France, Germany Exit Recession

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LONDON — Government programs to support the auto industry helped Germany and France return to economic growth in the second quarter, rebounds that stoked hopes the recession in the wider 16-country euro area may also end sooner than thought.

Europe's two biggest economies each saw growth of 0.3 percent from the previous three-month period, surprising analysts' expectations for equivalent declines and technically ending their worst recession in decades.

The French and German increases marked a stunning turnaround from the previous quarter, when Germany shrank by a massive 3.5 percent and France contracted by 1.3 percent.

The unexpected increases in Germany and France meant that the 16-country euro area contracted at a sharply reduced rate of 0.1 percent, much less than the 0.5 percent anticipated in the markets.

Though the euro zone drop was the fifth straight quarterly decline, it was a marked improvement on the record 2.5 percent fall recorded in the first quarter and was even better than the 0.3 percent quarterly decline recorded in the U.S., the world's single largest economy.

France's Finance Minister Christine Lagarde credited the government-backed stimulus plan for the auto industry for the country's ability to weather the economic storm and return to growth.

"France is finally coming out of the red," she said on RTL radio.

Lagarde later told Le Figaro newspaper that she expected the economy to demonstrate "a complete exit from the crisis" in mid-2010. "We are clearly in the stabilization phase," she was quoted as saying in an interview released Thursday night.

Countries across Europe have established so-called "cash for clunkers" programs in the hope that wary consumers will trade in their old cars for newer and more efficient models – in the process kick-starting the economy.

Unicredit economist Andreas Rees reckons that the export-dependent auto sector contributed 0.25 percentage point to overall German GDP growth.

Despite the apparent benefits, Europe's economy is not out of the woods yet – it still faces the prospect of a marked rise in unemployment when programs to support workers putting in reduced hours end, and worries about what happens after the expiration of the auto incentives.

And recovery would start from a much lower base level – the euro zone economy is 4.6 percent smaller than a year ago and that could take two to three years of solid economic growth to make up.

Nevertheless, Thursday's figures will likely surprise policy-makers at the European Central Bank. As recently as last week, the central bank's president Jean-Claude Trichet said the recession would likely continue until next year at least.

The better than expected performance helped the euro bounce half a percentage point to $1.4270.

Much will depend on what happens in the currency markets over the coming months. Europe's manufacturers will not have been pleased that the euro has consolidated above $1.40 after having fallen toward $1.25 earlier in the year – a higher euro makes euro zone products more expensive in export markets.

The signs so far are that exporters in Germany, the euro zone's biggest single economy, have managed to offset the impact of the higher euro amid rising global demand. Government figures last week showed that German exports were up 7 percent on the month in June, their biggest rise in nearly three years.

Other countries may not be as capable as Germany at offsetting the negative euro impact, analysts cautioned.

"Whilst German exporters may be able to absorb a rising euro, given that their high-end produce faces less competition than those of their neighbors, it is doubtful whether France and Italy can without suffering much pain," said Neil Mellor, analyst at the Bank of New York Mellon.

Economists also stressed that the road to recovery will not be straightforward – especially as much of the improvement in Germany and France was due to very sharp falls in imports, which reduced trade deficits and lessened the GDP reduction stemming from the net trade balance.

In addition, they said rising unemployment will continue to rein in consumer demand.

"With output unlikely to return to pre-recession levels in the medium term, unemployment may become a serious drag on the euro area's economic performance," said Jorg Radeke, economist at the Centre for Economic and Business Research in London.

The contrasting economic performances among the euro member states are likely to cause headaches for the European Central Bank, said Radeke.

While Germany and France saw output rise in the second quarter, other euro zone countries remain mired in recession, including Italy, which saw GDP fall another 0.5 percent, and the Netherlands, where GDP dropped 0.9 percent. Figures Friday could well show Spain contracted a further 1 percent as its economy reels from a near 20 percent unemployment rate.

The EU as a whole, including countries that don't use the euro such as Britain and Sweden, saw output drop 0.3 percent in the second quarter from the previous three month period. Britain dragged the rate lower with a 0.8 percent decline.

Once again, the Baltic countries were the big laggards, with output sliding a quarterly 3.7 percent in Estonia, 1.6 percent in Latvia and a massive 12.3 percent in Lithuania.

A more detailed breakdown of the GDP figures in the EU will be released on September 2.

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Associated Press Writers Angela Charlton and Maria Danilova in Paris contributed to this report.

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