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A worker welds in a factory in Gravellona Lomellina, 45km southwest of Milan, in this file photo. (STEFANO RELLANDINI/Reuters)
A worker welds in a factory in Gravellona Lomellina, 45km southwest of Milan, in this file photo. (STEFANO RELLANDINI/Reuters)

Euro zone recovery? Italy back in recession; German factories falter Add to ...

So much for the euro zone recovery. Italy, the region’s third-largest economy, is back in recession and factory orders in Germany, the alleged engine of European growth, were worse than expected.

Italy’s grim gross domestic product estimate, released Thursday morning by Istat, the national statistics agency, raises the spectre of long-term stagnation in the euro zone. The Italian economy contracted by 0.2 per cent in the second quarter after a fall of 0.1 per cent in the first quarter, fulfilling the technical definition of recession – back to back contractions.

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While Italian growth turned negative, the country is not the only laggard on the continent. France, the second largest economy, is barely out of recession, reporting a 0.2 per cent growth rate in the second quarter. A new French recession is not out of the question. Spain’s growth is somewhat stronger but is insufficient to put a big dent in its crippling jobless rate of 24.5 per cent.

Among the 28 euro zone countries, Germany remains the star, with a 0.8 per cent growth rate in the first quarter. But even it may be a flat-liner in the making. Last month, the German central bank warned that the economy probably stagnated in the second quarter and today’s report on industrial orders confirmed that growth is almost certainly waning. German industrial orders fell for the second consecutive month, at a 3.2 per rate, following at 1.6 per cent fall in May. The German economics ministry said “geopolitical developments and risk above all led to certain reluctance in placing orders.”

That was probably a reference to the European and American sanctions against Russia, which are hurting both sides. Germany has close trading and investment links to Russia, which explains why it has been wary about implementing severe sanctions to punish Russia’s incursion into Ukraine.

Italy, however, remains the prime worry spot; its economy, which is about a quarter larger than Canada’s, accounts for 20 per cent of euro zone output. Istat did not provide a lot of details in the preliminary report (which could be revised downward), other than to note the weaknesses in industry, services and agriculture.

“We had expected until yesterday an average Italian GDP growth to the likes of 0.2 per cent in 2014 [but] after today’s release, the number might well turn negative,” said ING Financial Markets economist Paolo Pizzoli.

Italy was clobbered by the financial crisis and the recession. Industrial production – Italy is the second largest European manufacturer, after Germany – is down 25 per cent from its level in 2007, the year before Lehman Bros. collapsed. The jobless rate in June was 12.3 per cent, with youth unemployment at a staggering 43 per cent.

The new recession will put enormous pressure on prime minister Matteo Renzi, who took over in a palace coup in February, to ramp up the reform measures. So far, he has been more talk than action. He has promised spending cuts, a wide range of privatizations and a jobs agenda. So far, the main accomplishment has been a tax cut for low-income earners.

Italian sovereign bond yields rose a few basis points on Thursday, but remain at rock-bottom levels, historically speaking. The 10-year yield was 2.78 per cent, not much higher than equivalent yields in Britain or the United States. Only three years ago, the yield was at the crisis level of 7 per cent, making it a candidate for a bailout. No bailout came because the European Central Bank in 2012 promised to do “whatever it takes” to keep the euro zone intact.

As yields have plummeted in Italy, and also in Spain, Greece, Portugal and Ireland, so has Rome’s incentive to kick the economic reform measures into high gear. The new Italian recession may provide fresh impetus to do so.

Follow on Twitter: @ereguly

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