the eurozone economy has not – so far – fallen into a post-Lehman Brothers-style downturn.

But ECB forecasts for eurozone growth this year and next are likely to be revised downwards at its September meeting; hints about further monetary policy tightening could soon cease.

All is not lost. Germany’s economy has slowed rather than been thrown into reverse. Moreover, the second-quarter data almost certainly exaggerated the trend. While a deceleration was inevitable after an exceptionally strong first quarter and as a result of a cooling global economy, the 0.1 per cent increase in gross domestic product was not consistent with business confidence still near record highs nor continuing employment growth.

Crucially, unemployment is likely to continue falling in coming months – which will help boost the mood of consumers and politicians. If weak growth persists, industry’s prescient collective decision to hoard rather than shed labour during the 2009 recession would be repeated.

As a result the third quarter could see a rebound. But, currently, it is hard to see any dramatic reacceleration in Germany or the eurozone. Eurozone exports are already stalling – falling by almost 5 per cent in June compared with May, according to separate seasonally adjusted data on Tuesday. In July, German and EU exports to China were down 11 per cent compared with the second-quarter average, calculates Barclays Capital.

Fresh fiscal austerity measures will act as a further brake, not only in Italy and Spain but also France. Financial market turmoil will only make economic prospects gloomier – and the road ahead for the eurozone still more treacherous.

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