Significance: The moderation in Eurozone GDP growth to 0.4% quarter-on-quarter (q/q) in the third quarter from 1.0% q/q in the second was in line with expectations.

Implications: The slowdown in Eurozone growth during the third quarter reinforces IHS Global Insight's belief that the recovery will be bumpy and gradual overall in the face of serious headwinds, including major fiscal tightening across the region, likely slower global growth, and less favourable inventory developments. Eurozone sovereign debt problems are also likely to continue to flare up, as is currently happening.

Outlook: In our November forecast, we project that Eurozone GDP growth will be only moderate in the fourth quarter of 2010 and the early months of 2011. Consequently, we project overall Eurozone growth to be 1.7% in 2010 (raised from the October forecast of 1.6%). Eurozone economic activity is expected to stabilise and then gradually regain momentum in the second half of 2011, helped by improving global growth and an easing back of the euro. Nevertheless, Eurozone growth is expected to be limited to 1.4% in 2011 (unchanged from our October forecast).

Eurozone GDP growth more than halved to 0.4% quarter-on-quarter (q/q) in the third quarter of 2010 after spiking up to 1.0% q/q in the second quarter from 0.3% q/q in the first, according to a preliminary estimate from Eurostat. Nevertheless, the third quarter of 2010 was the fifth successive quarter of growth since the Eurozone exited recession in the third quarter of 2009. Meanwhile, year-on-year (y/y) Eurozone GDP growth was stable at 1.9% in the third quarter, up from 0.8% in the first quarter. The Eurozone's recession had lasted for five quarters, with particularly sharp declines in GDP during the first quarter of 2009 (down 2.5% q/q) and the fourth quarter of 2008 (down 1.9% q/q) when global economic activity and trade nosedived amid financial sector turmoil following the collapse of U.S. investment bank Lehman Brothers. Consequently, Eurozone GDP contracted by 4.0% in 2009 following growth of just 0.3% in 2008.

Some slowdown in Eurozone growth during the third quarter of 2010 was inevitable as there had clearly been an element of catch-up in the second quarter after activity had been held back in the first quarter by the very bad weather at the start of the year that affected economic activity in most countries, and particularly hurt construction activity.

Significant Differences in Individual Country Performances

A marked divergence is evident in the performances of the Eurozone economies in the third quarter. Eurozone growth once again benefited from a strong German performance in the quarter, as it had in the second. Specifically, German GDP expanded by a further 0.7% q/q in the third quarter after surging 2.3% q/q in the second quarter, which had been the strongest performance in the post-reunification period. The third quarter of 2010 was the sixth successive quarter of German growth following particularly deep recession in 2008/09 when Germany was hit very hard by the collapse in world trade. German GDP was up 3.9% y/y in the third quarter. Growth was also robust during the third quarter in Austria, where it only eased back to 0.9% q/q from 1.2% q/q in the second quarter and was up 2.5% y/y. Similarly, Slovakian GDP only edged down to a still very healthy 0.9% q/q in the third quarter from 1.0% q/q in the second quarter and was up 4.1% y/y. Finnish GDP expanded by 1.3% q/q in the third quarter after growing 1.9% q/q in the second quarter, resulting in y/y growth of 3.6%.

Among the middle-performing Eurozone economies, French GDP growth moderated to 0.4% q/q in the third quarter from 0.7% in the second. This marked a sixth successive quarter of generally modest expansion from a recession that had been less deep than Germany's. French GDP was up 1.8% y/y in the second quarter. Belgian GDP growth was similar at 0.5% q/q and 2.1% in the third quarter, down from 1.0% q/q and 2.6% y/y in the second quarter. In addition, Portuguese GDP growth held up better than feared in the third quarter, coming in at 0.4% q/q and 1.5% y/y. This was actually up from growth of 0.2% q/q and 1.4% y/y in the second quarter. Meanwhile, Cypriot GDP growth improved to 0.6% q/q and 1.5% y/y in the third quarter from 0.5% q/q and 0.2% y/y in the second quarter.

Among the Eurozone laggards, Dutch GDP dipped by 0.1% q/q in the third quarter after growing 0.9% q/q in the second quarter and 0.5% q/q in the first. The third-quarter relapse was partly due to a marked turnaround for the worse in the stocks contribution and Dutch GDP was still up 1.8% y/y.

