Europe's Weak Growth Numbers May Have Big Impact on U.S.

The face of U.S. economy worries has another wrinkle: Europe.

Economic data from Europe this morning showed that France and Germany, the continent's two biggest economies, grew at a weaker-than-expected pace in the first quarter, amid softening exports and investment, while also showing signs of inflation.

The slowdown in Europe poses another challenge to a corporate America struggling to fend off the slowing at home. While analysts said today's numbers weren't stark enough to provoke widespread panic, a global slowdown could imperil the second-half recovery for the U.S. economy that Wall Street is betting heavily on.

"If the economy in Europe continues to slow, it would be negative as investors are betting for a fourth-quarter recovery for the U.S. economy," said Peter Boockvar, equity strategist at Miller Tabak. "[The slowing in Europe] may push out the timing for a recovery."

Gross domestic product in Germany, Europe's largest economy and biggest exporter, grew 0.4% in the first quarter, below the 0.5% forecast by economists. The economy expanded 1.6% from a year ago, the slowest pace in a year and a half. In France, first-quarter GDP grew 0.5%, the slowest pace in more than two years and below economists' expectations of 0.7%.

The major European indices posted moderate losses today. The euro, meanwhile, declined to near six-month lows against the dollar today, after the decision by the European Central Bank to leave rates at 4.5%.

Inflation, or rising prices, has tied the hands of the ECB from making further interest-rate cuts after reducing borrowing costs a quarter-point on May 10. Reports this morning showed a number of German states reported higher consumer prices for the month to mid-May, and prices in France for April rose at the fastest pace in seven months.

"With a strong dollar and weak domestic demand in Europe's two largest countries, U.S. companies expecting to support weak U.S. sales with strong international sales may have to re-evaluate," said Thomas Van Leuven, J.P. Morgan's stock market strategist.

Donald Coxe, chairman and chief strategist at Harris Investment Management, said he is "far more worried" about the weakening of the euro against the dollar, as he believes it's the largest threat to the earnings of U.S. companies that make their money in euro dollars. "This is really bad news for the auto companies, chemical companies, and the U.S. manufacturing sector in general," he added.

Also, a large number of big-name U.S. technology companies get a large share of their revenues from overseas. Even though companies may charge in U.S. dollars, a weaker euro may mean that European companies simply cannot buy as much product.

Chip leader Intel (INTC Quote) is a case in point. The world's leading semiconductor maker has in the past seen its results fall short of forecasts, primarily because of weak demand in Europe. The latest earnings release from Intel shows that 25% of the company's revenue hails from Europe, compared with 35% from the Americas and 12% from Japan.

Others like JDS Uniphase (JDSU Quote), Novell (NOVL Quote) and Sun Microsystems (SUNW Quote) look to Europe as one of their largest markets.

The telecom industry is also closely entwined with the fortunes of Europe. The Philadelphia Stock Exchange Wireless Telecom Sector index, includes European companies that trade as American depositary shares, or ADRs, in the U.S., such as Swedish handheld firm Ericsson(ERICY Quote) and Finland's Nokia (NOK Quote). The index fell 3.7% today,.

The "regular cast of characters" would be the companies most hit by Europe's slowdown, said Van Leuven, pointing out technology and consumer staples as the two groups he believes could be most affected. "Today's data are not a plus for a near-term recovery."