Eurozone GDP came in slightly stronger than expected in the fourth quarter of 2011, contracting -0.3% q/q compared with an expected -0.4%. That's not exactly a good news story, "less bad" is probably a more apt description. Annual growth for the eurozone stood at +0.7% for the 2011 year.
The biggest surprise was the "strength" in France over the quarter. We thought France would probably hold up better than Germany given its lesser reliance on exports, but it was stronger across the board. France grew 0.2% q/q, compared with -0.2% q/q in Germany. Over the year Germany posted growth of 2.0% with France coming in at 1.4%.
Countries facing harsh austerity measures are in deep recession. Annual growth in Greece was -7 .0% in 2011, while Portugal contracted -2.7% over the same period. Of the larger economies, Italy posted growth of -0.5% for the year with contractions in activity in the third and fourth quarters.
The overall result fits nicely with our expectation of a mild recession in Europe. But it’s important not to get carried away with recent good partial activity data including manufacturing (see post below). That data has some commentators talking about the eurozone returning to growth in the current quarter, thereby avoiding a technical recession. We're not that optimistic. Our expectation is we will see further mild contractions in the first quarter of this year and possibly the second mostly led by weakness in the periphery and Italy. Into the second half of the year we think Europe will return to very modest growth with full-year 2012 GDP of around -0.5%.
Further out growth will remain constrained by fiscal contraction especially in the periphery where harsh austerity measures have already lead to deep recessions. Furthermore, weakness in Europe generally generates a negative feedback loop to Germany where exports make up 40% of GDP with the bulk of those going to its European neighbours.
We have, however, moderated our view on further interest rate cuts by the ECB. At the end of last year we thought it was highly likely the ECB would cut rates further. However with the recent better-than-expected activity data and improvement in finance sector risk indicators, further interest rate cuts have become less likely. That’s not to say the ECB is doing nothing: the provision of unlimited liquidity to the banking sector has played a key role in reducing financial stress in the eurozone.
Of course the major risk still playing out in Europe is that of a disorderly default in Greece. While we still think a deal securing the second bailout will get done, the risk is it doesn't. However, we think that in 2012 Europe is better placed to cope with such an outcome than it was in 2011.