WRAPUP 1-Austerity hits Greek economy harder than forecast

* Economy shrank more than expected by 1.5 pct q/q in Q2

* Cuts in government spending, investment main drag

* Jobless rate posts record y/y jump to 12 pct in May

By George Georgiopoulos

ATHENS, Aug 12 (Reuters) - Greece's economy shrank more than expected in the second quarter and unemployment climbed to 12 percent, reflecting the pain of austerity measures agreed with lenders to overcome the country's financing crisis.

Flash estimates released by the Greek statistics service on Thursday showed gross domestic product (GDP) contracted by 1.5 percent in the three months to June, and economists whose forecasts had centred on a 1.0 percent slide said things were likely to get worse before they turn better. ECONGR

"We think the largest hit to private consumption from tighter fiscal policy is probably still ahead of us," said Citigroup economist Giada Giani. "We expect growth to remain negative for the rest of the year, with an average decline of around 3.5 percent for 2010."

Greece so far has mustered the political will to implement reforms and is on track to meet its goal to slash the budget deficit to 8.1 percent of GDP from 13.6 percent last year, scrambling to convince markets its past profligacy is over.

Belt-tightening helped shrink the budget gap by 45 percent in the first half, prompting praise from euro zone peers and the IMF which came to its rescue with a 110 billion euro ($141 billion) bailout in May to avert a broader debt crisis in the 16-nation currency bloc. [ID:nLDE67A08I] [ID:nLDE67907I]

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But the deepening recession remains a risk for the government's revenue-generating ambitions, especially if the 240 billion euro economy slumps more than a projected 4.0 percent this year, as public sector pay cuts and tax hikes take a toll.

Highlighting the pain, unemployment posted a record jump in May, climbing to 12 from 8.5 percent a year earlier, with the EU and the IMF projecting further deterioration to as high as 15 percent in the next two years. [ID:nLDE67B0SA]

MARATHON RACE

Apprehension over fiscal reform fatigue has kept funding costs prohibitively high -- the extra yield investors demand to hold Greek 10-year bonds rather than benchmark German bunds is still stuck at around 8 percentage points, while five-year credit default swaps on Greek debt rose to 795 basis points, up 32 basis points on the day, shortly after the GDP release.

This means it now costs 795,000 euros per year to insure an exposure of 10 million euros of Greek government bonds.

Many market participants worry that sustained economic malaise may set the stage for political tension and unrest down the road.

Now in its second year, the Greek recession is deepening consumers' insecurities about jobs and debt, driving them to cut spending and to try to unwind borrowing. Economists project the impact will become more pronounced in the second half.

"The labour force figures for May, which showed a sharp increase in unemployment, illustrate that the second half of the year will continue to be very difficult for the Greek economy and for households in particular," said Diego Iscaro, an economist at IHS Global Insight.

According to the latest research by retail confederation ESEE, about a fifth of small shops in central Athens have shut down as a result of the downturn.

"Unemployment will rise more in the months ahead. We have not gone through such a situation in the past: out of some 100 shops in my area 15 have closed in the last four months and I see things worsening from September," said Konstantinos Kserikos, 37, a book store owner in the centre of Athens.

Even major companies like Aldi, the world's biggest discount food retailer, and French high-street retailer FNAC are leaving the Greek market. Atlantic (ATLr.AT), a Greek supermarket chain, filed for bankruptcy protection, citing the recession.

One mitigating factor providing some support is the improvement in net exports, helped by a weaker euro and a global recovery.EUR= "We need to look beyond today's numbers towards 2011, as this will be the real crunch year that will decide Greece's fate," said Anke Richter, credit research director at Conduit Capital Markets.

"Greece is so far on a good track to reduce its budget deficit, but this is a marathon race. After five kilometres everyone looks in good shape. The question is, will the voters and politicians have the stamina in a year's time?" (Additional reporting by Tatiana Fragou, Harry Papachristou and Lefteris Papadimas; Writing by George Georgiopoulos; Editing by Ingrid Melander and Ruth Pitchford)