Eurozone teeters on the edge of first-ever recession

The eurozone economy is on the verge of its first-ever recession after the economies of Germany, France and Italy all shrank in the second quarter of this year.

The overall 0.2 per cent fall in activity over the three months to June in the 15-nation single currency area was worse than the markets had anticipated, and helped to give the pound a rare boost against the euro. Sterling also stabilised, albeit at a 22- month low, against the dollar, following a week of dramatic falls. The EU revised July's rate of inflation for the eurozone down slightly, from 4.1 to 4 per cent.

The unexpectedly poor news on European growth came a day after the Bank of England hinted at the strong possibility of a recession in the UK over the next year, and added to a global round of bad news. However, the fall in European GDP was still smaller than that revealed yesterday in the world's second biggest economy, Japan, which shrank 0.6 per cent in April to June. The US recorded growth of 0.5 per cent, partly driven by tax cuts. The upshot was that sterling bounced a little against the euro, which fell 0.4 per cent to 79.52p, and, with little movement against the dollar after the dramatic falls earlier in the week, sterling edged off an 11-year low set the previous session, on a trade-weighted average basis.

But most focus yesterday was on the deteriorating prospects for eurozone countries. Although less bad than a previous leak had suggested, the figure for Europe's largest economy, Germany, was nonetheless disappointing, with a 0.5 per cent quarterly contraction in her economy, following a surge of 1.3 per cent in the first three months of this year.

The gathering strength of the euro, and the slowdown in demand for German-made capital goods in emerging markets such as China, accounted for much of the sharp decline. Germany has for some time been highly dependent on its successful export sector to maintain its growth rate, and has benefited, compared to the Anglo-Saxon economies, from relying more on engineering and less on financial services and the appreciation of house prices to sustain itself. However, the global slowdown has begun to hit Europe hard. The deputy economy minister, Walther Otremba, said he could not rule out that the German economy would shrink further in the third quarter.

Most of Europe is in decline. France also reported a reduction in its national income, with GDP down by 0.3 per cent on the previous quarter. Spain, suffering especially severely from a property crash, grew by just 0.1 per cent, hardly sufficient to make an impact on an unemployment rate of over 10 per cent, the worst of Europe's major economies. The Dutch economy recorded zero growth. Taken together with a previously reported decline of 0.3 per cent in Italian economic activity, Eurostat says the overall eurozone GDP contraction was 0.2 per cent on the quarter.

Nor are prospects for the third quarter much better. As in the UK, forward indicators of economic growth, such as business confidence and forward orders, point to a recession over the next three months. Matters have not been helped by a hike in the eurozone interest rate last month, though most observers now think the next moves by the European central bank will be in the opposite direction – hence the currency's comparative weakness against sterling yesterday.

Longer term, though, analysts were more optimistic about the eurozone than the UK or the US, because of its more broadly based economy. Jennifer McKeown, European economist at Capital Economics said: "As the economy does not suffer from the serious imbalances apparent elsewhere, we still expect the region to outperform the UK and the US over the medium term."