It's official: eurozone collapses into its first recession

Pressure on ECB to cut rates after Germany and Italy pull down economy
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Europe's economy officially collapsed into recession for the first time since its inception during the third quarter, boosting hopes that the European Central Bank will be forced to cut interest rates again in December.

The eurozone, made up of the 15 countries that use the euro as their primary currency, shrank by 0.2 percentage points between July and the end of September, having contracted by the same margin during the preceding three months as well. Two successive quarters of negative growth marks an economy's official shift into recession.

Germany and Italy, the continent's largest and fourth largest economies, dragged the eurozone down – both slipped into recession during the third quarter. Spain also suffered its first quarter of negative growth in 15 years. However, France just managed to maintain a positive growth rate.

"Now that the recession has been confirmed, the debate will concentrate on its length and severity," said Martin Van Vliet, from ING Financial Markets.

"Historically, recessions preceded by episodes of banking-related financial stress have tended to be more profound and long-lasting. Consequently, it seems overwhelmingly likely that the current, credit crisis-induced downturn is going to be more painful than the previous one in 2001/2002, after the dotcom bubble burst.

"At the same time, however, we remain hopeful that the aggressive policy measures taken thus far, and the seemingly inevitable further policy stimulus, will help pave the way for a gradual recovery in the second half of next year."

The latest GDP figures reignited hopes that the European Central Bank (ECB) would cut interest rates again next month. Rates stand at 3.25 per cent after the bank announced two 0.5 percentage point cuts at the start of October and November.

Other economies around the world have been cutting rates much more quickly than the ECB, putting pressure on the bank to follow suit.

The US Federal Reserve has cut rates all the way from 4.25 per cent to 1 per cent since the start of the year, while the Bank of England surprised the markets with a 1.5 percentage point cut in interest rates last week, which put UK rates at 3 per cent – their lowest level since 1955.

In spite of further expected rate cuts in Europe, the euro continued to strengthen against the pound, as investors speculated that the recession would be deeper and longer in the UK than on the Continent.

Comments by the Prime Minister, Gordon Brown, suggesting that the Bank of England was planning further imminent UK rate cuts, also added to another bad day for the British currency. Sterling hit new 13-year lows of less than €1.17 to the pound.

"All the data and news out of the UK has been on the negative side, suggesting we will see further aggressive rate cuts from the Bank of England, which has kept sterling under pressure," said Ian Stannard, the BNP Paribas senior foreign exchange strategist.

Nevertheless, while Britain is predicted to suffer a worse recession than Europe, economists were still downbeat about prospects for the eurozone over the coming months.

Howard Archer, the chief European economist for consultants Global Insight, said: "Not only did the third-quarter contraction in GDP confirm that the eurozone is now in recession, but latest data and survey evidence indicate that the fourth quarter is likely to see a sharper fall in GDP as the financial crisis bites harder."

"Consequently, with consumer price inflation now retreating markedly across the eurozone and underlying inflationary pressures now clearly moderating appreciably, we expect the ECB to cut interest rates by a further 50 basis points from 3.25 to 2.75 per cent in December, and to bring them down to 2 per cent in the first half of 2009. This would match the low point in interest rates since the eurozone came into being in 1999, and it is highly possible that interest rates could fall lower still."