By Alan Wheatley, Global Economics Correspondent
LONDON (Reuters) - The cheery freeze frame of the euro zone economy last quarter is no guarantee of a happy ending to what has been a horror movie for most of the single currency bloc since the onset of the great financial crisis.
The return to growth, albeit of just 0.3 percent between the first and second quarters, is unalloyed good news for Europe and the world after 18 months of contraction.
But the recovery is vulnerable to external shocks and too weak yet to make a difference to two of the major issues hanging over the euro zone: record unemployment and the sustainability of the area's public and private debt.
Quarterly growth of 0.7 percent in Germany and 0.5 percent in France, the bloc's two biggest economies, was faster on an annualized basis than in the United States, whose economy expanded 1.7 percent in the second quarter using that calculation.
Context counts, however. Inflation-adjusted U.S. output is about 5 percent higher than it was in the first quarter of 2008. Households have acted swiftly to pay down debt and the housing market is enjoying a brisk upswing. Growth has responded, even if the recovery has been weak by historical standards.
The euro zone, by contrast, is still in catch-up mode. Gross domestic product remains 3 percent below the peak reached five years ago and, on current trends, is unlikely to regain that high water mark until the middle of 2015 at the earliest, according to Jefferies, an investment bank, in London.
Mirroring the unused resources in the economy, unemployment is a record high 12.1 percent.
"Europe is a long way behind the U.S. in the cycle. We had a decent Q2 - better than expected, for sure - but it's still very early days," said Marchel Alexandrovich, a Jefferies economist.
LOOKING UP AT LAST
Some of the factors boosting growth, such as the end of a hard winter giving way to a buoyant tourism season, are inherently fleeting. A build-up in inventories - which accounted for 40 percent of France's growth in the second quarter - will turn out to be a dead weight if final demand does not improve.
But the benefits of the European Central Bank's near-zero interest rates and generous liquidity provision are gradually rippling through the economy.
The drag from higher taxes and government spending cuts is fading. Global uncertainty is easing somewhat as China stabilizes and economists pencil in faster U.S. growth in 2014.
"This is what is allowing the region to exit recession. The situation is not great, but it is no longer as bad as it was last year," Greg Fuzesi, an economist with J.P. Morgan, wrote.
Ebrahim Rahbari with Citi in London said he was reasonably optimistic that the euro zone would be able to keep posting quarterly growth.
"No matter how bad things are, you really do reach a trough at some point unless you are continuously hit by bad shocks. And we haven't been hit by major shocks in Europe for a while," he said. "With all of this slack, an economy should be able to generate clearly positive growth at this point in the cycle."
For many, however, it will still feel like recession. That is because firms have plenty of spare capacity and so will be able to meet rising demand without hiring more workers - or investing in new plant - until this so-called output gap has been closed. Productivity will rise before employment does.
"It's not enough for growth to be positive to create jobs. Output growth has to exceed productivity growth. We're in an environment where firms are trying to become more efficient, so even the growth pattern we see right now does not give you much promise of unemployment coming down," Rahbari said.
PAIN IN SPAIN
Take Spain, where unemployment is more than 26 percent.
In a recent health-check on the economy, the International Monetary Fund said Spain in the past has never added jobs when the economy grew by less than 1.5 percent to 2.0 percent a year.
Yet growth is unlikely to reach these rates even in the medium term. Unemployment is still likely to be above 25 percent in 2018, the Fund said.
Besides the social and political dangers posed by entrenched unemployment, low growth in Spain and other southern countries risks widening the divide with faster-growing Germany and other northern members of the euro zone. It could also prompt markets to question again whether the periphery's debts are manageable.
The task, then, for euro zone policy makers in the year ahead is to ensure a recovery in the labor market before adverse debt dynamics kick in and the long-term jobless lose their skills and become unemployable.
Wage restraint is part of the answer - even as private sector employment in Spain fell 15 percent between 2008, wages grew 10 percent, according to the IMF - but Rahbari said governments needed to deploy an array of active labor market policies, as Germany did by subsidizing low-paid jobs.
Such deep-seated labor reforms can take years to enact and years more to have an impact. The same goes for freeing up Europe's protected product markets and service sectors.
Yet without root-and-branch changes, good news such as the rise in second-quarter GDP risks being a flash in the pan.
"Your benchmark shouldn't be positive economic growth. It should be lowering your output gap and unemployment. Until you get there, it really is still very much a story of, ultimately, policy failure," Rahbari said.
(Editing by Jeremy Gaunt)