German economy shrinks, hitting European recovery hopes

German, French and Italian weakness weigh on euro zone
By Michelle Martin and Noah Barkin
||Last Updated: 08/15/2014

BERLIN (Reuters) — Europe's largest economy, Germany, suffered a surprise contraction in the second quarter, raising doubts about whether it can prop up growth across a continent where tougher sanctions against Russia are already fuelling business anxiety.

The 0.2 per cent fall in German gross domestic product (GDP), the first quarterly contraction in more than a year, was driven by foreign trade, a traditional supporter of German growth, and a decline in construction investment, the Federal Statistics Office said on Thursday.

Hailed as Europe's growth locomotive in recent years, Germany now faces the prospect of sinking into a technical recession this year if, as some expect, the escalating showdown with Russia over Ukraine hits the economy harder in the third quarter by crimping trade and discouraging corporate investment.

"The German economy may have slipped into a slight recession due to crises," said Ferdinand Fichtner, an economist at the Berlin-based DIW think tank.

The weak German data followed figures showing a similar second quarter contraction in Italy and stagnation in France, Germany's biggest trading partner.

Together, the GDP reports raised serious doubts about the strength of Europe's recovery from the deep financial crisis of past years. Growth in the euro zone as a whole ground to a halt in the second quarter, data from Eurostat showed.

Germany posted robust growth of 0.7 per cent in the first quarter of the year, but this strength was exaggerated by an unusually mild winter which fuelled construction activity at the start of the year.

This was unwound in the second quarter, and the rise in imports exceeded exports in the three-month period, further denting GDP. The Statistics Office said public and private consumption had provided modest support in the quarter.

The weak data comes even before the impact of tougher sanctions against Moscow. The European Union decided to target Russia's banking, defence and energy sectors in July and this month Russia retaliated by stopping imports of most food from the West.

Exports to Russia, which fell 15 per cent in the first five months of the year, make up only 3.3 per cent of total German exports. But the standoff has added to uncertainty among German companies, already unnerved by government energy policies and a rollback of pension and labour market reforms under Chancellor Angela Merkel's seven-month-old grand coalition.

A string of German companies, including consumer goods group Henkel, optical systems maker Jenoptik and generic drugmaker Stada, have complained about theRussia crisis hitting business in recent weeks.

"We can't expect high growth rates in the coming quarters either due to the Ukraine/Russia crisis," said Stefan Kipar, an economist at BayernLB. "Foreign trade won't make a positive contribution to growth for the foreseeable future."

Euro zone concerns

The Economy Ministry said earlier this week that weaker euro zone momentum, uncertainty over the conflict in Ukraine and the crisis in the Middle East had weighed on the German economy in the second quarter, although positive growth trends remained intact.

Other recent data has disappointed, with industrial orders suffering their sharpest fall in nearly three years, and output and exports rising only modestly.

Corporate morale has darkened as the Ukraine crisis takes its toll. The closely-watched Ifo index of German business sentiment fell for a third straight month in July, the first time it has done that since mid-2012 at the height of the euro zone's financial crisis, and the ZEW think tank's gauge of analyst sentiment fell sharply earlier this week.

The German economy proved a bastion of strength throughout much of the euro crisis but slowed towards the end of 2012 and had a subdued year in 2013.

The government is currently expecting growth to pick up to 1.8 per cent this year, more than four times faster than last year, but it seems likely to revise down its forecast after the second quarter data.

Germany's DIHK Chambers of Commerce and Industry cut their forecast for 2014 growth to 1.5 per cent on Thursday, from a previous estimate of 2.0 per cent.

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