If there is one clear upside surprise in recent economic news, it surely must be the remarkably fast rebound of the core European economies. Not only have France and Germany reported marginally positive Q2 GDP growth, but forward looking data like the German PMI, which jumped to 54 in August, suggest the rebound is no blip. The services sector in both countries has been particularly strong, as consumers have avoided the leverage bubble afflicting the US and UK, and consequently fiscal and monetary stimulus has apparently found greater traction. While US consumers are saving their tax refunds and the windfall from lower energy prices, Europeans are spending. Neither has there been a residential real estate boom to unwind, with real prices essentially flat in Germany for a decade. There is no question that Southern Europe, and notably Spain, are still suffering the fallout from a manic local property and construction boom, and Spanish unemployment will likely hit 20% in 2010.

However, it seems likely that overall Eurozone growth will turn positive for Q3 and forecasts will have to be upgraded for 2010. The ECB will be vindicated for not following the Fed and BOE in slashing rates to microscopic levels; Europeans are essentially savers, while Americans are spenders. The vast surplus savings of conservative German retirees have been recycled into speculative schemes from Hollywood movies to Spanish golf courses and the fly in the ointment is the German banking sector, which remains hugely exposed to further writedowns, particularly in Eastern Europe.  An additional risk is corporate debt at 100% of Eurozone GDP, almost twice that in the US, which is forcing rapid deleveraging via equity and bond issuance and asset divestment.

A key factor behind Europe's resilience is the 'shock absorber' function of a deeper social safety net that gives many newly unemployed 50-75% of their previous incomes for a year, and the fact that generally unionized corporates have been far more reluctant than in the US to shed labour, but have taken a deeper margin hit instead. Many US observers have criticized the German government for a modest fiscal stimulus plan, but because social benefits are so generous, there is an automatic stabilizer that doesn't exist in the US or even the UK to anything like the same extent. Adding thsoe cyclical social costs to the various incentive programs makes the French/German effort much more comparable. The relative rise in unemployment hasn't been as brutal in Germany and France (although both have an endemic long-term unemployment problem with immigrant communities) nor its personal consequences as severe.

The consensus full-year forecast for Eurozone GDP in 2009 now stands at -4%. The 2010 full-year estimate is still for an anaemic recovery of sub 1%, but that may well get revised higher by year-end. While a tepid, below-trend recovery is likely (as in the US), the fact it is occuring sooner than expected is positive in so far as there is less foregone output to replace. Meantime, risk assets from equities to commodities will take encouragement from what is looking more and more like a synchronized global recovery next year. The biggest downside risk for Europe will be a renewed banking sector crisis; the German financial sector has leverage about twice that of the UK, and three times that of the US. A further economic deterioration in Eastern Europe would force further balance sheet contraction on German banks and imperil a promising recovery.