THE German and Italian economies shrank abruptly in the final quarter of last year, confronting the European Central Bank with a dilemma over a two-speed eurozone.

Bleak official figures revealed that Germany slid back to the brink of technical recession in the quarter as its economy shrank by 0.2 per cent, after stagnating in the previous three months.

The unexpected slump in Europe’s number one economy came after Germany has already suffered two technical recessions — defined as two successive quarters of falling output — over the past four years.

Italy, too, succumbed to a surprise fourth-quarter drop in its output, which tumbled by 0.3 per cent, all but reversing a third-quarter gain of 0.4 per cent.

Domenico Siniscalco, Italy’s Economy Minister, said that this was “a nasty surprise”.

But the surprise setback for Germany and Italy coincided with a marked acceleration in growth in France and Spain, facing the ECB with a growing quandary over diverging eurozone performance.

France’s growth in the final three months of 2004 leapt to 0.7 per cent, surging from a flat third quarter. Spanish output rose by 0.8 per cent, on the heels of an already buoyant 0.6 per cent gain in the previous three months.

The good news from Paris and Madrid was not enough, though, to offset the plight of Germany, which makes up a third of the eurozone economy.

Germany’s deepening economic misery meant that fourthquarter growth for the eurozone as a whole almost ground to a halt, slowing to 0.2 per cent from 0.3 per cent previously.

A gulf in growth between eurozone member states was underlined by the performance gap between its smaller economies.

The Netherlands economy also shrank in the fourth quarter, by 0.1 per cent, while Finland enjoyed a healthy 1 per cent growth.

Eurozone economists described the German and Italian figures as “pretty catastrophic” and “shockingly bad”.

“The writing has been on the wall for a long time that the eurozone recovery is in trouble,” David Brown, of Bear Stearns, said.

But leading policymakers insisted that the eurozone remained on course for gradual recovery.

The European Commission argued that it saw no reason to cut its 2 per cent forecast for 2005 eurozone growth.

Analysts also saw a glimmer of hope for Germany as its ZEW survey of investors’ confidence rose for a third month running.

Economists predicted that while the ECB’s Governing Council might now soften its recent hawkish rhetoric it was likely to continue to defy any demands for lower eurozone interest rates.

INFLATION FEARS

Soaring household fuel bills helped to keep UK inflation higher than expected last month, reinforcing City expectations that the Bank of England will today keep open the door to higher interest rates.

Record year-on-year gains in utilities’ charges and dearer food offset the effect of cheaper petrol and discounts in the high street sales in January, leaving consumer price inflation unchanged at 1.6 per cent.

On the Retail Price Index, inflation eased to 3.2 per cent, from 3.5 per cent in December. But economists argued that underlying price pressures would see the Bank dampen hopes that rates have peaked in today’s Inflation Report.

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