Euro Zone Economy Shrinks for First Time

The euro zone economy recorded its first ever contraction in the second quarter, pulled down by falling activity in its biggest economies, which could lead to a technical recession.

The European Union's statistics office Eurostat on Thursday estimated that the economy of the 15 countries sharing the euro contracted 0.2 percent against the first quarter and grew 1.5 percent year-on- year.

Both figures were in line with market expectations.

Eurostat said the quarterly decline was the first since its data series for the euro zone started in 1995.

The next worse result was 0.0 percent growth in the second quarter of 2003.

The fall was still smaller than in the world's second biggest economy Japan, which shrank 0.6 percent in April-June but well below the United States, where gross domestic product expanded 0.5 percent.

"There is a good chance that the economy is already in recession, but even if it isn't the outlook remains for subdued growth in the quarters to come," said Stuart Bennett, senior FX strategist at Calyon.

But slowing activity has helped curb rampant inflation, economists said, as Eurostat revised down its initial estimate for July price growth to 4.0 percent year-on-year from 4.1 percent.

Germany, Europe's biggest economy, reported a 0.5 percent quarterly fall in April-June GDP, which was better than the 0.8 percent drop expected by economists.

The German Bundesbank told Reuters the dip did not warrant undue pessimism about the economy even though high oil prices caused the economy to shrink faster than it had expected.

But deputy economy minister Walther Otremba told Reuters he could not rule out that the economy would shrink again in the third quarter.

French Surprise

French GDP fell 0.3 percent quarter-on-quarter instead of expanding 0.2 percent as expected by markets.

French Economy Minister Christine Lagarde rejected talk of a recession in France, but economists were less upbeat.

Italy, the euro zone's third largest economy, had already announced a deeper than expected 0.3 percent quarterly contraction.

"A technical recession in the euro zone is possible, because there is a chance that we will have a slight contraction in the third quarter as well, according to leading indicators in the last months," said Christoph Weil, economist at Commerzbank.

A technical recession is defined as two consecutive quarters of negative economic growth.

The fourth biggest euro zone economy, Spain, grew 0.1 percent quarter-on-quarter, just beating market expectations of no growth at all, but still at its slowest since 1993.

Smaller euro zone members fared better, Eurostat data showed.

Greece expanded by 0.6 percent, Austria and Portugal 0.4 percent and Belgium 0.3 percent.

"Today's reports all paint a similar picture: sharp corrections in fixed investment and exports - those having been the main engine of growth over the past few years - and stagnating private consumption," said Peter Newland, economist at Lehman Brothers.

Economists said the scenario of a euro zone recession would almost certainly stop the European Central Bank from further rate rises, despite an inflation rate at more than twice the bank's target of below, but close to 2 percent.

"The question is when will they cut interest rates, but with inflation so high, the ECB cannot cut in the coming months -- we expect a cut only in the third quarter of 2009," Weil said.

The ECB left rates unchanged at 4.25 percent last Thursday and said risks to economic growth were starting to materialise.

Euro zone economic indicators have weakened sharply in recent weeks, with service sector morale and retail sales falling sharply.

The service sector, which makes up roughly two thirds of the euro zone economy, contracted at its fastest pace in five years in July -- a statistic mirrored in the manufacturing sector.

Euro zone retail sales, an indication of consumer demand, also saw their biggest ever annual fall in June.