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This has to be the worst of it. If it is not, then the eurozone’s prospects are grim indeed. The German economy shrank by 4 per cent in the first quarter compared with the last three months of 2008. That is far from the astonishing 11 per cent shrinkage suffered by Slovakia during the same period. But it was still the lousiest performance of any big eurozone country, by far. If the German economy continues to shrink at this rate, it will be a fifth smaller by the end of the year, entirely reversing the decade and a half of growth since unification.

That has worrying implications for government revenues, which will fall as the recession bites. Even the hairshirts in Berlin forecast a budget deficit of more than 4.2 per cent of gross domestic product next year. At €90bn, it will also be Germany’s biggest, in absolute terms, since the second world war. Further tax rises and spending cuts required to return the deficit to within the 3 per cent limit stipulated by stability pact rules will only slow growth further. All eurozone countries, but especially those with proportionately bigger deficits, such as Italy and Spain, face the same challenge. That being the case, the credit quality of European sovereigns can only get worse.

Yet, paradoxically, spreads of other European government debt over German bunds have tightened dramatically over the past three months. That is partly thanks to the market rally, which has boosted not only equities but also the prices of European sovereign bonds that some had speculated might default. Yields on 10-year Irish government bonds, for example, have fallen by 32 basis points, and on 10-year Spanish debt by 11bp. A larger part of the tightening spreads, however, has come because bund yields have risen by some 25bp over the same period. That is a uniquely bad performance by German bonds among eurozone sovereigns. Indeed, if the recession proves longer and deeper than now hoped, German debt may be the credit to short.

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