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The Euro Zone's Hidden Powerhouse

Those watching the euro zone's battle to contain debt in periphery countries know Germany will do the heavy lifting in pushing economic growth.

German gross domestic product will likely rise 3 percent in 2011, according to economists at Capital Economics. But their pick for next-strongest euro-zone economy tends to fly under the radar.

Luxembourg's economy will likely grow by 2.8 percent this year and 3 percent in 2012, Capital said.

"As strong public finances limit the need for fiscal correction and export growth holds up, the open Luxembourg economy will continue to outperform the region," Captial said in a research note. "But the large banking sector remains vulnerable to the periphery’s troubles."

Luxembourg's continued growth in 2012 contrasts sharply with Capital's predictions for Germany. It expects the euro zone's largest economy to grow by just 1.5 percent in 2012.

It "is far from clear that German consumers will put their money where their mouths are," the macroeconomic research company said. "Despite the relatively healthy state of the labor market, sluggish wage growth and, in the near-term at least, rising inflation, will keep real income growth weak."

"Overall, Germany’s export boom will continue to drive the economy forward strongly in the first half of 2011," Capital said. "But a renewed deterioration in the global environment and continued weakness in domestic spending are likely to see growth lose steam in the second half of the year and in 2012."

Overall, "there are still major doubts over whether domestic demand in the core euro-zone economies will strengthen markedly as the fiscal squeeze spreads from the periphery and the (European Central Bank) perhaps grows more hawkish," according to Capital. "All this, coupled with the likelihood that the peripheral debt crisis will intensify, will keep fears of a euro-zone break-up alive and push the euro lower."

Contact Europe: Economy

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