By Stephen Wilmot, 25 August 2010
One of the more unlikely twists of market sentiment this year has been the emergence of the eurozone as an icon of economic salvation. As signs have appeared that the US and Asian recoveries can no longer be trusted, investors have begun to pin their hopes on Germany and France, which posted surprisingly strong second-quarter growth numbers this month. But the most recent indicator now suggests the eurozone is losing momentum, too.
The data provider Markit's closely-watched output index for the region fell back in August. That's not a result of the summer lull for which places like France and Italy are known and loved, as it's seasonally adjusted. Instead, it seems to be evidence that the spring boost to manufacturing was unsustainable - as most economists suspected.
The good news was that the decline was gentler than feared. The index, which is based on surveys of purchasing managers, only fell from 56.7 in July to 56.1 this month. That still indicated a quarterly GDP growth rate of 0.7 per cent, according to Markit (any reading above 50 means growth is positive). Azad Zangana, European economist at Schroders, said the French and German figures in particular were a "pleasant surprise".
In Germany, services staged a surprise comeback, with the highest reading since mid-2007. That offset slowing export growth to take the index for total German output to its highest level since April. That's particularly good news for Europe's largest economy - and Britain's second largest trading partner - because the service sector depends on local consumption rather than exports. The recovery has a better chance of becoming self-sustaining if it is supported by demand from German companies and households rather than by infrastructure projects in the emerging world, the main source of growth so far.
France's reading was a five-month low, but still high at 59. Much more worrying is the eurozone's ever-increasing dependence on its two largest members. Rob Dobson, senior economist at Markit, reported that growth slowed to near stagnation elsewhere, with new orders and employment in the service sector contracting. The bond markets tell a similar story, with Spanish government debt trading at spreads over German bunds not seen since the euro crisis in early May and the Irish - German yield spread at levels never seen before.
That's a headache for decision makers in the European Central Bank. And it's also bad news for governments that are set on cutting their budget deficits hard and fast. The link between public-sector austerity and an ailing service sector was clear in places like Greece, Italy and Spain, which have already been forced by capital markets to retrench. Export growth is no panacea either, as it hit its lowest level since January this month, according to Markit.
Mr Zangana expects the recovery to slow in the big European economies when it is their turn to embark on budget-cutting programmes next year. That's an increasingly uncontroversial prognosis.
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