The U.K. economy unexpectedly shrank by 0.4% in the third quarter this year, officially sending the region into its longest recession since record-keeping began more than 50 years ago.  (Why the United Kingdom is hurting).

Edmund Conway and Andrew Porter for Telegraph U.K. report that adding insult to injury is that the United Kingdom has fallen beneath Italy for the first time since the mid-1990s to become the world’s seventh-largest economy. (When will Italy rebound?)

Blame two things: the devaluation of the British pound and the severity of the recession overall. France surpassed the United Kingdom last year. (Tom talks Europe on CNBC).

Italy first surpassed Britain’s economy in 1987. The milestone is being hailed as  confirmation that Italy has proved its resilience.

For more stories about Italy or United Kingdom, visit the corresponding categories.

• iShares MSCI Italy Index (NYSEArca: EWI): up 30% year-to-date

• iShares MSCI United Kingdom (NYSEArca: EWU): up 33.5% year-to-date

According to mortgage specialist Conti, property investors looking to snatch up houses overseas are sticking to proven, more traditional locations for long-term investment, according to NuWire Investor.

Locations of interest has France in the lead with 31% of inquiries received by the company, followed by Spain with 22%. Turkey remains in third with 13%, Portugal in fourth and Italy in fifth. Location interest is waning in countries such as Bulgaria and the United States.

• France. France has a relatively stable market. The country’s financial system is eager to lend to foreign investors, so much so that it may be possible to borrow up to 100% of the property value. Interest is low and many property sellers are still dropping prices.
• Spain. Buyers have a large selection of available properties and the benefit of low interest rates. But there are problems with exposure to corrupt licensing laws or land grab issues.
• Turkey. Turkey is situated in a nice Mediterranean location and overseas buyers won’t be up against a strong euro. Tourism is on the rise, which should increase demand for quality rental properties in tourist areas.
• Portugal. Portugal has seen a drop in interest rates and lower property prices, with some locations down 30%. Recently, the country reported an end to its recession.
• Italy. Italy can yield profitable acquisitions in more popular areas with international tourists.
• Bulgaria. Lenders have been in a bind with development and the market has a glut of  buildings. The result is a steep drop in valuations and banks are questioning asset security, which inevitably has lead to lower overseas demand.
• United States. The main reason overseas buyers look to the United States is because of a depreciating dollar, which has made properties cheaper.

• SPDR Dow Jones Wilshire International Real Estate (NYSEArca: RWX): up 36.4% year-to-date; France is 11.3%, Italy is 0.14%

• iShares FTSE/NAREIT Global ex-U.S. (NASDAQ: IFGL): up 41.8% year-to-date; France is 7.1%, Italy is 0.2%

For more information on the real estate sector, visit our real estate category.

Max Chen contributed to this article.

Germany and France both reported increases in growth and the numbers have convinced some analysts that Europe’s economy is recovering, perhaps even faster than that of the United States’, reports Charlie Parker for Citywire.

There are some risks, though:

• Some economists think, however, that the improved numbers may not be a show of overall economic strength but rather a fall in imports as exports remain the same, which would come up as a stronger net trade.

• The unemployment rates in Germany and France may also be misleading because of the larger public sector. It is seen that the fall in production in Europe did not reflect an equal fall in unemployment. The economies could suffer later from the excess weight.

• The European Central Bank has cut its benchmark interest rate to a record 1% low and begun a $86 billion program of buying assets, writes Simon Kennedy for Bloomberg. Officials are regarding the economic recovery with caution and won’t be reversing their policies any time soon.

• The ECB projected that the European economy may contract 4.6% this year and contract 0.3% in 2010. Deutsche Bank estimates a 1.3% contraction next year and UBS AG predicts 2.1%.

One way to access the European market is through the PowerShares FTSE RAFI Europe (PEF) ETF. PEF, currently up 42% year-to-date, tracks the performance of the largest European equities in the FTSE RAFI Europe Index, which normally invest 90% of its total assets in securities that comprise the Index and ADRs based on securities in the Index, as stated by InvescoPowerShares. The ETF has 526 holdings with an expense ratio of 0.75%.

