Euro Zone Shrinking Again

The euro zone's two largest economies avoided shrinking between April and June, but the resilience of Germany and France wasn't enough to prevent the currency bloc's economy as a whole from falling back into contraction.

Euro-zone economic output fell 0.2% in the second quarter from the first, the European Union's statistics agency Eurostat said Tuesday. That is in line with economists' forecasts in a Dow Jones Newswires poll. Output fell 0.4% year-to-year, again matching expectations.

The decline, which follows zero growth in the first three months of the year, is likely to make it harder for euro-zone leaders to end the fiscal crisis which has forced several member states to request financial aid and raised questions about the bloc's ability to survive in its current form. Rising unemployment and falling consumer and business confidence could worsen public finances in many countries, pushing back debt-reduction targets and heightening concern among investors.

Growth in Germany and stagnation in France—performances that were both better than economists had expected—prevented a steeper decline in euro-zone output in the period. But with signs growing that these two core economies will struggle during the rest of the year, the prospects for the euro-zone as a whole look set to deteriorate.

Germany's ZEW institute said confidence surrounding the euro zone's largest economy worsened for the fourth consecutive month in August to hit the lowest level this year. The economic expectations index fell to minus 25.5 from minus 19.6 in July, confounding forecasts for a slight improvement in sentiment.

ZEW said that suggests financial-market experts anticipate the German economy will continue to cool over the coming six months. Other forward-looking gauges of the German economy have also worsened of late, with a survey of purchasing executives in July showing the steepest drop in business activity and new orders in three years.

The poor outlook will put more pressure on the European Central Bank to intervene to support the economy, mainly by trying to start credit flowing again through a paralyzed financial system. ECB President Mario Draghi said last month the bank will do "whatever it takes" to save the euro.

"The contraction in euro-zone GDP…reinforces our belief that the ECB will trim interest rates from 0.75% to 0.5% within the next couple of months," Howard Archer, an economist with IHS Global Insight, wrote in a note to clients. He said a cut was more likely in October, but could come as soon as next month.

Eurostat's data showed five euro-zone nations are in recession, defined by many economists as two straight quarters of declining gross domestic product. They are Greece, Spain, Italy, Cyprus and Portugal. All of them except Italy have requested some form of international financial support. Data on the Netherlands have been increased to show that country isn't in recession, as Eurostat had previously estimated. The euro zone as a whole isn't yet in recession, owing to its zero growth reading in the first quarter.

"The euro zone has been able to avoid a 'technical' recession by the skin of its teeth, thanks to the flat outcome in the first quarter which was a result of the unexpectedly strong data out of Germany," said Ken Wattret, economist at BNP Paribas BNP.FR +0.55% .

"As things stand, however, that looks like being a temporary reprieve," he said. "With numerous forward-looking indicators of economic activity signaling a continued contraction in GDP in the third quarter, it probably won't be long before the recession is made official."

Mr. Wattret said BNP Paribas expects the economy to shrink by 0.4% in 2012 as a whole, before returning to growth next year.

Separate data from Eurostat Tuesday showed industrial production falling further in June. That suggests the economy's momentum as a whole was slowing at the end of the second quarter, making an imminent recovery less likely. Industrial output fell 0.6% in June from May and was 2.1% lower than a year before.

The GDP figures showed Germany grew 0.3% in the second quarter, beating economists' forecasts for a rise of 0.2% but still barely half its first-quarter growth rate of 0.5%. France stagnated for a third straight quarter, defying expectations its economy would shrink by 0.1%.

The steepest falls in economic output were recorded in Portugal, down 1.2%, and Finland, which shrank 1.0%. Italy's economy contracted by 0.7%.

Quarter-to-quarter data for Greece aren't available, although that country did record a year-to-year decline of 6.2%—slightly improved from its 6.5% contraction in the first quarter, but still by far the worst annual performance of the euro-zone countries.