I have to admit it: I was wrong about Europe. After a year of deflationary increases in taxes, interest rates and exchange rates, I had expected a severe slowdown in Europe by now. The eurozone did weaken a bit in the first-quarter GDP figures, as revealed in the figures produced by Eurostat last week. But the slowdown in growth to 0.6 per cent in the first quarter, from 0.9 per cent in the fourth quarter of 2006, was hardly the drama that I had been expecting. Worse still for my reputation as an economic pundit, there has been no sign of the plunge into near-recession that I had been predicting for Germany after the three-percentage-point increase in VAT in January.

In fact, Germany was, despite the tax increases, again the strongest economy among the eurozone’s big three, with a calendar-adjusted growth rate of 0.5 per cent in the latest quarter, much better than the market’s consensus forecast of 0.3 per cent growth.

These statistics suggested that German politicians and central bankers were correct to insist that German consumers would shrug off the effects of higher taxes and absolutely right to ridicule the dire predictions of Anglo-Saxon economists, such as myself, schooled in the Keynesian tradition, when we argued that no economy could withstand the simultaneous blows of fiscal, monetary and exchange-rate deflation hitting Germany this year. It seems that the ordinary laws of macroeconomics, which have applied not only to Britain and America but also to Japan in the 1990s, are simply inoperative in Germany. In the week when Nicolas Sarkozy officially abandoned the concept of l’exception française, maybe it is time to announce die deutsche Ausnahme.

Before doing so, however, we should note a couple of anomalies in the recent economic news from Europe. Even though economic figures in the past few weeks have been stronger than expected, the markets have started behaving as if the opposite were true. The euro peaked just under $1.37 at the end of April and has now fallen to below $1.35, raising the possibility of a technically important change in the euro’s upward trend. The German stock market, meanwhile, has fallen by 3 per cent relative to Wall Street, its biggest bout of relative underperformance since last spring.

Are markets starting to sense that the latest European statistics, favourable though they were, may actually mark a peak in Europe’s world-beating relative performance? Is this a classic case of “buy on the rumour and sell on the news”? Maybe I am guilty of eurosceptic wishful thinking, but two little-noticed factors encourage me to stick with my (wrongly) negative views about the euro and European economic growth for a little while longer.

First, it is worth noting that the composition of Europe’s GDP in the latest quarter has not yet been revealed, but preliminary indications from government statisticians suggested that the structure of growth was far from healthy. Almost all German growth apparently came from capital investment, exports and rising inventories, with little contribution from consumers. “In comparison with investment and exports,” the Federal Statistics Office said, “consumer spending clearly slowed economic growth, which should be seen as related to the increase in value-added tax at the beginning of the year.” It may well be, therefore, that Germany has not entirely repealed the normal rules of economics, but merely that the usual response to a massive tax increase has been delayed. A second interesting point is that Europe was not the only region that revealed strong economic statistics last week. It turned out that another big economy grew even faster in the past six months than Germany, by 0.6 per cent in the first quarter (against Germany’s 0.5 per cent) and 1.2 per cent in the fourth quarter of 2006 (compared with Germany’s 1 per cent). This other booming country is Japan.

Although Japan has reported substantially faster growth than Germany in the past two quarters, this news has not been treated as evidence of a new, miraculous economic boom. Japan is said to be suffering from chronically weak consumer spending. Its overreliance on exports and investment is viewed as a serious economic problem and a threat to the durability of its expansion. In Germany, by contrast, exactly the same structural distortions are hailed as evidence that the postwar Wirtschaftswunder has revived. Why is this so? Why do investors shun Japan because of its overreliance on exports and investment while they celebrate the economic miracle of Germany’s export and investment boom?

Probably the most convincing argument for greater confidence about Europe than Japan is that overreliance on exports and investment is a purely German phenomenon. Outside of Germany, European growth has been powered mostly by consumption. Exports actually have been very weak and have consistently subtracted from economic growth in France, Italy and Spain. The eurozone as a whole, therefore, is much less dependent on exports than Germany alone. In fact, Germany’s export growth is largely a consequence of strong consumption in Southern Europe. This, in turn, has been entirely dependent on Anglo-Saxon-style house-price and mortgage booms. These started in Spain and Ireland after the creation of the euro and, in the past few years, have spread to France and Italy. Europeans still have plenty of scope to follow the Anglo-American example by increasing their leverage and extracting more equity from housing. Assuming that the normal principles of economics apply in Europe, at least to some extent, a slowdown in housing seems much more likely than an acceleration. Signs of a shakeout in the Spanish housing market have recently become apparent, exactly 18 months after the European Central Bank (ECB) began to raise interest rates in December 2005. And last week the ECB’s Monthly Bulletin added some statistical backing to the anecdotal evidence of European housing markets facing tougher times. The ECB’s pan-European index of house prices rose by 6.4 per cent in 2006, down from 7.9 per cent in 2005, and the rate of increase eased steadily through 2006. Mortgage growth in Europe has fallen from a peak of 12.1 per cent in March 2006 to 8.9 per cent in March this year.

There was, however, one big economy where the property market moved the other way. After declining by 1.6 per cent in both 2004 and 2005, house prices in Germany enjoyed “a tentative pickup” in 2006, according to the ECB. The size of this pick-up? A princely gain of 0.3 per cent. So, even if Germany follows different economic laws from Britain, maybe comparisons with Japan make sense after all.

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