The Wall Street Journal-20080215-Slump in Euro Zone Could Linger

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Slump in Euro Zone Could Linger

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The euro zone's economy shows signs of slowing sharply, and the limited flexibility of its labor markets, coupled with policy makers' reluctance to cut interest rates aggressively, could lead to a protracted slump.

Weak consumption in Germany and a decline in business inventories in France helped halve the pace of the euro zone's expansion in the fourth quarter of last year to 0.4% from 0.8% in the third quarter, according to official data released yesterday.

Most observers expect the slump to continue this year, as slowing global growth crimps export demand, record inflation damps domestic consumption and credit-market turmoil restricts lending. "All of the reliable leading indicators of euro-zone economic growth point to even worse news ahead," BNP Paribas economist Ken Wattret wrote in a research note.

Many economists expect growth of around 1.5% this year in the 15 countries that share the euro, down from 2.7% in 2007. A closely watched service-sector survey hit a 4 1/2-year low in January. Though an outright recession remains unlikely, the bloc's slowdown could be longer than the one in the U.S. The reasons include Europe's less- competitive labor and retail markets, the lack of a coordinated economic-stimulus effort and the European Central Bank's minimalist approach to interest-rate cuts.

Slumping house prices and a struggling financial-services sector also are likely to hurt growth in the United Kingdom this year.

The turmoil in credit markets is affecting global growth unevenly. The euro zone's 0.4% fourth-quarter growth compares with Japan's 0.9% growth for the same period, triple the previous quarter's rate.

In the U.S., where the convention for measuring gross domestic product is different, the economy expanded at an annualized rate of 0.6% in the fourth quarter; on a comparable basis, the euro zone's fourth-quarter growth was 1.6%.

While the Federal Reserve has cut its key interest rate -- now at 3% -- by 1.25 percentage points since mid-January and is expected to make further cuts, the ECB has kept its key rate on hold at 4%. In January, euro-zone inflation hit a record 3.2%, well above the ECB's goal of just under 2%.

Policy makers fret that Europe's less-flexible markets -- including some labor contracts indexed to inflation and a relative lack of competition in retailing that can keep prices high even as demand slows -- mean wages and prices will stay higher longer than in the U.S. They also worry increases in food and energy prices will spill over into big wage gains.

Inflation is likely to keep euro-zone consumption growth muted, damping hopes that domestic demand could pick up the slack as global weakness slows Europe's export growth. Only a few countries offered detailed GDP breakdowns yesterday; a sharp fall in domestic demand helped drag down Germany's growth, while consumption also slipped in France. Spain's GDP growth held up well, but economists anticipate the bursting of a housing bubble in Spain will slow consumption this year.

Euro-zone consumers also are unlikely to receive the kind of income boost the U.S. is providing under its plan to issue tax rebates this spring. France and Italy have big budget deficits; German officials are wary of lowering taxes after bringing the budget into balance last year.

Export growth also is starting to look wobbly. Germany's export- fueled economic revival has lifted the European economy in the past three years. But the value of the country's exports fell to around 73 billion euros, or about $106 billion, in December, down 15% from around 88 billion euros the previous month -- a sign the slowing global economy is starting to affect exporters.

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Mike Esterl in Frankfurt contributed to this article.