* Growth badly undershoots expectations, Q4 revised down
* Domestic demand drives strong German growth
* France flatlines, government forecasts threatened
* Italian GDP shrinks, Netherlands, Finland in doldrums (Recasts with euro zone, adds Greece, analysts, details, graphics)
By Martin Santa and Annika Breidthardt
BRUSSELS/BERLIN May 15 (Reuters) - The euro zone economy grew much less than expected at the start of the year and inflation remained locked in the ‘danger zone’ below 1 percent, increasing pressure on the European Central Bank to ease monetary policy at its next meeting in June.
The 9.5 trillion euro economy expanded only 0.2 percent quarter-on-quarter in the first three months of 2014, the same as the downwardly revised rate in the last quarter of 2013, while economists had expected 0.4 percent growth.
The first quarter figure stayed positive mainly thanks to strong growth in the biggest economy Germany, which compensated for stagnation in France and shrinking output in Italy, the Netherlands, Portugal and Finland.
“Today’s figure is a major disappointment, as it suggests that the euro zone is still far away from reaching the escape velocity required for a sustainable recovery,” said Peter Vanden Houte, chief euro zone economist with ING.
With growth so weak and consumer price growth well below the ECB target, the bank is preparing a package of measures for its June meeting, including cuts in all its interest rates and steps to fight the risks of deflation.
“The package...the ECB appears to be preparing is welcome... but the overall steps are likely to be too small to make a real difference,” said Nick Kounis, economist at ABN AMRO.
“More aggressive easing than the ECB currently seems to be considering would help from that perspective,” he added.
German quarterly growth of 0.8 percent marginally exceeded forecasts and was double the pace at the end of 2013. The zero growth in France was a disappointment compared with expectations of 0.2 percent growth.
Inventory changes and public spending were the only factors which kept the French economy from contracting while Germany’s performance was driven largely by domestic demand, French and German statistics office data showed.
France will now need 0.5 percent growth each quarter to meet a government forecast for 1 percent growth in 2014, Natixis Asset Management chief economist Philippe Waechter said.
“France’s public finance plan has been built on the 1 percent growth forecast. If we don’t achieve it, France will not meet its (debt and deficit) targets for 2014 and 2015,” Waechter said. Missing the deficit targets again is likely to put Paris on a collision course with European Union rules under which it has to cut its deficit below 3 percent of GDP by 2015.
France is not the only euro zone member in the doldrums.
Italy defied growth expectations and contracted 0.1 percent, denting a fragile recovery begun at the end of last year when the country finally put an end to its longest recession since World War Two.
The euro zone growth outlook for the second quarter was poor too, which will not help reduce the risks of deflation.
“We believe GDP growth is unlikely to be stronger in Q2 than in Q1. This ‘recovery’ remains far too weak to halt deflationary pressures,” said ING’s Vanden Houte.
Germany expects domestic demand to drive growth of 1.8 percent this year and Finance Minister Wolfgang Schaeuble said that everything pointed to a broad economic pick-up.
Meanwhile France is facing a public sector strike by the hardline FO labour union over civil service pay freezes - a reminder of the difficulties of enacting reform and making the French economy more competitive.
Greece, after four years of tough reforms introduced in exchange for a 240 billion euro bailout, continued to shrink year-on-year in the first quarter, but at the slowest pace since early 2010, adding credibility to expectations that Athens will limp out of a six-year recession this year.
The silver lining is the absence of pressure from the markets, with borrowing costs for many euro zone countries at record lows.
DON‘T BLAME THE EURO
The ECB has said a strong euro is one of its concerns, given the downward pressure it puts on import prices and exports.
France wants euro zone governments to take action on the currency and has called for negotiations to weaken it after EU parliament elections next week.
But the head of France’s Medef national employers association said on Tuesday that Paris should not use its call for a weaker euro as a substitute for much-needed reforms.
Other euro zone countries which have taken strong medicine to improve competitiveness are starting to see the benefits.
Spain reported first quarter GDP growth of 0.4 percent two weeks ago, giving a year-on-year expansion of 0.6 percent, the strongest in three years. The Spanish government upped its 2014 growth forecast to 1.2 percent from a previous 0.7 percent.
In global terms, much depends on demand for European goods from China, but there are positive signs elsewhere.
Japan clocked its fastest pace of growth in more than two years in the first quarter, raising hopes the economy will have enough momentum to tide over an expected slump following an April 1 sales tax hike.
And the United States is expected to bounce back from a weather-ravaged start to the year.
^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ Economic recovery in Europe: link.reuters.com/zyk57v ECB rates/euro/inflation: link.reuters.com/jer39v Euro zone inflation: link.reuters.com/vex45v Euro zone GDP since Q1 2008: link.reuters.com/pyj42v ECB Q2 survey on CPI: European Commission forecasts: ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ ($1 = 0.7294 Euros) (Additional reporting by James Mackenzie in Rome, Madeline Chambers in Berlin, Jussi Rosendahl in Helsinki and Anthony Deutsch in Amsterdam. Writing by Mike Peacock, Martin Santa and Jan Strupczewski; Editing by Toby Chopra)