The Euro Zone: Recession Forecast: Gradual Clearing

The latest economic news from the euro zone has been surprisingly upbeat--so much so that most economists now believe the 12-nation area will avoid a recession. Almost all euro countries are putting a plus sign in front of their first-quarter forecasts for gross domestic product and nudging up their full-year projections.

To be sure, the fourth quarter was a disaster. By Mar. 1, the Netherlands, Spain, France, Germany, and Italy, in that order, will have reported 85% of the zone's GDP. Fourth-quarter area-wide GDP is expected to fall at an annual rate of 1% to 2% from the third quarter, following gains of 0.3% and 0.6% in the second and third quarters, respectively. Germany, comprising a third of the total, will likely report a second consecutive drop.

However, even Germany is showing signs of improvement. German factory orders and industrial production picked up markedly in December, and in January, the IFO Institute's index of business sentiment rose for a third month in a row.

More important, the broad euro zone purchasing managers' index posted a surprisingly strong gain in January, led by the services sector. Based on that survey, inventories are in better shape, and capital spending is showing nascent signs of improvement.

Households are the area to watch, though. Measures of consumer and retailer confidence fell in January, and outside of France, spending is sluggish. Some January weakness may reflect temporary gyrations caused by the introduction of new euro notes and coins, but the poor showing is also due to weak labor markets. The euro zone jobless rate was 8.5% in December. Still, spending should pick up in coming months as employment firms up, inflation declines, and interest rates stay low.

Some economists believe that economic slack and lower inflation will give the European Central Bank the latitude to cut interest rates one more time. But more signs that the recovery may be coming sooner and stronger than expected could mean that the ECB's easing cycle is finished.

By James C. Cooper & Kathleen Madigan

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