Is Europe’s economic house of cards about to collapse?

Germany suffered its sharpest drop in industrial production since 2009 in August: factory output fell by 4 per cent – surprising analysts who had expected it to fall more slowly, and boosting fears that Germany will enter recession.

Industrial production is just one economic indicator but, as Germany is the workshop of Europe, the slowdown reflects a wider problem hitting Eurozone economies: stagnation.

Italy, France and Germany – the three core economies – are all hovering around either zero growth (for the first two) or growth way below par in Germany’s case. The IMF, in its updated World Economic Outlook, said there was a even a one-in-three chance of the whole Eurozone entering recession this year.

And the reason is pretty clear: demand in the Eurozone is suppressed by its busted banking system, which is being made to mend itself, and therefore cannot stimulate the economy through lending.

Unlike Britain the Eurozone’s central bank can’t do quantitative easing (printing money). Nor are the core Eurozone economies prone to cheap labour and property speculation, which have allowed Britain to create hundreds of thousands of jobs without raising wages, and the property market to help revive the rest of the economy.

‘A blank IOU’

So all eyes are now on the European Central Bank. It has promised to re-start “unconventional” monetary policies – buying up pieces of paper called “asset backed securities” to put ready cash into the banks.

But few economists believe this will be enough. On the ECB’s stated aim, of pumping about three trillion euros worth of cash into the economy, it will need around another trillion – and that will have to come through outright QE.

Technically the ECB is not allowed to do this: it would be like Germany signing a blank IOU to the rest of the Eurozone economies. Privately much of the German political class – which has resisted Euro-QE – is coming round to printing money.

But the German electorate is getting very antsy: 12 per cent support for the anti-Euro Alliance for Germany party in two regional elections in September are a signal of that.

No time for schadenfreude

So what people in the markets think is this: the ECB’s boss, Mario Draghi, will do everything he can short of printing money until the new year. Then, as their beloved vorsprung durch technik economy slides into recession, the Germans will come around to letting him print one trillion euros and give it to the banks.

Draghi has already spelled out what the alternative is: abandon the tight austerity targets Europe imposed on itself after the 2010 crisis. But this, too, is deemed politically unacceptable.

So the Eurozone economy remains becalmed – by the aftermath of the banking crisis and the continued inability of policymakers to do the right thing at the right time. The full ghastly picture will come out when the European Commission releases its monthly update on the economy on Thursday.

If you’re thinking of unleashing schadenfreude, don’t. Germany is a big export market for Britain, as is the whole of the Eurozone. If they don’t grow, ultimately, large parts of the UK economy does not grow either. And if that happens, under the fiscal rules set by the coalition government, there would have to be more austerity into the future.

And if the sicker parts of the Eurozone go into deflation – Italy and France are on the brink of that – then the whole Eurocrisis will be back on.

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