Bad News Piles Up for European Economy

Rising prices and weaker consumer demand are increasing the risk of a recession in the area where the euro is used

By Alexander Jung and Michael Sauga

Before leaving for her summer holiday last week, German Chancellor Angela Merkel appeared to give her last public address of the season in a bordeaux-red blazer. Her message to the people: Everything will be okay, everything is under control. In terms of the economy, she conceded, "things haven't gotten any easier," but it has been "more independent and robust" than ever before. She also noted that the ideal of "full employment" had been achieved in some regions and that if the government continued to work together, a solution to the country's chronic unemployment could be in sight.

Less than 24 hours later, Germany's most important economic indicator, the Ifo Business Climate Index, released its latest report, which "dropped like a rock," as one Frankfurt banker put it. Analysts had forecast a decline to 100 points, but it's fall to 97.5 suggested the "economic upswing is coming to an end," Ifo President Hans-Werner Sinn said.

The raft of bad economic news for Germany continued into this week. After the Ifo report's release, Germany's second-largest industrial concern, Daimler AG, announced profits had drastically collapsed—an announcement that caused its share price to take an 11.5 percent tumble. Finally, Deutsche Bank, Germany's biggest financial institution, announced that profits had fallen by 63 percent during the second quarter.

Increasing Risk of Recession

Meanwhile, this Thursday the euro zone reported 4.1 percent inflation for the month of July, up from 4 percent in June and representing the highest level of rising costs registered since the European Union began gathering such statistics for the euro-zone in 1997. The European Central Bank's preferred target for inflation is 2 percent.

Rising prices and a related shrinking of consumer demand are increasing the risk of a recession in the area where Europe's common currency, the euro, is used.

Back in Germany, Bert Rürup of Darmstadt University—who chairs the German Council of Economic Advisors that advises Merkel's government—said there had been a "clear economic cooling down" and that there was a danger that unemployment could start to mount again by year's end after months and months of job creation. Because of the industrial orders that have been booked, though, he said "a recession in Germany is unlikely." He still didn't rule out the possibility, though.

This is all bad news for Merkel's governing coalition, which is made up of her conservative Christian Democrats and the center-left Social Democrats. Up until now, the government has been able to rely on sunny economic prospects that have made governing between two parties that are traditionally in opposing camps a little bit easier. Instead of allocating the fruits of the upswing as Merkel has been able to do up until now, her cabinet may soon be forced to deal with an economic downswing.

Indeed, after three years of economic growth and job creation, the Germany economy is starting to upend. Although the industrial sector may still have orders to fill, there is a dearth of new orders coming in at the moment, turnover is declining and profits sinking.

Spending Program?

Last weekend, Germany Economics Minister Michael Glos let it be known that he wants to launch a €10 billion ($15.6 billion) spending program to help cushion the country from the effects of a slowing economy. "If the economic climate cools off, then we need to discuss measures this autumn that could reinforce growth," Walther Otremba, a deputy minister in the Economics Ministry told SPIEGEL.

The program would be aimed at increasing consumer spending. The measures would include tax cuts for private households and the reintroduction of a tax break for commuters.