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Could Weak Euro Zone GDP Spell End to Austerity?

Dominique Faget | AFP | Getty Images

Austerity as the solution to the euro zone's protracted debt crisis could be on the way out if another bad set of euro zone gross domestic product (GDP) numbers are released this week, according to Carl Weinberg, chief economist at High Frequency Economics.

Weinberg said this year will see deficit and debt reduction programs stall, as sluggish growth and rising unemployment take their toll and policymakers take heed of austerity's stifling effect on the economy.

"We fear prolonged economic hardship may make it impossible for Italy, Spain and perhaps even Greece to sustain fiscal austerity," he wrote in a note on Sunday evening.

Fourth quarter GDP numbers for the euro zone are due on Thursday, and are widely predicted to show a contraction. Barclays forecasts the bloc will fall by 0.4 percent in the fourth quarter,quarter-on-quarter, on top of the third quarter's 0.1 percent contraction.

High Frequency Economics goes further, predicting the bloc contracted by 0.9 percent in the fourth quarter.

However with federal elections this fall, some analysts said German Chancellor Angela Merkel was unlikely to agree to any roll back in peripheral countries' austerity measures, for fear of angering voters.

"I think it is unlikely austerity will be abandoned. Much of [European area] policy is tied in with austerity, notably of course German policy," Gabriel Stein, managing director at Stein Brothers, told CNBC.com.

"It would be politically very difficult for Merkel to give a nod to easing fiscal policy in troubled countries prior to the German election in September. I doubt very much that we will see a rapid change in underlying fiscal policy."

Despite this, Stein said weak growth numbers could usher in some form of easier monetary policy, given hints from European Central Bank President Mario Draghiat last week's press conference about taking action if the euro's appreciation persists.

Meanwhile,Weinberg said a reversal in austerity measures could put upward pressure on bond yields.

Nicholas Spiro, managing director at Spiro Sovereign Strategy, warned the "relief rally" in Spanish and Italian bond yields has run its course, and fiscal policy within the euro zone was "undermined some time ago".

"The most glaring example is Spain, where even after being cut some fiscal slack by Brussels, budget deficit targets are badly off track. With the exception of Ireland and possibly Portugal, aggressive fiscal retrenchment in the euro zone periphery has not led to lower bond yields," Spiro told CNBC.com.

"Spanish and Italian debt markets are caught in a tug-of-war between the reassurance provided by the European Central Bank's OMT [Outright Monetary Transactions]program, and the increasing political and economic risks in both countries. Political stability and policy continuity have been taken for granted [and] we believe markets have yet to price in these political risks,"he added.

While Greece is out of the spotlight at the moment, its peripheral neighbors Italy and Spain have dominated headlines in recent days due to political turmoil.

Spanish Prime Minister Mariano Rajoy continues to battle corruption charges and Italy's elections later this month have stirred up unease about post-election instability.

However,Credit Suisse was more upbeat about the outlook for the euro zone in 2013. In a note on Monday, analysts at the Swiss bank forecast the single currency area's economy declined 0.5 percent in the fourth quarter, but said contraction has "slowed meaningfully" this year.

By CNBC's Shai Ahmed; Follow her on Twitter @shaicnbc

Contact Europe: Economy

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