The Eurozone's recession eased substantially in the second quarter, as real GDP contracted by a much-reduced 0.1% quarter-on-quarter (q/q), according to a second estimate from Eurostat. This followed record Eurozone GDP contraction of 2.5% q/q in the first quarter and another hefty drop of 1.8% q/q in the fourth quarter of 2008. However, the second quarter of 2009 was still the fifth successive quarter of Eurozone contraction as GDP had also fallen by 0.3% q/q in both the third and second quarters of 2008. Furthermore, the year-on-year (y/y) decline in Eurozone GDP was still a dismal 4.7% in the second quarter of 2009, compared with 4.9% in the first.

All Eurozone Countries See Improved Q2 Performance, Led by Germany and France

All of the Eurozone countries that have released their second-quarter GDP data saw a markedly improved GDP performance during the period. The turnaround was most pronounced in Germany, which moved out of recession as real GDP expanded by 0.3% q/q, the first rise since the first quarter of 2008. This was in marked contrast to the 3.5% q/q plunge suffered in the first quarter of 2009. This had been the sharpest drop since German reunification in 1990 and was primarily the consequence of plunging exports as world trade collapsed in late 2008/early 2009. Despite the improvement between the first and second quarters, German GDP was still down by 5.9% y/y, compared with a 6.7% y/y fall in the previous quarter. Meanwhile, the French economy also emerged from recession, with GDP growing by 0.3% q/q in the second quarter after having fallen continuously from early 2008. However, French GDP was still down by 2.6% y/y in the second quarter. There was also a very marked slowdown in the rate of Italian contraction in the second quarter, as GDP fell by 0.5% q/q, compared with a drop of 2.7% q/q in the first quarter. The y/y decline in Italian GDP was stable at 6.0%. The Italian economy started to contract in the second quarter of 2008.

Spanish GDP contracted by a still substantial 1.1% q/q in the second quarter of 2009, but this is at least down from 1.6% q/q in the first quarter, as the rate of decline was limited by the government's stimulatory measures. These included major infrastructure spending, as the government sought to support the slumping construction sector. Nevertheless, this was the fourth successive quarter of Spanish contraction, with the y/y decline of 4.2% the deepest since the GDP series started in 1970. Dutch recession moderated substantially in the second quarter as GDP fell by 0.9% q/q after plummeting by 2.7% q/q in the first quarter. This was a fifth successive quarter of contraction, with GDP down by 5.1% y/y.

Elsewhere, Belgian GDP contraction narrowed to 0.4% q/q in the second quarter of 2009 from 1.7% q/q in both the first quarter of 2009 and the fourth quarter of 2008. However, the y/y decline widened to 3.8%, reflecting the fact that the Belgian economy only started contracting in the fourth quarter of 2008. Austrian GDP also contracted at a much reduced rate of 0.4% q/q in the second quarter, which was down from a fall of 2.7% q/q in the first quarter. However, the y/y fall in GDP widened to 4.4% from 3.5% y/y. Portugal moved out of technical recession as GDP rose by 0.3% q/q in the second quarter after falling by 1.6% q/q in the fourth quarter, although y/y contraction remained at 3.7%. Meanwhile, Greek GDP grew by 0.3% q/q in the second quarter after declining by 1.2% q/q in the first quarter. This meant that Greece technically avoided recession, as the first quarter was the only quarter of q/q contraction. Nevertheless, Greek GDP was down 0.2% y/y in the second quarter. Slovakian GDP grew by 2.2% q/q in the second quarter after plunging by 11.0% q/q in the first, leaving GDP down by 5.3% y/y. However, Cyprus officially moved into recession in the second quarter, even though GDP contraction of 0.5% q/q was marginally down from a 0.6% q/q drop in the first quarter. GDP was down 0.7% y/y.

Positive Net Trade and Modest Consumer Spending Growth Limit GDP Contraction in Q2

The breakdown of the second-quarter Eurozone GDP data shows that modest growth in consumer and government spending, and significantly positive net trade were the major factors in limiting the rate of contraction. Consumer spending rose by 0.2% q/q in the second quarter after contracting by 0.5% q/q in both the first quarter and the fourth quarter of 2008. Consumption was clearly lifted by the car scrappage schemes enacted in a number of countries (most notably Germany), while sharply reduced consumer price inflation boosted purchasing power. Even so, Eurozone consumer spending was still down by 0.8% y/y in the second quarter as its upside was limited by markedly higher and rising unemployment, tight credit conditions, and still elevated concerns over the economic situation, personal finances, and jobs.

