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The euro sign is seen in front of the European Central Bank in Frankfurt. (Kai Pfaffenbach/Reuters/Kai Pfaffenbach/Reuters)
The euro sign is seen in front of the European Central Bank in Frankfurt. (Kai Pfaffenbach/Reuters/Kai Pfaffenbach/Reuters)

The euro zone's conundrum: A two-speed economy Add to ...

It's not all gloom and doom in the debt-mired euro zone, even though the latest growth figures show that the two-speed Europe is still intact.

The economies of Germany and France, the biggest and second-biggest in the 17-country euro zone, respectively, are powering ahead, defying expectations for tepid growth after a nice bounce in 2010.

National statistics released Friday showed that Germany grew by an astonishing 1.5 per cent in the first quarter compared with the last quarter in 2010, in spite of rising oil prices. France's figure was 1 per cent, making it the strongest quarter since mid-2006. Economists had forecast in 0.9 per cent and 0.6 per cent, respectively.

Even though France's growth was less impressive than Germany's, it was enough to boost the French Finance Ministry's confidence. That's because the fine first-quarter showing means that the economy is likely to expand in line with the official forecast of 2 per cent, "which itself suggests that bringing down the fiscal deficit to 6 per cent of GDP from 7.1 per cent last year is doable," Deutsche Bank economist Gilles Moec said.

The question is whether the plump first-quarter figure will prevent the ratings agencies from putting France under negative watch, signalling a probable downgrade. It just might.

"Paris still has a lot on its plate to address fiscal shortcomings, but the usual model for France of offsetting lacklustre underlying budget performance with relatively strong nominal growth seems to hold for now," Mr. Moec said.

James Ashley, senior European economist in London for RBC Dominion Securities, said the largest contribution to French growth in the first quarter came from the buildup of inventories. Because inventory buildups are typically followed by wind downs, "the composition of French first-quarter growth suggests some slight downside risk to second-quarter growth," he said.

RBC expects slower French growth - 0.5 per cent - in the second quarter.

Germany's statistics office said corporate investment, household consumption and construction were behind the strong first-quarter showing. Exports continued to surge; they were up 7.3 per cent in March, to their highest values since records began in 1950. German unemployment, at 7.1 per cent, is the lowest on record since reunification. More than a few German industrial giants, BMW among them, are making record or close-to-record profits as domestic consumption and exports rise quickly.

The growth figures were underwhelming in Italy, Spain and Portugal.

While overall euro zone growth was 0.8 per cent, against the forecast 0.6 per cent, the figure was obviously skewed by the galloping pace in Germany and France.

Italy, the euro zone's third-biggest economy, expanded by just 0.1 per cent in the first quarter, a below-expectations figure that matched the shabby performance in the previous three months. Rome expects growth of just 1.1 per cent this year, a figure that may prove optimistic unless Italy's efforts to make itself more competitive suddenly bear fruit.

Italian output is still 5 per cent below the precrisis peak.

Portugal, the newest bailout victim, sank 0.7 per cent, after a 0.6-per-cent decline in the fourth quarter. The back-to-back losses formally put the country back in recession.

Spanish growth was an anemic 0.3 per cent. The big surprise was Greece, which recorded growth of 0.8 per cent in the first quarter. It seems to have been a blip - RBC described it as "frankly baffling" - though a welcome one; the economy is still expected to shrink this year by about 3.5 per cent, after a 4.4-per-cent contraction last year, as the savage austerity programs take their toll.

Today's GDP figures highlight the challenges faced by the European Central Bank and its new Governor, Mario Draghi of Italy, who is to replace Jean-Claude Trichet in the autumn.

With overall euro zone growth making a comeback, along with inflation, the ECB will be tempted to raise interest rates. Last month, it raised rates for the first time in two years and may well do so again in the summer. The European Commission has lifted its 2011 inflation forecast for the euro zone to 2.6 per cent from 2.2 per cent. The target rate is 2 per cent or less.

The two-speed nature of the euro zone means any rate hike will put extra burdens on the weakling countries.

European stocks rose on the better-than-expected GDP figures. The markets were bolstered by strong profits reported by UniCredit, one of Italy's biggest banks, and Vivendi, the French music and video game company.

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