German growth engine sputters

The eurozone economy has shrunk for the 19th time in 20 months, according to a survey of services and manufacturing activity in April. New orders have fallen for 21 months in a row, and the fall is gaining speed. Activity in Germany went into reverse for the first time in six months. German business confidence has now slipped for two months in a row.

Still, Italy's ten-year yield fell below 4%, a three-year low, as prices rose. The re-election of President Giorgio Napolitano has fuelled hope that a new government will soon be formed. Other peripheral yields have also slid.

What the commentators said

"The eurozone's economic engine is stuttering," as Carsten Brzeski of ING put it. Weaker growth in China and the decline of the yen have played a part in hampering export-led Germany's growth, while the ongoing downturn on the rest of the continent has now apparently affected it too. The bottom line is that the German economy is set to stagnate this year, reckoned Capital Economics, as the eurozone's recession grinds on.

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A shrinking economy will make it all the more difficult to cut deficits and prevent debt piles from growing, said Allister Heath in City AM. Look what happened last year. The debt-to-GDP ratio in the eurozone as a whole grew from 87.3% at the end of 2011 to 90.6% a year later.

Yet while the eurozone is clearly "in a spiral of recessionary decline", markets are sanguine. This "disconnect" is due to all the liquidity created by central banks, which has boosted the feel-good factor and prompted investment in risky assets.

That has implications for the future of the debt crisis too, as James Mackintosh pointed out in the FT. European politicians are "already taking advantage of the absence of the bond vigilantes". Several countries will now be allowed to miss their deficit targets.

Governments always backtrack on promises when markets give them a break. They might be tempted to ditch painful structural reforms that would boost long-term growth too. All this implies debt piling up further in the periphery and greater German reluctance to help shore up the EU. Bond investors, concluded Neil Unmack on Breakingviews.com, have succumbed to complacency.