Euro zone gross domestic product stagnated in the first quarter, the EU's statistics office Eurostat said on Tuesday.

That was a touch better than forecast by economists, who had expected a 0.2 percent slump, and dodging a technical recession following a 0.3 percent contraction in the last three months of 2011.

A surprisingly strong 0.5 percent expansion by Germany, Europe's biggest economy, appeared to save the bloc from recession, even as the French economy stalled and Italy reported weaker-than-expected output that epitomized southern Europe's anaemic economies.

"Germany is leading the bloc, but this doesn't mean we will have a strong rebound, austerity is not going away and southern European economies are really struggling," said Mads Koefoed, a senior economist at Saxo Bank. "We are looking at stagnation to very mild growth in the year to come," he said.

Barely out of the 2009 financial crisis, businesses and households in much of Europe are hampered anew as governments cut back on spending to curtail budget deficits and companies freeze plans to invest.

Despite two summits this year and another planned for next week, EU leaders have been unable to find a way back to growth, while many southern Europeans are turning against austerity measures, holding huge street protests in Madrid and backing radical political parties in Greece's recent elections.

Optimism in January that the euro zone would recover quickly in 2012 has been crushed by unexpected contractions in manufacturing, consumer confidence and business morale, while one in 10 euro zone workers is out of a job.

"The euro zone economy... is not likely to recover any time soon," said Jurgen Michels, an economist at Citigroup in London.

Germany's economy, lifted by exports of precision machinery and luxury cars, bounced back from a 0.2 percent contraction in the last three months of 2011.

Austria, Slovakia and Finland also posted modest growth.

GERMANY VS THE SOUTH

But for the rest of the bloc, efforts to reduce deficits are costing growth and making it harder to reach EU-mandated targets, calling into question the wisdom of cutting so deeply.

"There's a growing divergence in the euro zone, with particularly sharp contractions in the peripheral countries that need to do the most structural reforms, while Germany is the outperformer," said Joost Beaumont at ABN Amro in Amsterdam.

Italy's economy, the third largest in the euro zone, contracted by more than expected in the first quarter, falling 0.8 percent and marking the third consecutive quarter contraction.

After a decade of falling productivity in Italy, the impact of the debt crisis has highlighted how barriers to competition, heavy regulation and bureaucracy are dragging on the economy, discouraging investments and prosperity.

"Technical recession is here to stay for at least another couple of quarters," said Paolo Pizzoli, an economist at ING.

Spain, which is struggling to reduce a huge deficit and rebuild its banking sector following a burst property bubble, is already in recession, after GDP shrank 0.3 percent in the first quarter.

Even in the wealthy Netherlands, economic output contracted for a third consecutive quarter, shrinking 0.2 percent in the first quarter of 2012 compared to the previous three months, underscoring just how damaging the crisis has become.

(Reporting By Robin Emmott; editing by Rex Merrifield)

• A Permanent Economic Emergency