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Faltering Germany Casts Cloud Over Fragile Eurozone

Traders are seen at their desks in front of the DAX board at the Frankfurt stock exchange, Germany, July 10, 2014.
Traders are seen at their desks in front of the DAX board at the Frankfurt stock exchange, Germany, July 10, 2014.
Reuters

Germany's faltering economy has cast further doubt over the eurozone's prospects for recovery this year, with no other big country strong enough to pick up the slack.

Since late last year, the 18 countries using the euro have been climbing steadily out of a two-year recession. But just as the bloc appeared to be turning the corner, its star economy, Germany, has fumbled the ball.

To make matters worse, other big states, including the eurozone's second-largest economy France, show little prospect of a strong rebound.

French industrial production plunged unexpectedly in May, and inflation fell to its lowest level since the financial crisis in 2009. Adding to the gloom, Italy's factories also saw a 1.2 percent drop in output in May, the steepest fall in more than a year-and-a-half.

And while Spain is expecting growth to accelerate to near 2 percent in 2015, one in four of Spain's workforce are out of work after the collapse of a property price bubble.

“Europe is getting more and more Japanese,” said Carsten Brzeski, an economist with ING, echoing concerns of others that the region faces permanent slow growth and no price inflation.

“The eurozone is flat lining. I don't see substantial growth for another year.”

Choking exports

At the start of 2014, the picture looked different.

Throughout the first three months, the German economy grew at its strongest rate in three years - 0.8 percent - thanks in part to mild weather lifting construction work.

That made up for stagnation or slowdown in France, Italy and the Netherlands and prevented the bloc's overall recovery from stalling.

While Britain, outside the bloc, underlined its robust recovery with the strongest quarterly growth in four years - to end June - the mood is turning in continental Europe's industrial powerhouse. German exports, imports, industrial orders, output and retail sales all fell in May compared with a month earlier.

On Thursday, Germany's economy ministry cautioned about the impact of the crisis in Ukraine on confidence in Germany as it painted a bleak picture of the second quarter.

“After a growth-strong start to the year, the development of the German economy in the second quarter is subdued,” the report said.

Across the whole eurozone, analysts expect growth in the second quarter at around 0.2 percent, quarter on quarter, as seen in the three months to March.

In the boardrooms of Germany's Mittelstand, the small and medium-sized companies that employ about 70 percent of its workforce, the sense of nervousness is palpable.

“The mood has deteriorated after the strong start to the year,” Mario Ohoven, head of the BVMW Mittelstand association, told Reuters. He blamed the 'smoldering' eurozone crisis and Ukraine for crimping companies' export forecasts.

Martin Wansleben, Managing Director of the German Chamber of Industry and Commerce, made a similar assessment.

“The ongoing Ukraine-Russia crisis, the conflicts in the Middle East and the ropy economic activity in emerging markets are clearly choking the export business,” he said.

Both expect an improvement later in the year, as do economists, but few believe Germany's economic muscle can this time pull its neighbors from the trough.

“The numbers are bumpy,” said Jonathan Loynes, Chief European Economist at Capital Economics. “I think the economy is growing, but ... not strongly enough to sustain a strong economic recovery across the eurozone as a whole.”

Stubborn

There is a wider debate across Europe about whether to shift the policy focus towards spending to lift the economy and away from spending cuts and austerity.

Italy's Prime Minister Matteo Renzi is leading a drive for greater flexibility in the way European budget rules are applied, whereas Germany wants to keep the focus on thrift.

But for some, that debate glosses over a deeper problem that holds back the eurozone economy - a reluctance to change.

Germany, they say, is stubbornly wedded to its model of manufacturing, while others, including France, are resisting social and economic reforms needed to boost industry.

“Germany should be the locomotive of Europe,” said Guntram Wolff of Brussels-based think-tank Bruegel.

“But the feeling in Germany is that we want to rely on the strength of the last 10 years in manufacturing, and we don't accept change in the economy. The services sector, for example, is still quite regulated.”

In neighboring France, the government has struggled to reform its social welfare system and labor model.

President Francois Hollande is pinning his recovery hopes on plans for nearly 40 billion euros in corporate tax breaks to be phased in over the coming three years.

But the announcement has done little so far to lift business confidence, which has ebbed ever lower in France. The country's central bank estimates growth of only 0.2 percent in the second quarter after stalling in the first three months.

Weak business confidence in turn weighs on company investment, which the government is counting on to underpin growth even though consumer spending, currently weak amidst high unemployment, is traditionally the main driver.

For captains of industry, such as Christophe de Margerie, the chief executive of French oil major Total, this reluctance to reform is one of the chief problems.

“Why doesn't it [the economy] take off as fast as we would like?” he recently told reporters.

“Probably first of all because we were hit by the crisis later than others so there is a delayed impact, but also because our welfare system ... sometimes hides how tough times are.”

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