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Euro zone economy shrank by 1.5 pct in Q4

The drop in output for the fourth quarter compared to the third was the biggest since the euro was created in 1999 and the third quarterly fall in a row.

The drop in 15 of the 16 euro countries - Slovakia only joined Jan. 1 and wasn’t counted in euro zone figures - means the euro zone’s economy contracted even more than the U.S.’s equivalent 1.0 percent, according to Eurostat, even though Europe’s banking system is not considered to be as exposed to toxic subprime loans.

Analysts said the blame for the sharp drop in output can be put squarely at the feet of waning trade volumes, hurt by both slumping demand as well as a relatively strong euro which makes exports more expensive.

“At the heart of this is the decline in manufacturing exports that can perhaps predominantly be blamed on the uncompetitive euro together with the undeniable fact that as this is a global recession few nations are buying,” said Howard Wheeldon, senior strategist at BGC Partners.

The preliminary growth figures from the European Union statistics agency Eurostat come as other data show that industrial production and exports across the continent plummeted.

The biggest major casualty so far has been Germany, the euro zone’s single largest economy, which saw GDP drop an eye-watering 2.1 percent during the quarter - the biggest decline since the country’s reunification nearly two decades ago - as exports fell off a cliff.

Jorg Radeke, economist at the Centre for Economic and Business Research, said Germany’s reliance on exports of things like cars and factory equipment means that it is “particularly exposed” to the global downturn and collapsing world trade.

“The data wipes out any illusion that the euro zone is getting off lightly in this global downturn. Indeed, what started as financial market turmoil has long moved to the real economy,” he said.

While France recorded a 1.2 percent quarterly contraction, its sharpest decline since at least the 1970s, Italy’s 1.8 percent quarterly drop pushed the annual rate of decline to 2.6 percent - the deepest recession since 1980.

The scale at which the recession is deepening has caught policymakers off-guard and Friday’s figures will prompt a significant lowering of the European Central Bank’s staff projections, which will be published alongside the March 5 interest rate meeting.

Analysts said the pressure on the European Central Bank to cut interest rates again will be huge, especially as the situation in the euro zone will likely get a much worse as swelling unemployment and the deepening global recession continue to hit exports and consumer spending hard.

Though the bank’s President Jean-Claude Trichet has indicated that another interest rate reduction is likely in March, he has sounded a relatively harsher tone on inflation than his counterparts at the U.S. Federal Reserve and the Bank of England. While the Fed has already cut its benchmark rate to near zero percent and the Bank of England reduced rates to an all-time low of 1 percent earlier this month, the ECB decided to pause after four consecutive cuts.

“This crisis has dimensions that still have yet to be defined and we must watch and we are watching with concern,” Italy’s Premier Silvio Berlusconi told a press conference ahead of this weekend’s meeting of the Group of Seven finance ministers and central bankers in Rome.

Though the scale of the recession hitting the industrialized world will be top of the agenda, few concrete measures are expected to emerge from the meeting, ahead of a broader, 20-country summmit in April.

For the EU as a whole, including the 12 other countries that were not as of the end of 2008 using the euro, output also slumped by 1.5 percent on a quarterly basis, following a 0.2 percent decline in the third quarter.

Of the figures available to Eurostat, only Greece, Cyprus and Slovakia posted quarterly increases, with Lithuania recording the biggest quarterly slump of 2.4 percent.