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Signs of life in euro zone could point to recovery

Sean Gallup | Getty Images

All the usual caveats still apply, but there is consistent evidence that the worst may be over for Europe's economy.

Five years after the start of a financial crisis that set off broad economic, social and political problems and severely strained the idea of European unity, an overdue cleanup of euro zone banks is about to begin. French business confidence is improving.

(Read more: Could default risk put US in euro-zone doghouse?)

Perhaps the most striking news on Wednesday was that the Spanish economy crawled out of a two-year recession in the third quarter, though it grew at an estimated annual rate of about 0.4 percent.

With its housing bubble and 26 percent unemployment rate, Spain has been the most striking symbol of the euro zone debt crisis. The turnaround there comes after an end to recession in Portugal. It offers hope to Europe's periphery, the so-called misery belt, which also includes Greece, Italy and Ireland.

"Most of the euro zone periphery is out of recession by now," said Holger Schmieding, chief economist at Berenberg Bank in London, which has calculated that even Greece is growing again. "That is absolutely good news. The rebound in the economy is ultimately the solution to almost everything."

In Frankfurt on Wednesday, the European Central Bank outlined plans to search for and expose all the bad loans and damaged investments lurking in euro zone banks. That effort would be the first step in forcing banks to fix their problems so they can start lending again. Without lending to businesses and home buyers, there can be no sustained economic growth.

Maybe more important, the review of large banks was a sign that euro zone leaders, who sometimes appear out of touch, had made concrete progress on policy. Their decision last week to designate the European Central Bank as top banking cop is intended to de-Balkanize the euro zone banking system. A single currency, they argue, should have a single banking system.

Shares of European banks fell after the central bank disclosed details of the planned bank assessment, but in a strange way that may have been a good sign. It meant investors expected the central bank to be tough and thorough, culling the sick banks and freeing the healthy ones from the stigma attached to euro zone lenders. Earlier efforts by a patchwork of national regulators to conduct supposed "stress tests" on Europe's banks proved woefully inadequate.

(Read more: Euro zone manufacturing output falls in September)

There have been other hopeful omens lately, like an increase in European car sales in September from 20-year lows. Ireland, once one of Europe's most troubled countries, said recently that it expected to emerge from its bailout program by the end of the year.

On Wednesday, a closely watched survey showed that French businesspeople were becoming slightly more optimistic because of an uptick in exports. In Germany, the euro zone's first among equals, the Christian Democrats led by Chancellor Angela Merkel are edging toward an accord with the Social Democrats to form a government. That would end a de facto freeze on euro zone policy making while Ms. Merkel was preoccupied with domestic politics.

Few economists are ready to pop open the Prosecco just yet — not after a crisis that has lasted five years, and with unemployment in the euro zone still at 12 percent. Youth unemployment in several countries is three or four times that. But Nicolas Véron, a senior fellow at Bruegel, a research organization in Brussels, said that the bank cleanup, as it unfolds during the coming year, could help inspire a broader return of confidence.

"There is a sort of happy scenario where this becomes a game-changer and creates a chain of positive consequences that really boost European growth," Mr. Véron said.

(Read more: Is the euro the next currency battleground?)

He said that he still had doubts things would turn out that well.

In fact, it is impossible to talk about Europe without mentioning everything that could still go wrong. Nowhere is growth particularly strong. Mujtaba Rahman, director for Europe at Eurasia Group, a political consulting firm, said that political leaders had still failed to give the central bank the tools it needs to do the job. There still is not an adequate source of money to recapitalize sick banks, nor is there a mechanism to gently wind down those that cannot be saved.

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If anything, German leaders are undermining earlier commitments to help weaker countries like Spain bear the costs of bank cleanups. "The debate remains stuck in outer space," he said.

But if there is still plenty of data to nourish the pessimists, the optimists also have more to chew on than they did a few months ago. With many European citizens angry about cutbacks in job protections and other austerity measures, the news on Wednesday of Spanish growth provides evidence that such unpopular changes may be paying off. Prime Minister Mariano Rajoy of Spain, who took office almost two years ago, has pushed through deeply unpopular spending cuts and tax increases to comply with budgetary targets in accordance with Spain's European partners.

If the revival in the Spanish economy proves sustainable, it could embolden leaders in countries like Italy or France to step up the pace of change.

Spain is not expected to return to precrisis growth levels for several years, as it continues to struggle with weak consumer spending and unemployment. That Spain has been in and out of recession since 2008 has left some economists wary about the staying power of the latest recovery.

Spain's economy had contracted for nine consecutive quarters. After a decade-long property bubble burst in 2008, it sank into a first recession, before briefly returning to growth in 2010. A banking crisis then forced Madrid to negotiate a European bailout to keep afloat lenders weighed down by property loan defaults, sending Spain back into recession.

(Read more: Euro zone moving from economic to political crisis)

The main Spanish stock market index returned this month to its highest point since July 2011. Spain's borrowing costs have also fallen sharply in recent months.

In the best case, Spain, Portugal, Ireland and even Greece and Italy could start to grow rapidly as they benefit from measures to improve economic performance. Labor costs have fallen in most of the countries, which could lure new investors and jobs. Latvia and Estonia, which only a few years ago were in just as bad shape, are now booming.

"Countries that have fallen a lot have potential to rebound a lot," Mr. Schmieding of Berenberg Bank said. He added, "That is just hope, not what we are seeing in the data."

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