The eurozone economy is heading into its second recession in just three years and the wider European Union will stagnate, an EU executive said on Thursday, warning that the currency area has yet to break its vicious cycle of debt.
The European Commission forecast that economic output in the 17 nations sharing the euro will contract 0.3 percent this year, reversing an earlier forecast of 0.5 percent growth.
The wider, 27-nation EU, which generates a fifth of global output, will not post any growth this year.
Battered Greece will enter its fifth year of economic contraction, and Spain and Italy, which saw their financing costs pushed up to near unaffordable levels last year, will shrink by about 1 percent, it forecast.
With the eurozone’s sovereign-debt crisis moving from a chronic to an acute phase, the EU’s top economic official warned that there would be little clemency for heavily indebted countries that must meet strict budget targets even as their economies stall. However, there seemed to be some leniency when it came to Spain.
“Member states facing close market scrutiny should be ready to meet budgetary targets,” EU Economic and Monetary Affairs Commissioner Olli Rehn said, defending his strategy of tough love for nations that live beyond their means.
However, he suggested that Spain’s deficit target this year of 4.4 percent may be allowed to rise once all available data was gathered by the EU’s statistics agency Eurostat.
“The full information of budgetary figures will be available in the March notification, which will be then validated and [published] by Eurostat in April. On that basis, we work with the Spanish authorities and decisions will be taken once we have a full picture,” Rehn said.
Economists are increasingly questioning the EU’s strategy for southern Europe as austerity reaches such extremes that some indebted town halls are unable to pay staff, social services shutter and joblessness reaches record levels.
However, the commission said budget cuts were the way to regain investor confidence.
“Negative feedback loops between weak sovereign debtors, fragile financial markets and a slowing real economy do not yet appear to have been broken,” it said.
Inflation for the eurozone this year should come to nearer to what the European Central Bank judges about the right level for stable prices and a healthy economy: 2.1 percent, the commission forecast.
The growth forecast for the eurozone is a shade more optimistic than the IMF’s view that output in the currency area will dip 0.5 percent this year. However, both agree the bloc will manage only a modest recovery in the final months of this year.
The forecasts could still worsen. They rely on the assumption that EU leaders will act to resolve the sovereign debt crisis, which is now in its third year and has shattered investor confidence in a region once regarded as one of the world’s safest havens.
“The balance of risks to GDP growth remains tilted to the downside amid still-high uncertainty,” the commission said. “The interim forecast continues to rely on the assumption that adequate policy measures are decided and implemented.”
EU leaders hold a summit in Brussels next week where investors hope they will agree to raise the ceiling of the eurozone’s joint rescue funds and pave the way for more IMF funds to stand behind heavily indebted southern European economies.