Europe's economy contracted in the fourth quarter for the first time in 2.5 years as the region's debt crisis undermined confidence and forced governments from Spain to Greece to toughen budget cuts.

Gross domestic product (GDP) in the 17-nation euro area fell 0.3 per cent from the prior three months, the first drop since the second quarter of 2009, the European Union's statistics office in Luxembourg said today. Economists had forecast a drop of 0.4 per cent.

In the year, the economy grew 0.7 per cent.

Europe is facing its second recession in less than three years and Moody's Investors Service cut the ratings of six of the region's countries on February 13th, saying policy makers haven't done enough to restore investor confidence.

"We'll probably see another contraction in the first quarter, which means a technical recession," said Christoph Weil, a senior economist at Commerzbank AG in Frankfurt. "The situation should stabilise afterward followed by a slight economic recovery. The fiscal crisis is the main risk."

In a separate report today, the office said that euro- region exports rose 0.1 per cent in December from the previous month, when adjusted for seasonal swings. Imports fell 0.9 per cent from November and the trade surplus widened to €7.5 billion from €6.1 billion.

In Germany, Europe's largest economy, GDP fell 0.2 per cent from the third quarter. Economists in a Bloomberg survey had forecast a drop of 0.3 per cent.

France's economy unexpectedly expanded in the fourth quarter, with GDP rising 0.2 per cent. "The German economy only took a growth pause and is not approaching a new recession," said Carsten Brzeski, a senior economist at ING Group in Brussels. "Of course, a quick rebound is not an automatism and the big unknown for the German economy remains the sovereign-debt crisis."

The economies of Spain, Belgium, Italy and Portugal also contracted in the final three months of 2011. In Hungary, the economy expanded 0.3 per cent from the third quarter, while Bulgarian GDP advanced 0.4 per cent and the Czech Republic reported a drop of 0.3 per cent, reports showed.

Greece's GDP slumped 7 per cent in the fourth quarter from a year earlier, according to a report yesterday.

Still, recent surveys indicate the pace of contraction won't accelerate in the current quarter. Euro-region services output expanded in January after shrinking in the previous four months and economic confidence increased. German investor confidence jumped to a 10-month high in February.

European Central Bank president Mario Draghi has also pointed to signs of stabilisation in the euro-area economy and said the ECB averted a credit crunch with its three-year loans to lenders in December. The central bank will offer a second round of financing, known as LTRO, at the end of this month.

Bloomberg