Euro zone set to enter recession as fortunes diverge

BRUSSELS Mon May 14, 2012 7:11pm EDT

BRUSSELS (Reuters) - The euro zone's sick economy probably slipped into its second recession in just three years in early 2012, data is due to show on Tuesday, as the debt crisis sucks southern Europe into a downward spiral and widens the split with paymaster Germany.

Euro zone gross domestic product is seen contracting 0.2 percent in the first quarter, according to economists polled by Reuters, following a 0.3 percent contraction in the last three months of 2011 and driving it into a recession.

Barely out of the 2009 global financial crisis, businesses and households are engulfed anew as governments cut back on spending to curtail budget deficits and companies freeze plans to invest, unable to find a way back to economic growth.

Optimism at the start of the year that the euro zone would escape a downturn has been crushed by unexpected contractions in manufacturing, consumer confidence and business morale, while one in 10 of every worker in the euro zone is out of a job.

"The euro zone economy is heading into recession and is not likely to recover any time soon," said Jurgen Michels, an economist at Citigroup in London.

"This definitely won't be that mild and will probably last much longer than policymakers expected," he said.

Germany, the largest economy in the 17-nation bloc, is among the few countries likely to escape the malaise by growing 0.1 percent in the first three months of this year, while France's economic output will likely remain unchanged in the quarter.

For the rest of the bloc, efforts to reform and cut deficits are costing growth and making it harder to reach EU-mandated targets, calling into question the wisdom of cutting so deeply.

"There's a growing divergence in the euro zone, with particularly sharp contractions in the peripheral countries that need to do the most structural reforms, while Germany is the outperformer," said Joost Beaumont at ABN Amro in Amsterdam.

That divergence is epitomized by indebted Italy, the bloc's third largest economy, where output is set to shrink 0.6 percent in the January-to-March period after contracting 0.7 percent in the last three months of 2011.

After a decade of falling productivity in Italy, the impact of the debt crisis has highlighted how barriers to competition, heavy regulation and bureaucracy are dragging on the economy, discouraging investments and prosperity.

Spain, which is struggling to reduce a huge deficit and rebuild its banking sector following a burst property bubble, is already in recession, after GDP shrank 0.3 percent in the first quarter.

Even in the wealthy Netherlands, economic output is seen shrinking 0.2 percent and taking the country into a slide, underscoring just how damaging the crisis has become.

"We are likely to be in recession for at least the whole of 2012. You may see some pick up from foreign demand for euro zone goods, but when it comes to domestic demand, it all looks pretty grim," Citgroup's Michels said.

(Reporting By Robin Emmott)

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