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With France stalling, euro zone recovery comes to near halt

French President Francois Hollande (L) German Chancellor Angela Merkel (R) and European Commission President Jose Manuel Barroso leave after
French President Francois Hollande (L) German Chancellor Angela Merkel (R) and European Commission President Jose Manuel Barroso leave after

By Leigh Thomas and Martin Santa

BRUSSELS/PARIS (Reuters) - The euro zone economy all but stagnated in the third quarter of the year with France's recovery fizzling out and growth in Germany slowing.

The 9.5 trillion euro economy pulled out of its longest recession in the previous quarter but record unemployment, lack of consumer confidence and anaemic bank lending continue to prevent a more solid rebound.

In the three months to September, the combined economy of the 17 countries sharing the euro grew by a slower than expected 0.1 percent. In the previous quarter it rose 0.3 percent - the first expansion in 18 months.

The euro fell to a session low in response.

The French economy contracted by 0.1 percent, snuffing out signs of revival in the previous three months. It had been expected to post quarterly growth of 0.1 percent and has now shrunk in three of the last four quarters.

German growth slowed to 0.3 percent, from a robust 0.7 in the second quarter, but Europe's largest economy clearly remains in much better shape.

France is becoming a focus for concern within the currency bloc. The Bank of France predicts the economy will expand by 0.4 percent in the last quarter of the year but the government's labor and pension reforms are widely viewed as too timid.

A report on French competitiveness by the Paris-based Organization for Economic Cooperation and Development warned that it is falling behind southern European countries that have cut labor costs and become leaner and meaner.

"To reduce the economic lag and lost time, France needs to keep up structural reforms," OECD chief Angel Gurria said.

The report will be hard for the government to ignore since it was commissioned by President Francois Hollande.

German growth was fuelled by domestic demand. Exports faltered, another indication of the malaise gripping the rest of the euro zone.

"ECB interest rates are far too low for Germany. Germany will probably grow significantly more strongly than the euro zone," said Joerg Kraemer, chief economist at Commerzbank. "Early indicators point to similar growth in the fourth quarter."

The European Commission forecasts the currency area will shrink by 0.4 percent over 2013 as a whole before growing by a modest 1.1 percent in 2014.

However, with unemployment in the bloc running above 12 percent and one in two young people out of work in Greece and Spain, talk of recovery rings hollow.

Compounding the French gloom, private sector payroll data showed some 17,000 jobs were destroyed in the third quarter, while inflation

PERIPHERY PAST THE WORST?

Italy matched France's performance, shrinking by 0.1 percent. The Netherlands eked out 0.1 percent growth.

A senior Italian official told Reuters this week that the euro zone's third largest economy would return to growth in the last three months of the year, expanding by as much as 0.5 percent and ending nine quarters of slippage.

Spain reported last month that it had pulled clear of recession in the third quarter, albeit with quarterly growth of just 0.1 percent, putting an end to a recession stretching back to early 2011.

Portugal is still struggling with austerity as part of its bailout plan yet managed to grow by 0.2 percent in the third quarter following stunning 1.1 percent expansion in Q2. Unlike other embattled euro zone states, unemployment has started to fall there too.

Cyprus, still in the midst of an austerity program in return for being bailed out, contracted by 0.8 percent on the quarter while Greece's deep recession eased a little.

Doubts about an unsteady Italian coalition government's ability to push through economic reforms remain a major concern for the euro zone. But France is climbing the worry list fast.

Both Spain and Portugal have had the outlook on their credit ratings raised to stable in recent days while Standard & Poor's cut France's rating to AA from AA+, still well above its Iberian neighbors but narrowing the gap.

The European Central Bank surprised markets with an interest rate cut last week, although that was more to do with evaporating inflation.

"The sluggish growth outlook implies that disinflationary forces will likely remain in place for the time being. Against this backdrop, further monetary easing by the ECB certainly cannot be excluded, said Martin van Vliet, an economist at ING.

On Wednesday, ECB chief economist Peter Praet raised the prospect of the bank starting outright asset purchases if things got too bad. Bundesbank chief Jens Weidmann took the opposite tack, saying rates should not stay at record lows for too long.

(Additional reporting by Gavin Jones in Rome and Reporting by Madeline Chambers in Berlin, Writing by Mike Peacock, editing by Jeremy Gaunt)

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