Europe's outlook sunnier -- at least for now

By GEIR MOULSON

BERLIN

Things are looking up for Europe's economy -- relatively speaking, at least.

Less than three months ago, fears were rife that the continent was headed for a government debt debacle and a painful economic crash. But upbeat economic signs -- including robust German business confidence, predictions of stronger second-quarter growth and successful bond auctions by financially shaky Greece, Portugal and Spain -- have helped change the picture.

Investors are meanwhile increasingly occupied not by Europe's woes but by fears of weakening U.S. growth.

The latest piece in the puzzle: a placid market reaction Monday to last Friday's release of "stress tests" designed to show how Europe's banks would cope with a deepening economic and debt crisis. Only seven of the 91 institutes surveyed failed.

To be sure, several of the 16 governments that use the euro -- Greece, Portugal, Italy and Ireland -- are still buried in debt that will take years to work off, while Spain faces 20 percent unemployment.

And many analysts remain skeptical about whether the tests were tough enough to be credible. But that did not rattle markets or the euro, which has pulled back from a springtime slump.

The tests come on top of a May decision to put up nearly $1 trillion to backstop troubled governments, which also seems to have helped calm market turmoil.

The stress test results mark a "before and after" in worries over Europe's banks, said Jose Manuel Gonzalez-Paramo, a Spaniard who sits on the European Central Bank's powerful, six-member executive board.

"Where before there was practically just rumor and prejudice, now we have data that investors can use to reach their own conclusions," Gonzalez-Paramo told Cadena Ser radio. "Taken as a whole, we think they show solidity and resistance capacity by European banks."

The publication of the results, which found that the banks need to shore up their finances by only $4.5 billion, came at a "very fortunate" time when there already is a "sense of stabilization," said Silvio Peruzzo, a eurozone economist at RBS in London.

Germany, in particular, is expected to turn in strong second-quarter economic growth figures as strong demand from Asia and elsewhere boosts its exports. Last week, a survey of German business confidence found the strongest monthly increase since reunification 20 years ago.

Peruzzo forecast quarter-on-quarter growth of 1.8 percent for Germany and 0.8 percent for the whole eurozone -- the latter up from a feeble 0.2 percent in the first quarter.

"Compared to where we stood in early May, the situation has improved on a number of fronts," he said.

He pointed to markets' gradual digestion of the fact there is now "substantial policy support" for eurozone sovereign debt, along with data suggesting that major eurozone countries are "maybe in a much better shape than people were fearing."

The euro traded as high as $1.2997 on Monday, up from $1.2922 after the stress tests results were released Friday and more than 10 cents clear of the four-year low of $1.1878 it hit in early June.

"We suspect that the euro's resilience has more to do with the recent upside surprises in the eurozone economic data and the dollar's general weakness ... than the results of the (tests per se," said Vassili Serebriakov, a currency strategist at Wells Fargo Bank.

Better news from the eurozone and elsewhere can help increase appetite for assets viewed as riskier than the dollar, a traditional safe haven for investors. And there has been increasing concern recently over prospects of a slowing U.S. recovery -- with disappointing data and Federal Reserve Chairman Ben Bernanke saying that the outlook is "unusually uncertain."

Back in Europe, many analysts suggested that the stress tests were too lenient. Still, Gary Jenkins, an analyst at Evolution Securities, noted that banks that flunked "will not be allowed to fail in the real world."

And "there is a lot less short-term concern regarding the European government bond market" than when the decision to announce the tests' results was made in mid-June, thanks to successful bond issues by Spain, he added.

"It was seen as being the one that had to hold, because if Spain got into trouble then we could have faced a meltdown situation," Jenkins said.

Whether Europe has truly put behind it for good the fears of the past few months is another question. After the strong second-quarter figures, the pace of growth is likely to ease off in the second half, Peruzzo said.

That could prompt volatile markets to "confuse or to misinterpret this deceleration process" as a sign of contraction, perhaps re-igniting debt concerns, he added.

And many governments have large debt piles that will take years of careful financial management to cut down to size. Fixing public finances in the eurozone's more troubled countries and unwinding their debt "is a multiyear process," Peruzzo said.