Government spending increased by 0.4% q/q and 2.2% y/y in the second quarter after rising by 0.7% q/q in the first, as it was lifted by fiscal stimulus across the region aimed at boosting recovery prospects. It is also likely that increased government spending on infrastructure was a factor in causing the decline in Eurozone gross fixed capital formation, narrowing to 1.3% q/q in the second quarter from 5.3% q/q in the first quarter and 3.4% q/q in the fourth quarter of 2008. Nevertheless, gross fixed capital formation was still down by a massive 10.9% y/y in the second quarter and it is evident that business investment saw a further sharp fall as companies faced muted demand, weakening capacity utilisation, very tight credit conditions, and deteriorating profitability.

A further sharp running down of inventories cut 0.7 percentage points off q/q Eurozone GDP in the second quarter. This was similar to the negative contribution of 0.8 percentage points seen in the first quarter. This major inventory adjustment was triggered by the plunge in demand seen in the latter months of 2008 and the early months of 2009. However, lower stock levels will help the Eurozone economies going forward.

Net trade made a positive contribution of 0.7 percentage point to Eurozone q/q GDP in the second quarter, in marked contrast to the major negative contributions seen in the first quarter (0.4) and the fourth quarter of 2008 (1.1). This was because Eurozone exports fell at a much reduced rate as global economic activity and trade showed signs of stabilising. Specifically, Eurozone exports contracted 1.1% q/q in the second quarter. This followed drops of 8.8% q/q in the first quarter of 2009 and 7.2% q/q in the fourth quarter of 2008, when Eurozone exports were hammered by global recession and collapsing trade as well as a still relatively strong euro. Eurozone exports were still down by 17.1% q/q in the second quarter. The contraction in Eurozone imports also moderated in the second quarter, but at a lesser rate than exports. Specifically, imports fell by 2.8% q/q after drops of 7.8% in the first quarter and 4.7% q/q in the fourth quarter of 2008. Eurozone imports were down 14.4% y/y in the second quarter.

Outlook and Implications

Latest Eurozone data and survey evidence shows ongoing overall improvement, thereby raising hopes and expectations that the economy will achieve expansion in the third quarter. In particular, the composite indicator for the Eurozone purchasing managers' manufacturing and service sector surveys compiled by Markit Economics rose for the sixth successive month in August to reach a 15-month high of 50.0, which signifies unchanged activity. This was up from 47.0 in July, 44.6 in June, and a record low of 36.2 in February. The survey showed manufacturing activity contracting at the slowest rate since May 2008, while service-sector activity declined at the weakest rate in 14 months. Meanwhile, overall Eurozone economic sentiment rose for a fifth successive month in August to reach an eight-month high, with both consumer and business confidence improving significantly overall.

Eurozone economic activity seems to be increasingly responding to the monetary and fiscal stimulus that has been enacted, while much of the required inventory adjustment resulting from sharply weakened demand in late 2008/early 2009 now seems to have been completed. In addition, there are signs that foreign orders for Eurozone products are now stabilising. Measures to support the Eurozone financial sector, sharply lower oil and commodity prices compared with their mid-2008 peak levels, and a limited retreat in the euro from its July 2008 peak level of US$1.604 are also helping matters.

Nevertheless, even if the Eurozone does return to growth in the third quarter, serious obstacles remain to sustainable significant expansion and there is concern about how well economies will hold up once monetary and, especially, fiscal stimulus starts to be withdrawn. Financial-sector problems are far from solved with the result that credit conditions remain very tight across the Eurozone and are still hampering economic activity. Worryingly, unemployment has increased sharply across the Eurozone and seems certain to rise substantially further, thereby countering the boost to purchasing power coming from current mild deflation. Meanwhile, global economic activity is still relatively weak, and this is limiting the upside for Eurozone exports, while the region's exporters will also be perturbed to see the euro rising from a low of US$1.25 earlier in 2009 to currently trade around US$1.44. In addition, oil prices have firmed from US$40/b early in 2009 to recently trade as high as US$75/b. Finally, significant corrections in overvalued housing markets are still weighing on overall economic activity in some countries, most notably Spain and Ireland.

Consequently, we suspect that Eurozone economic activity will expand only modestly in the second half of 2009 and early-2010 before picking up gradually. As a result, in our August monthly forecast, we projected that Eurozone GDP would contract 4.1% in 2009, with all of the major Eurozone economies enduring serious GDP declines: Germany (5.0%), France (2.2%), Italy (5.2%), Spain (3.9%), and the Netherlands (3.8%).

Eurozone GDP is seen rising 0.5% overall in 2010, led by a 1.3% expansion in Germany. France is projected to grow by 0.8% and the Netherlands by 0.7%, while Italy is seen expanding 0.4%. Nevertheless, further contraction is seen in Spain (1.1%). Over the longer term, Eurozone growth is likely to be limited by the need for a substantial tightening of fiscal policy in a number of countries to rein in bloated government deficits.

Global Insight (Reino Unido)