• Country allocations: United Kingdom 30.6%, France 14.7%, Germany 13.3%, Italy 7.6%, Switzerland 6.4%, Netherlands 5.8%, Spain 5.3%, Sweden 4.0%, Ireland 2.6%, Belgium 2.5%

For more information on Europe, visit our Europe category.

Max Chen contributed to this article.

Bank of Italy Governor Mario Draghi says Italy’s economy will take a minimum of four years to rebound to 2007 levels, and public debt and deficits will continue to skyrocket in the meantime, writes Christopher Emsden for The Wall Street Journal. The government could begin to run a primary deficit (budget spending before interest payments on public debt) for the first time in 18 years.

One key point Draghi insists on is a crackdown on tax evasion. Istat, the Italian government statistics agency, calculates that 16% of Italian GDP is in the untaxed informal sector.

In an attempt to safeguard businesses, Draghi urged the government to lower tax rates on workers and businesses, reports Paolo Biondi for Reuters. But this suggestion may fall on deaf ears as Italy labors under the highest debt in the euro zone and third highest in the world.

The Italian research institute Isae calculates Italy’s economy will shrink by 5.3% this year, twice previous forecasts, reports Steve Scherer for Bloomberg. Italy, Europe’s 4th largest economy, could see a 0.2% growth next year.

• iShares MSCI Italy Index (EWI): up 7.3% year-to-date

For more information on Italy, visit our Italy category.

Max Chen contributed to this article.

Partial results show Prime Minister Silvio Berlusconi’s Freedom People Party received around 35%, down from projected 45%, of the vote in elections for the European parliament, reports Luca Casiraghi for The Wall Street Journal. Ultimately, 35% was enough and Berlusconi prevailed, but it’s a sharp decline in support.

As the economy is estimated to contract 5% this year, citizens feel that Berlusconi, a rich businessman, is out of touch with the problems of the Average Joe. Unemployment is a sensitive issue, and the Northern League, an anti-immigration and pro-federal political body, gained at opposition’s expense.

Berlusconi thinks the country’s economic downturn is waning, noting improvements in some sectors, according to ChinaView.

However, the national retailers’ association Confcommercio says that signs of an economic recovery are still too weak to be substantial. A report showed that household spending trends in April was marked by uncertainty. Consumer spending rose in March but dropped 0.4% in April.

• iShares MSCI Italy Index (EWI): down 1.2% year-to-date

For more information on Italy, visit our Italy category.

Max Chen contributed to this article.

Meanwhile, the style factor is not compromised in Italian design, as designers are set to weather the recession with clean, timeless design that can stay the decade. Sensible and sustainable were the mantras for the 2,700 manufacturers that launched collections to more than 300,000 showgoers at the Milan Fairgrounds and at independent exhibitions all over the city, reports David A. Keeps for The LA Times.

Italian carmaker Fiat is set to grow, as they take  a stake in Chrysler LLC. Fiat may spin  off its automobile division following a purchase of General Motors Corp.’s European unit, sending the Italian carmaker’s shares to a seven-month high in Milan. Fiat already plans to take control of Chrysler, based in Auburn Hills, Michigan, in a deal announced by President Barack Obama last week, reports David Risser and Steve Rothwell for Bloomberg.

• iShares MSCI Italy Index (EWI): down 4% year-to-date

France, Germany and Italy are the top three economies within the euro zone and second quarter outlook are bleak as sentiment is low. The reports, all released Thursday, combined with a report a day earlier that German corporate sentiment fell to a record low in March, says Paul Carrel for Reuters on International Herald Tribune.

Household borrowing has stopped and business lending has slowed down since earlier this year. Many are anticipating a rate cut sooner than the proposed 0.50% cut currently set for April.

