Europe Heads Toward Recovery, but Slowly

German Growth Helps Drive Euro Zone to End of Longest Recession in Decades, Though Severe Unemployment Likely to Persist

By CHARLES FORELLE in London, NINA ADAM in Frankfurt and ILAN BRAT in MadridCONNECT

The Wall Street Journal

Europe's longest recession since World War II appears to be on the verge of ending, driven by a surge in German growth that is helping to blunt the severe economic pain faced by many in the region, but is too modest to lift the global outlook.

A string of recent economic data, including a robust German industrial production report on Wednesday, has boosted hopes that the 17-member euro zone has returned to weak growth after six quarters of contraction. German industrial production in June jumped 2.4% from May, the country's economy ministry said Wednesday, beyond economists' expectations for a 0.3% gain.

The positive news from Germany followed an upbeat survey of purchasing managers in the euro zone last week and signs of slowing recessions in Italy and Spain—the region's third- and fourth-largest economies. Across the Channel, the Bank of England upgraded its growth forecasts on Wednesday. And Portuguese unemployment fell for the first time in two years.

Taken together, the data point to an imminent albeit weak German-led recovery, either in the second or third quarter, economists say. Euro-zone gross domestic product data for the second quarter are scheduled to be released Aug. 14.

"Germany's economy staged an impressive growth comeback in the second quarter, which should be sufficient to have pushed the entire euro zone out of the recession," said Carsten Brzeski, chief economist at ING.

Europe's recession, though prolonged, has been shallow and its recovery will likely be slight. That means growth will likely be insufficient to create markedly more jobs in struggling countries such as Greece or Spain, where depression-level rates of unemployment are likely to persist for some time.

The latest data aren't "signaling a cyclical recovery that you might remember from an old-fashioned recession," said Jens Larsen, chief European economist at RBC Capital Markets in London. "This is a slow recovery."

RBC predicts data will show the euro-zone economy grew in the second quarter—but only by 0.1%.

A modest recovery in Europe would do little to help the global economy, which is already burdened by slowing growth in Asia and many emerging markets and by only moderate U.S. expansion.

There are several reasons Europe is rebounding: exporters are riding modest global growth; consumers are marginally more willing to spend; and policy makers are slightly easing the severe budget cuts that have damped economic output.

Nevertheless, unemployment remains staggeringly high in many countries. Bank lending is terribly weak. The minuscule levels of growth that might materialize in the coming months aren't enough to arrest the region's rise in government debt—which risks reopening that crisis again.

Like most of the rest of the developed world, Europe tumbled in the 2008 financial crisis. But unlike the U.S., it has struggled to come back, thanks largely to the explosion of the debt crisis in 2010.

That crisis had three particularly deleterious effects. It pushed governments into rapid spending cuts and tax increases, in order to slow the growth of their debts. It drove banks to pull back lending, especially to smaller businesses in weaker countries. And it battered confidence, both of consumers who might spend and businesses who might invest.

Each of those effects is waning, if only slightly. Having made big fiscal cuts in 2011 and 2012, governments have slowed the pace as the pressure from financial markets to cut debt growth eases off. Bank lending is still very weak but appears at least to have stopped worsening.

"We are seeing something on the lending side," European Central Bank President Mario Draghi said at a news conference last week. "But it is just a very beginning."

There are also signs that the consumer is getting sunnier. People "postponed a lot of purchases," says Francesco Garzarelli, co-head of global macro and markets research at Goldman Sachs. "Car sales in Italy have been abysmal," he points out. "Those are coming back and normalizing."

A true turnaround in the euro zone would require substantial improvement in the region's biggest economies after Germany: France, Spain and Italy, where signs of true recovery remain elusive.

In Spain, for example, GDP declined just 0.1% in the second quarter of this year compared with the first quarter, prompting government officials to say the economy is bottoming out after nearly two years of recession. But business executives say they are stuck in a limbo between recession and a recovery many don't expect to begin until well into next year.

In a recent Deloitte survey of 269 of Spain's largest companies, about half said their markets would show no improvement in the second half of this year. Roughly equal numbers said their markets would improve or worsen.

The continuing economic malaise is hampering growing companies such as Tablet Army SL, a Spanish startup Ana Ormaechea founded early last year to make tablet apps for publishing interactive reports and magazines.

The 37-year-old entrepreneur said her client base is increasing, and her Madrid-based company is churning out increasing numbers of publications by joining with a half-dozen freelancers. But endemic economic problems in Spain are dragging on her expansion. A credit crunch across the economy is spurring some customers to delay their payments by as much as seven months, and she is unable to get bank financing at affordable rates to help fund her operations.

If more customers paid on time, she said she would consider hiring someone full time for more projects, freeing her to drum up more business overseas.

"When the country's in such bad shape, you've got no other option than sowing new seeds and pulling your own cart," she said.

Italian companies are also still struggling, and many employers complain that deep labor reforms are necessary to unshackle the economy, a refrain across the region.

"If the industrial conditions in Italy remain such that it is impossible to properly govern the industrial operations in this country then obviously any commitment we have to this country is up for grabs," Fiat SpA CEO Sergio Marchionne said last week.

Indeed, much of the optimistic data in Europe is of the "less bad" variety. Italy reported Tuesday that its preliminary estimate of second-quarter gross domestic product showed a decline of 0.2% compared with the previous quarter—a gentler drop than economists had forecast. But it was still Italy's eighth straight quarter of decline, and GDP was 4.4% below where it was in the second quarter of 2011.

Nonetheless, even stabilization has been enough to entice some investors back to Europe's stock markets. The broad euro Stoxx index, which covers the euro zone, is up 16.9% over the past 12 months. Bulls say the Continent's stock market offers a ripe chance to buy global companies at a still-cheap price.

Europe's bond markets are less excitable. Spanish and Italian government bonds are much improved from their peak-crisis levels, but they still trade at a substantially worse price than benchmark German bunds. But if economic growth takes hold, countries like Spain and Italy could stand to benefit most from the current environment of low interest rates.

"The combination of better growth and accommodative rates should improve fiscal profiles and get people away from the bund market," says Mr. Garzarelli.

—Manuela Mesco and Giovanni Legorano in Rome contributed to this article.

Write to Charles Forelle at charles.forelle@wsj.com, Nina Adam at nina.adam@wsj.com and Ilan Brat at ilan.brat@wsj.com

A version of this article appeared August 8, 2013, on page A7 in the U.S. edition of The Wall Street Journal, with the headline: Europe Heads Toward Recovery, but Slowly.