German investor sentiment fell sharply in May on concern growth will be stifled by a 750-billion-euro ($930 billion) rescue package designed to calm market fears of a wave of Greek-style debt crises.
Tough conditions, similar to those imposed in International Monetary Fund (IMF) bailouts, have been set for euro zone states to qualify for protection from hostile markets concerned about their debt levels.
That has forced Spain and Portugal to agree an additional round of unpopular austerity cuts as they try to slash public spending and rein in their budget deficits.
The closely watched ZEW analyst and investor survey saw medium-term growth down in Europe's biggest economy, with uncertainty over the euro also weighing on sentiment.
The EU rescue package will in the mid-term reduce budget deficits, but it will also dampen demand and mid-term growth will be dampened as well, ZEW economist Michael Schroeder told reporters.
After agreeing a record 110-billion-euro bailout this month for Greece, hit by crippling borrowing costs due to market fears it could default, euro zone leaders a week ago agreed a $1 trillion package with the IMF to help other vulnerable members.
Spain and Portugal have now agreed to extra austerity measures which, while easing default fears, could slow 2010 growth the European Commission already saw at just 0.9 percent.
Reacting to the ZEW survey, Unicredit's Alexander Koch said there would be a knock-on effect on German growth caused by increased savings efforts in neighboring states.
There the thumb screws are being applied to the budget: i.e. tax increases and spending cuts. This dampens private consumption and public investment, he said.
U.S. President Barack Obama has discussed the debt crisis with European leaders and some U.S. analysts warn the U.S. economy, where GDP growth is seen at 2.8 percent this year, could stall again if Europe's crisis failed to stabilize.
Norway's Central Bank chief Svein Gjedrem told parliament events in Europe and the financial markets had increased economic uncertainty and a senior IMF official said the Greek crisis had shown considerable risks remained to the global economic outlook.
The global recovery remains sluggish, uneven and still in need of policy support ... As recent events in Greece have shown, risks remain considerable, IMF First Deputy Managing Director John Lipsky told a symposium in Tokyo.
Together with strong implementation by euro area countries, notably through actions to put public finances on a sustainable path, they will help sustain the global recovery, he said.
ECONOMIC GOVERNANCE, FISCAL REFORM
Euro zone finance ministers met in Brussels on Monday to iron out wrinkles in their rescue plan, which comprises standby funds and loan guarantees that euro zone governments could tap if shut out of credit markets like Greece.
They agreed to consider proposals the EU Commission produced last week at their request. They suggested broad macroeconomic outlines of national budgets be discussed in advance at the European level and speedier penalty procedures for countries that breach EU budget rules.
It is essential now that we show we are serious about fiscal consolidation. I could sense broad support for the Commission proposals (on economic surveillance), said Economic and Monetary Affairs Commissioner Olli Rehn.
The bailout of Greece was a first for the euro zone, where contagion fears and now concerns over growth have been blamed for the dip in the euro. It has fallen some 14 percent against the dollar this year.
Our distrust in the euro currency has led us to hedge all our positions in Europe by buying the dollar equivalent, French fund manager Carmignac, which manages around $40 billion, said in a note.
As a result, the entire Carmignac Investissement (international equities) portfolio is exposed either to dollar or emerging currencies.
However, some saw a silver lining to the storm clouds.
While many observers currently tend to see the euro as a crisis barometer, recent surveys show that many German businesses tend to be more pragmatic. For them, the weaker euro could be a blessing which simply boosts exports, said Carsten Brzeski at ING Financial Markets.
(Additional reporting by Jan Strupczewski and Brian Love in Brussels; writing by Jon Boyle; editing by Michael Roddy)