Analysis: Slowdown in core a new threat for euro zone

Reuters

By Noah Barkin

BERLIN (Reuters) - It's not hard to come up with reasons for the euro zone's exasperating inability to get a grip on its debt crisis.

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There's the German government's reluctance to take the bold steps that seem necessary to bring about a change in market sentiment toward Europe's single currency project.

There's the incessant public squabbling between the bloc's 17 member states and the snail's pace at which the crisis-fighting decisions they take come into effect.

And then there's the daunting challenge of chipping away at the unsustainable debt mountains that have built up in Greece and other euro zone stragglers.

But until now there has been one constant throughout the crisis which has helped the bloc muddle through despite all these faults: strong growth in the heart of Europe, with Germany leading the way.

Now even that pillar of support may be falling away.

News last week that Europe's largest economy grew a meager 0.1 percent in the second quarter has major implications for the broader euro area, even if it was partly overshadowed on the day by a Paris meeting between Germany's Angela Merkel and France's Nicolas Sarkozy.

Special factors -- a temporary surge in power imports and a correction in construction activity following a warm winter -- may have exaggerated the extent of German weakness.

But coupled with data showing zero growth in France over the same April-June period, the figures raise the possibility of a significant consumer-driven slowdown in the very countries that have kept the euro zone economy afloat since the debt crisis erupted nearly two years ago.

RECESSION RISK

That has worrying implications. First, countries like Greece and Portugal that are desperate for growth can no longer rely on strong demand from their northern partners to help lift them out of their hole.

On Friday, Greece's Finance Minister Evangelos Venizelos said his economy was likely to shrink by over 4.5 percent this year, casting new doubt on forecasts for a much-needed return to growth next year.

For the bloc as a whole, this is poison.

Elga Bartsch, an economist at Morgan Stanley, believes the euro zone now faces a real risk of recession due to a volatile mix of factors: slower global demand; tighter credit from banks; repeated austerity efforts; high commodities prices; an overvalued euro; and higher interest rates from the European Central Bank.

"What the poor data show is that neither Germany nor France is going to be a locomotive for the euro zone going forward," she said. "With the euro area as a whole teetering on the brink of recession territory, the risks of another shock pushing the region over the edge are significant, in our view."

DISENCHANTED VOTERS

A sudden slowdown in the two countries that make up one half of the bloc's gross domestic product (GDP) could also have major

political ramifications, narrowing both Merkel and Sarkozy's room for maneuver in fighting the crisis.

Merkel already faces a tough task in winning support from her conservative allies for an expansion of the powers of the euro zone's rescue mechanism, the European Financial Stability Facility (EFSF), when the German Bundestag votes next month.

Should the economy weaken further, pushing up unemployment, skepticism about helping Germany's euro zone partners could grow among voters and the ruling parties in Berlin at a time when Merkel faces intense diplomatic and investor pressure to take bolder action, for example agreeing to joint euro zone bond issuance.

"If the economic weakness that we saw in the second quarter does persist, the debate in Germany could change," said Norbert Barthle, a budget expert in Merkel's Christian Democrats.

Elections next month in two German states -- Mecklenburg-Vorpommern and Berlin -- should give a first indication of the extent of public dissatisfaction with the German leader's management of the euro crisis.

(Writing by Noah Barkin; Editing by Ruth Pitchford)