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Euro zone economy shrinks

The euro zone's debt-ravaged economy shrank in the second quarter, despite German growth.

Euro. Picture: AFP

BRUSSELS - The euro zone's debt-ravaged economy shrank in the second quarter, having flat lined in the first, despite continued German growth which economists said could soon be snuffed out.

The 17-nation currency bloc contracted by 0.2 percent on the quarter, data showed on Tuesday. Germany eked out growth of 0.3 percent, 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 were 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.

"Overall it confirms the idea that the euro zone is in a recession phase," Aline Schuiling, economist at ABN AMRO, said.

"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 ... 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. The euro also rose though its climb was thwarted 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 percent. But Finland, one of Germany's northern European allies in pushing for austerity, suffered a 0.7 percent year-on-year fall in GDP.

EU Economic and Monetary Affairs Commissioner Olli Rehn said the European Union and European Central Bank were ready to act if needed to shore up the currency bloc.

"To my mind it is clear that both the European Union and ... ECB are ready to take action once certain conditions are met and if there is a request by some member state," he said in an interview.

Spanish and Italian bond yields have steadied since ECB President Mario Draghi promised to do whatever it takes to save the euro zone although a government would first have to ask for help from the bloc's rescue funds.

SOUTHERN PAIN

For the countries at the sharp end of the 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 percent on the quarter and Cyprus contracted by 0.8 percent.

Figures released on Monday showed deficit-cutting measures helped to shrink Greece's economy 6.2 percent 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 percent 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 percent over the same period, pushing it deeper into recession.

The big unanswered question is whether a weakening economy will make Germany, 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 ECB 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.

"I have full trust in the German people and political leaders that they are fully committed to the euro," Rehn said.

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. If so, most economists expect the German economy at least to rebound after a gruelling third quarter as confidence revives.

Christian Schulz, an economist at Berenberg Bank in London, said it was vital to get a grip on the euro zone crisis. "We expect that the ECB has initiated a turning point with its signal of bond purchases," he said. "After a weaker summer the German economy will be able to grow faster again from the fourth quarter."

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