Confidence in the euro zone's economy strengthened in January for the first time since early 2011, EU data showed on Monday, but a recovery in Germany masked a deterioration in France and Italy, highlighting the bloc's diverging fortunes.
Germany has shown more resilience to the euro zone's troubles than many of its neighbors, helped by fiscal prudence, a competitive edge and good demand for its high quality goods.
France and Italy have struggled to keep up, facing questions about the sustainability of their own finances as Greece tries to agree a debt restructuring and Portugal comes under fresh scrutiny in financial markets.
The divergence complicates the task of EU leaders who are meeting in Brussels on Monday to try and sketch a path out of the economic slump.
The European Commission's economic sentiment indicator rose by 0.6 points in the euro zone to 93.4, the first improvement in sentiment since March last year as some confidence returned to services, consumers and construction.
We're seeing a slight stabilization and we expect the recession the euro zone will end in the spring, said Christoph Weil, an economist at Commerzbank.
But we can also see that the divergence in the euro zone is increasing and that is of great concern, he said.
The European Central Bank's decision in December to provide 3-year loans to banks averted a credit freeze, while the U.S. economy expanded strongly in the last quarter of 2011 and China has remained robust, maintaining demand for Europe's goods.
But budget austerity and political divisions over how to solve the two-year debt crisis continue to depress business in the euro zone and the wider European Union, with non-euro zone country Britain heading for a recession in early 2011.
The rising optimism is still tempered by EU leaders' inability to resolve the euro zone debt crisis and the sentiment indicator was slightly lower than forecast by economists polled by Reuters.
Following last week's surprisingly positive purchasing managers' indices, or PMIs, business climate rose for the second month in a row to -0.21, in line with economists' expectations.
But factory managers saw a deterioration in the view of their order books and although this was offset by a positive assessment of stocks, it confirmed the mixed economic picture.
Industrial confidence remained at the lowest level since April 2010 while confidence in services rebounded by 2 points in the euro zone and construction was up 0.6 points.
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GERMAN RENEWAL, GREEK PAIN
The European Commission forecasts 2012 economic growth of just 0.5 percent for the 17 nations in the euro zone, which generates 16 percent of global economic output.
The International Monetary Fund is more pessimistic, forecasting a 0.5 percent contraction in 2012 that it says could drag the world into recession.
EU leaders face a tough task at Monday's summit as they try and bridge the divergence in economic performance among the 27-nation bloc's economies and reconcile austerity with growth.
Recent data suggests Germany will avoid a recession, while non-euro zone member Britain, as well as euro states Spain, Italy, Greece and Portugal, are likely to see their economies contract in 2012. Belgium and the Netherlands, also members of the single currency, will struggle to grow at all.
The Commission's data also supported that view, as economic sentiment improved in Germany by 2.3 points, the second consecutive monthly rise, but fell in France, Italy and the Netherlands.
While large economies such as France and the Netherlands will likely benefit from Germany's recovery, Italy and Greece must confront falling productivity and high debts to avoid years of stagnation.
Weakened domestic economic activity, intensified fiscal tightening in many countries and still serious uncertainties and concerns over the euro zone sovereign debt crisis continue to limit an improvement in sentiment, said Howard Archer, chief European economist at IHS Global Insight.
(Reporting By Robin Emmott; editing by Rex Merrifield/Anna Willard)