Germany, France Put Europe on Course For Recovery

By Matthew Brockett

Aug. 14 (Bloomberg) -- Germany and France are hauling Europe out of its worst recession since World War II, aiding a global economic recovery.

The euro region’s two largest economies, among the nations labeled “Old Europe” by former U.S. Defense Secretary Donald Rumsfeld in 2003, unexpectedly returned to growth in the second quarter. That cut the drop in the 16-nation bloc’s gross domestic product to just 0.1 percent, helping it outperform the U.S. and the U.K.

“It’s France and Germany that are pushing things up,” said Erik Nielsen, London-based chief European economist at Goldman Sachs Group Inc., which now predicts euro-region growth of 0.5 percent in the third quarter instead of stagnation. “But the recovery is still fragile, and it will be at least a year before the European Central Bank raises interest rates.”

Global stimulus measures to battle the deepest slump since the Great Depression have boosted demand for European exports, and government packages are supporting spending at home. The danger is that the rebound will run out of steam as those policies expire.

“These are short-term positive signs, but the French and the Germans have thrown a lot at it,” former Bank of England policy maker David Blanchflower said yesterday in a Bloomberg Television interview. “They’ve got the cash-for-clunkers program and subsidies in the labor market. My view is: early days. One quarter doesn’t make a trend.”

Cash for Clunkers

Government and household spending were among the main drivers of second-quarter growth in Germany and France. German Chancellor Angela Merkel, who faces national elections next month, has committed 85 billion euros ($121 billion) to revive the economy. French President Nicolas Sarkozy’s stimulus package is worth about 30 billion euros.

Both countries have turned to vehicle-scrapping subsidies as one way of encouraging consumers to spend. Germany offers a 2,500-euro payment to people who junk old cars to buy a new one, while France offers 1,000 euros. The subsidies are due to be withdrawn at the end of this year.

“As the schemes expire, households will have to face up to high and rising unemployment and weak earnings,” said Colin Ellis, an economist at Daiwa Securities in London. “We still think that the euro area will fall back into its old habits, with exports having to take up the mantle of growth again.”

Fewer Jobs

The euro area’s jobless rate of 9.4 percent is the highest since 1999. The region’s potential growth rate may slide to 1.3 percent from 2 percent, UniCredit Group estimates. The rate at which the U.S. can grow without inflation may drop to 2.5 percent from about 3.25 percent, the bank says.

There are signs that Europe’s exports are picking up. German sales abroad gained 7 percent in June and French exports rose 1 percent in the second quarter.

The German and France economies both expanded 0.3 percent in the three months through June after four consecutive quarters of contraction. Almost all forecasters in Bloomberg News surveys had predicted GDP would decline.

By comparison, the U.S. economy shrank 0.3 percent in the second quarter from the first three months of the year and British GDP dropped 0.8 percent. Japan will report second- quarter figures on Aug. 17.

Not all euro-area countries are growing. Italy’s economy contracted 0.5 percent in the second quarter, Dutch GDP declined 0.9 percent, and Spain is also forecast to post a 0.9 percent drop today, according to the median forecast of 12 economists in a Bloomberg News survey. That report is due at 9 a.m. in Madrid.

Exit Strategy

“In 2003, Germany was the sick man of Europe; now it’s Italy and Spain,” said Joerg Kraemer, chief economist at Commerzbank AG in Frankfurt. “Structural imbalances are not resolved, but growth will return earlier than expected.”

While signs of a global recovery have prompted speculation about central banks’ exit strategies, the ECB is showing little willingness to depart from its current policy of offering banks unlimited cash and keeping its benchmark interest rate at a record low of 1 percent.

ECB President Jean-Claude Trichet said last week officials “never pre-commit in any respect on the timing of various measures” after the bank started buying covered bonds to boost the flow of credit. Federal Reserve policy makers on Aug. 12 signaled they will avoid any rush to end their own efforts to strengthen a U.S. recovery.

The euro region’s surprise upturn will require most economists to raise forecasts for Europe. Goldman said it now expects the economy to shrink 3.8 percent in 2009 instead of 4.4 percent. The bank lifted its 2010 growth forecast to 1.2 percent from 0.7 percent.

“Germany and France have surprised massively,” said Sunil Kapadia, an economist at UBS AG in London. “We’re a bit wary of how sustainable this growth is, but we think an export recovery is quite likely and we think this will continue into 2010.”

----With assistance from Brian Swint in London and Frances Robinson, Simone Meier, Christian Vits and Jana Randow in Frankfurt. Editors: John Fraher, Reed Landberg

To contact the reporter on this story: Matthew Brockett in Frankfurt at mbrockett1@bloomberg.net.