Less surprisingly, Spanish GDP was only flat q/q in the third quarter, following growth of just 0.2% q/q in the second quarter and 0.1% q/q in the first quarter. This followed seven successive quarters of contraction through to the fourth quarter of 2009. Spanish GDP was up a mere 0.2% y/y in the third quarter and recovery prospects are being limited by very high unemployment, high debt levels, and an ongoing major correction in the construction sector. Furthermore, Spain raised value-added tax (VAT) at the beginning of the third quarter as part of its substantial fiscal consolidation measures. Meanwhile, the Greek economy continued to contract markedly in the third quarter, although the rate of decline did at least moderate to 1.1% q/q from 1.7% q/q in the second quarter. This left Greek GDP down 4.5% y/y. Third-quarter GDP data have not yet been released for Ireland or Slovenia.

GDP Components Mixed Across Countries

The component breakdown of third-quarter Eurozone GDP is not yet available; and the limited available information portrays a pretty mixed picture across the individual countries. German growth was reported to be broad based. Elsewhere though, inventory developments and net trade performances varied markedly from country to country, suggesting that they probably only made a modest positive overall contribution to growth. Consumer spending is likely to have seen reasonable but unspectacular growth across the Eurozone, given that retail sales volumes rose by 0.4% q/q. Investment probably continued to expand overall across the Eurozone after extended contraction through to the second quarter of this year, but it is unlikely to have been buoyant.

Outlook and Implications

Latest data and survey evidence suggest that Eurozone economic activity is currently reasonable overall but appreciably below the peak levels seen in the second quarter. For example, the composite indicator for the Eurozone purchasing managers' manufacturing and service-sector surveys compiled by Markit Economics retreated to an eight-month low of 53.8 in October from 54.1 in September and a 32-month high of 57.3 in April. Nevertheless, it was still significantly above the 50.0 level that indicates flat activity.

On the positive side, Eurozone economic activity is currently still being supported by low interest rates and some fiscal stimulus measures. Meanwhile, inventory developments are currently favourable as stocks continue to be rebuilt after being slashed in late 2008/early 2009. In addition, Eurozone exports have benefited from markedly improved global economic activity and trade compared with 2008/09.

Nevertheless, the fact remains that the Eurozone recovery has been relatively fitful and gradual overall since the region exited five quarters of deep recession in the third quarter of 2009. Furthermore, it seems probable that Eurozone growth will be relatively modest over the coming months.

The Eurozone sovereign debt crisis is leading to fiscal policy being tightened earlier and faster in a number of member countries, and it is also periodically affecting economic activity by weighing down on confidence and pushing up market interest rates for the perceived vulnerable countries. The latest example of this is occurring in November, with the focus this time more on Ireland than Greece. Fiscal policy was already becoming less supportive across the Eurozone in 2010 and tighter fiscal policy will increasingly bite in 2011, affecting consumer and business activity, in addition to government spending and investment.

Furthermore, consumer spending is likely to continue to be limited by persistently high unemployment in many Eurozone countries and muted wage growth. An exception to this though may be Germany, given that the country has low unemployment, improving wage growth, high savings rates, and some likely pent-up demand. Any marked pick-up in German spending would obviously be welcome news for the rest of the Eurozone. The problem is that in recent years German consumers have always seemed to find some reason not to step up their spending significantly.

Meanwhile, substantial spare capacity, limited demand, still relatively tight credit conditions, and many companies' uncertainties over the longer-term strength of the upturn mean that business investment is also likely to be relatively moderate. What investment there is will primarily be to upgrade or replace dated capacity rather than to add capacity. In addition, inventory rebuilding can only support economic growth for a limited period and may have nearly run its course.

On top of this, IHS Global Insight expects global growth to be modestly softer in late 2010 and the first half of 2011, which would not be good news for Eurozone exporters, especially as the euro has firmed appreciably from its early-June four-year low of 1 euro:US$1.188. Indeed, the euro has traded as high as 1 euro:US$1.42 in November.

Consequently, in our November forecast, we project that Eurozone GDP growth will moderate further in the fourth quarter and the early months of 2011. Consequently, we project overall Eurozone growth to be 1.7% in 2010 (raised from the October forecast of 1.6%). All of the major Eurozone economies are seen expanding in 2010, with the exception of Spain, which is seen contracting a further 0.3%. Germany is expected to lead the way in 2010 with growth of 3.3%, while far more modest expansion is anticipated in France (1.6%), the Netherlands (1.8%), and Italy (1.1%).

After slowing anew in the latter months of 2010 and early months of 2011, the Eurozone's upturn is expected to stabilise and then gradually regain momentum in the second half of 2011, helped by improving global growth and an easing back of the euro. Nevertheless, Eurozone growth is expected to be limited to 1.4% in 2011 (unchanged from our October forecast). Restrictive fiscal policy is likely to continue to constrain Eurozone growth after 2011 as governments will need to undertake extended corrective action to rein in bloated budget deficits. Eurozone GDP growth is projected at 1.6% in 2012.