Tuesday, August 18, 2009

Europe's Recovery

With the German economy having declined by 6% since 2008, it came as welcome relief to see a modest growth in German GDP during the last quarter. France also showed a modest economic recovery in the last quarter.

Germany has benefited from the renewed Chinese growth and investment and their own fiscal stimulus. After their finance minister openly criticised Keynesian expansionary fiscal policy, Germany pursued it anyway. IMF figures show the German fiscal expansion was larger as % of GDP than US.

Yet, the sluggish Euro area recovery is hardly cause for celebration. The peripheral areas of the Euro struggle with the hangover from their housing bubble bursting. Countries like Italy, Ireland and Spain are still showing a decline in GDP and are struggling to find an engine of growth since the collapse in their construction and housing sectors.

Given the nature of Euro monetary policy, there will be concern over the development of a two speed recovery.

Both Germany and France were relatively unaffected by the bursting of the housing bubble. As global growth picks up, their economies could retain to a normal pattern of growth and inflation. This is likely to cause the ECB to raise interest rates to maintain its strict inflation targets.

However, whilst a rise in interest rates and a strong Euro may be suitable for Germany and France, they could prove devastating for the peripheral Eurozone member countries, still struggling to recover.

There will be difficult choices facing the ECB in coming months and it is uncertain which will gain the highest priority - recovery in Spain, Italy e.t.c or keeping inflation low in Germany and France.

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