The country’s business lobby Confindustria also came out with some bearish figures, saying that it expected GDP to fall 3.5% this year. It fell 3.3% in the first quarter, reports Jennifer Clark for The Wall Street Journal. That’s worse than the previous forecase from the government for a 2% contraction.

Overall, the picture is a weak economic environment and the government must step in soon. Although sentiment and business morale was reportedly low in Italy, Forbes rated Italy as #31 for the best countries to do business.

Reasons include the diversified industrial economy, manufacture of high-quality consumer goods produced by small- and medium-sized enterprises, and a sizable underground economy making up around 15% of GDP.

• iShares MSCI Italy Index (EWI): down 17.8% year-to-date; up 11% for one week

Heather Bell of Index Universe notes that the new funds to hit the market by State Street Corp. are:

• SPDR Barclays Capital Mortgage Backed Bond ETF (MBG), which will invest in investment-grade mortgage bonds, holds 14 securities, tracks 1,700 components and charges an expense ratio of 0.20%. It will be in competition with iShares Barclays MBS Bond Fund (MBB), which charges an expense ratio of 0.36%, tracks 18 securities and around 400 components.
• SPDR Barclays Capital Short-Term International Treasury Bond ETF (BWZ), which will invest in one-to-three-year government bonds issued by 229 investment-grade countries outside of the U.S. It has 38 different holdings and charges an expense ratio of 0.35% and will be competing with the iShares S&P/Citigroup 1-3 Year International Treasury Bond Fund (ISHG). ISHG has 20 components and also charges 0.35%. Japan, Germany and Italy are top weightings in both funds.

Christpopher Codon of Bloomberg states that these new ETFs will attract demand from retail investors for bonds hit by the slump of the U.S. housing market and the resulting credit crunch. This could be good news for State Street, in that the only other ETF that targets mortgage backed bonds on the market are offered by iShares. They launched last week.

These new funds will combine the stock and bond picking appeal of actively managed mutual funds with the trading flexibility of ETFs, in addition to giving investors another way to gain cost-effective international fixed-income access.

A Plan That Isn’t Working. The inhabitants of the 16-country euro currency zone have experienced living beyond their means and taking on massive debt through consumption, only to find themselves in the throes of abandoning the currency altogether or going bankrupt. Landon Thomas Jr. for The New York Times reports that the adoption of the euro about 10 years ago by countries such as Greece, Italy, France and Spain was meant to unify Europe economically and politically.

Adding to Debt. The new idea is that the glory of the euro has glossed over the serious economic problems that plague these countries, and possibly exacerbated them by increasing debt. The currency had once been a possible way to rival the United States, while the poorer countries were prided on their euro zone membership, as proof they had their finances and debt in order.

Smaller Countries Have to Fight. Some of the stronger countries such as France, Germany and the Scandinavian members have been able to shore up their economies and create billion-dollar stimulus plans while protecting their banks; the smaller countries, such as Greece, Ireland, Italy and Spain, have been left out in the cold, having to fend for themselves in the global uncertainty. It’s turned out that membership hasn’t been a cure-all of social and economic issues.

• iShares MSCI Spain Index (EWP): down 18.2% year-to-date

• iShares MSCI Italy Index (EWI): down 17% year-to-date

Italian business confidence fell from 71.6 in Nov. to 66.6, its lowest level since index began in 1991, as contagious pessimism rampages through company outlook for orders and production, reports Sofia Celeste for The Wall Street Journal.

The drop further indicates economists’ view that the Italian GDP may fall as low as 2.4% in 2009, which may be Italy’s worst recession experienced since World War II.

The strain of the international financial crisis has Italy’s companies continuing to cite difficulty in garnering bank loans as banks ignore the Italian government and central bank call for continued lending.

The Prime Minister, Silvio Berlusconi, is expected to change the GDP forecast from +0.5% to -1% for 2009.

Without bright prospects, Italy and its ETF, iShares MSCI Italy Index Fund (EWI), which ended 2008 down 46.8% year-to-date, may have to brace for a long recession.