German slump drags Europe into even deeper recession

Sixteen eurozone nations suffer a 4.6 per cent fall in GDP in the first quarter

By Sean O'Grady, Economics Editor

Saturday, 16 May 2009

A "disastrous" contraction in the Germany economy of 3.8 per cent in the first months of this year, equivalent to more than 15 per cent on an annualised basis, has dragged the eurozone into a deep recession. German GDP is down 6.9 per cent on this time last year; the 16-nation eurozone 4.6 per cent lower.

The German performance shocked analysts, and is probably the most miserable quarterly showing since the foundation of the federal republic six decades ago. Germany's traditional strengths – exports and manufacturing – have turned against her as consumers postpone purchases of big-ticket items such as cars, industry cuts back on investment goods, and world trade has collapsed. As the eurozone's largest economy, this has had a grievous impact on her neighbours.

Despite a comparatively healthy performance recently, thanks to her relatively large public sector, France is also now officially in recession, for the first time since 1993: GDP is down 1.2 per cent on the quarter.

Italy and Spain, the next largest eurozone members, were also down, by 2.4 per cent and 1.8 per cent respectively. The eurozone shrank by 2.5 per cent compared with a 1.6 per cent contraction in the previous quarter. The equivalent UK figure is -1.9 per cent.

However, as in the UK, most economists now believe that the most serious phase of the recession is now over. Howard Archer, European economist at Global Insight, commented: "At least, this should mark the nadir in the eurozone's recession as there are mounting signs that the rate of contraction is now moderating appreciably as the monetary and fiscal stimulus increasingly kicks in."

The weaker than expected economic data will increase the pressure on the European Central Bank to relax monetary policy still further. Against the ECB's target inflation rate of 2 per cent, the latest figures show consumer price inflation in Europe at a record low of 0.6 per cent in April, and most observers expect prices to fall generally later this year.

The ECB will almost certainly, analysts say, keep interest rates at their level of 1 per cent of the rest of 2009 and much of 2010; the more serious question is whether the ECB will follow the Bank of England and the US Federal Reserve into a policy of "quantitative easing", having already announced a less extensive programme of "credit easing", which will not increase the European money supply as the British and American schemes do. The Governor of the Bank of England, Mervyn King, declared this week that he was "not disappointed" with the efficacy of their scheme, which was recently expanded by a further £50bn to a total cash injection to the economy of £125bn.

Richard McGuire, fixed income strategist at RBC Capital Markets, said: "A disastrously weak GDP outturn in Germany underpinned this downside surprise. While there are tentative signs the sharp pace of the European downturn may now be bottoming out, as alluded to by the ECB president [Jean-Claude] Trichet, the unexpectedly weak start to this year sees the risks to the ECB's growth projections. Flat quarterly data for the remaining quarters of 2009 would see annual growth come in at -3.8 per cent relative to the ECB's current forecast band of - 2.2 per cent to -3.3 per cent. This, in turn, stands to keep up the pressure on the Bank to consider some form of additional stimulus, whether it be taking rates sub 1 per cent or further beefing up its credit easing programme."

Some emerging economies in eastern Europe, many with currencies linked to the euro, have fared as badly as their western neighbours, according to the EU statistical agency Eurostat: the Hungarian economy contracted by 5.8 per cent on a year ago; Slovakia and Romania are down 5.4 per cent and 6.4 per cent on the same basis. The Baltic states, also EU members, have also gone into reverse.

Analysts at Capital Economics explained: "The region experienced a 'sudden stop' in capital inflows at the start of the year, which brought the banking system in a number of countries to the brink of collapse. A lasting return to positive growth remains dependent on a sustained recovery in the eurozone."