Third Quarter’s The Charm for Euro Zone?

For the past year or so, we’ve been seeing the magicians at the European Central Bank bust out their books, trying to find the spells that would carry the euro zone out of this recession. While the results weren’t pretty at first, more and more signs of recovery have been popping up in the past few months. In fact, Germany, the largest economy in the euro zone, posted positive growth of 0.3% during the second quarter.

Word on the castle grounds is that economic oracles are foreseeing that Germany would post further growth of 0.8% in the third quarter. Furthermore, visions from their crystal balls show that the entire Euro zone, which printed a 0.2% contraction in the 2nd quarter, would finally print positive GDP growth of 0.6% for the 3rd quarter!

However, I am not about to throw caution into the wind and accept the forecast with my arms wide open. For one, consumer demand remains weak. Instead of rising by 0.3%, September retail sales missed the consensus and fell by 0.7%, marking its fifth straight month of decline. This was also the biggest monthly fall since October last year, implying that consumer activity, which accounts for more than two-thirds of euro zone’s economic activity, could dampen overall economic growth.

The ZEW Survey also revealed that investors, economists, and analysts have been less and less optimistic about euro zone’s economy. After topping out at 59.6 in September, the survey has declined the past two months – falling to 56.9 in October and further down to 51.8 this month. They believe that the increasing unemployment rate and the inevitable expiry of stimulus measures would eventually put some downward pressure on growth.

Still, the oracles believe that the stars are aligning and that this forecast can be counted on. They point to the stellar progress in Germany and France, which happen to be the two largest producers in the euro zone kingdom. Germany makes up about a third of the entire zone’s output while France contributes about 15%. Shazam! During the second quarter of the year, something magical happened, as both countries surprisingly posted 0.3% growth, signaling that they were exiting the recession. Still, the euro zone as a whole fell short and posted negative growth of 0.1%.

Now, what do the recent readings show us? Recently, Germany made up for France’s 1.5% slump in industrial production by increasing its own by 2.7%. Germany and France are seen to conquer more grounds by posting economic growth of 0.8% and 0.6%, respectively. Some also believe that the economic stimulus will finally enchant Italy to finally deliver positive growth.

The question is: Would economic strength from these empires be enough to pull the entire euro zone out of the recession or would they require more backup? Strong GDP growth in the US and Japan, the euro zone’s second and third largest export markets, could provide formidable support for economic activity in the euro zone.

However, there’s still the risk that the euro zone will suffer the same fate as Britain – its main trading partner – as the last major economies stuck in recession. Recall that the UK, which has seen a 0.4% contraction in the third quarter, suffered from stagnating retail sales in August and September. Lackluster consumer spending in the UK is partly to blame for September’s 2.7% slump in euro zone exports, which probably had negative repercussions on the region’s economic growth.

Even if the euro zone manages to overcome these threats to growth and print a positive GDP reading come Friday, I suspect that the ECB wizards will still stay on guard, knowing that they still must overcome some sleight of hand and several hexes before seeing a fairy tale recovery ending.