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EU reduces euro area growth forecast as inflation seen slower

By Ian Wishart

The European Commission trimmed its economic growth forecast for the euro area and predicted low inflation to remain a threat to expansion for at least the next two years.

The 18-nation euro zone’s gross domestic product will rise 1.7 percent in 2015, compared with a February prediction of 1.8 percent, the Brussels-based commission said today. The inflation rate will be 0.8 percent this year and 1.2 percent in 2015, both lower than previously forecast and well below the European Central Bank’s target of just below 2 percent.

“Overall, the outlook has improved, but it remains conditional on continued credible action on several fronts at national and EU levels,” Marco Buti, the head of the commission’s economics department, said in a statement accompanying today’s forecasts. “The necessary competitiveness adjustment and debt reduction in vulnerable countries are more difficult to achieve with very low EU-wide inflation, in particular if it were to persist over too prolonged a period.”

Less than a year after emerging from its longest-ever recession, the euro area remains vulnerable as fragile public finances, tensions in emerging markets and low inflation keep a lid on recovery. While bond-market confidence has returned, the economy is still generating less output and providing work for fewer people than before the financial crisis started in 2008.

The ECB, which is considering taking unprecedented steps to avert the risk of deflation, including negative interest rates or implementing quantitative easing, could take action as early as this week when its Governing Council meets in Brussels.

ECB President Mario Draghi said last month that his “biggest fear” is a protracted stagnation in the euro area that leads to high unemployment becoming structural.

Today’s forecast showed joblessness gradually reducing over the next two years from a record high of 12 percent, to 11.8 percent this year and 11.4 percent in 2015, a more optimistic prediction than the commission made in February.

The upturn predicted across Europe conceals a splintered recovery, in which smaller, eastern European countries like Estonia, Latvia and Slovakia, which joined the currency union within the past five years, look toward growth of at least 3 percent in 2015 while some of the euro’s larger founding nations in the west like France and Italy lag further back.

Tension about the way the EU handled the debt crisis could erupt this month when voters from all of its 28 nations elect members of the European Parliament for the first time since Greece’s public finances nearly brought the euro currency bloc to its knees, triggered aid pledges of as much as 496 billion euros ($688 billion) and unleashed a wave of German-led austerity demands.

“While growth in advanced economies is generally firming, emerging-market economies register a moderate deceleration, and world trade has hit a soft patch amid a continued appreciation of the euro exchange rate,” the commission said. “New geopolitical risks have emerged on the back of tensions with Russia.”

Four years on from Greece’s first bailout, the commission expects euro-area growth to be 1.2 percent this year, matching forecasts made in February, helped by an upward revision in growth for Spain and the Netherlands.

“In view of the crisis legacy, growth is still set to remain moderate, but a gradual easing of the drag related to deleveraging, financial fragmentation, adjustment of external imbalances and uncertainty is noticeable,” Buti said.

Only Cyprus, the last euro country forced into a bailout, will contract this year, according to the forecasts. The commission predicted that in 2015 no countries will have negative growth.

Having been at 70.2 percent of GDP in 2008, debt will grow again this year to 96 percent in 2014, the forecasts showed, before dipping to 95.4 percent next year.

The predicted return to growth in the euro region this year will come after it contracted 0.4 percent in 2013 and 0.7 percent in 2012, the first time that output had fallen in two consecutive years since the introduction of the single currency.

The gradual pick-up in growth forecast today echoes other recent signs of recovery, including expansion in manufacturing, increasing consumer confidence and an easing of tension in the bond markets. Spain’s 10-year yield fell below 3 percent for the first time since 2005 last week and Italian 10-year bond yields dropped to a record low.

“The recovery has now taken hold,” commission Vice President Siim Kallas said in a statement. “Deficits have declined, investment is rebounding and, importantly, the employment situation has started improving.”

German Chancellor Angela Merkel has proved unable to protect the euro area’s largest economy from some of the overspill of economic misery that afflicted much of southern Europe. The commission predicted that Germany will grow by 1.8 percent this year and 2 percent next year.

Italy, the third-largest economy in the bloc, will continue to have the second-highest ratio of debt to GDP after Greece this year and next, the commission said. Its debt is forecast to be 135.2 percent of GDP in 2014, before dipping to 133.9 percent next year, both figures higher than the commission forecast in February.

“After a severe recession in 2012 and 2013, a slow recovery mainly driven by external demand is projected in 2014,” the commission said of Italy. “With credit conditions set to ease over the forecast horizon, growth is expected to strengthen in 2015,” with inflation “forecast to reach a historical low in 2014, at 0.7 percent.”

France’s parliament voted through 50 billion euros of spending cuts last week as President Francois Hollande seeks to reduce the country’s deficit. Today, the commission forecast it will narrow to 3.9 percent of GDP this year and 3.4 percent in 2015. The commission revised its prediction for growth in France downward, forecasting it to be 1.5 percent next year, following its prediction of 1.7 percent in February.

“For more than 30 years we’ve lived beyond our means,” Prime Minister Manuel Valls said on France 2 television on April 16.

“Domestic demand is expected to be the only contributor to growth, while net trade is likely to dampen it over the forecast horizon,” the commission said.

The commission revised upwards it forecast for growth in Spain’s economy to 1.1 percent this year and 2.1 percent next.

“The mild economic recovery in Spain is expected to gain momentum amid improved confidence and further relaxation of financial conditions, as declining risk premia and better financing conditions for the sovereign and for banks are gradually passed on to final borrowers,” the commission said.

It predicted inflation in Spain to remain as low as 0.1 percent this year and 0.8 percent next because of a fall in energy prices and sluggish demand.

[Bloomberg]

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