Euro economy to shrink, Commission report shows

Europe?s economy will fail to grow this year with risks to the outlook ?tilted to the downside? after nations from Spain to Italy slipped into recession, the European Commission said.

Gross domestic product in the 17-nation euro area will drop 0.3 percent, the European Commission said Friday, reiterating a February forecast. Greece will have the deepest contraction, with GDP declining 4.7 percent this year, while the economies of Spain and Italy are seen shrinking 1.8 percent and 1.4 percent. Portugal?s GDP will drop 3.3 percent, it said. In 2013, the euro-region economy may expand 1 percent.

Friday?s report comes against a backdrop of renewed market turbulence, after an anti-austerity revolt saw voters punish administrations at the ballot box in Greece and France. With the area?s economic slump deepening and unemployment at the highest in 15 years, governments may struggle to restore investor confidence. Fifty-seven percent of respondents in a Bloomberg Global Poll said at least one country would abandon the euro this year.

?The outlook continues to be surrounded by high uncertainty,? the Brussels-based commission said in the report. ?The largest downside risk remains an escalation of the sovereign-debt crisis in the euro area. A resurgence of financial turmoil due to negative confidence shocks would spill over to the real economy and reinforce negative feedback loops between fragile banks and weak sovereigns.?

The full-year Europe-wide contraction would be the first since 2009, when the U.S.-led banking crisis exposed the excessive borrowing and imbalances that plunged Europe into its sovereign debt troubles. In the 27-member European Union, GDP may remain unchanged this year and increase 1.3 percent in 2013, the commission said.

Adding to signs of a deepening slump after a 0.3 percent contraction in the fourth quarter, euro-area unemployment rose to 10.9 percent in March, economic confidence dropped last month to the lowest since December and manufacturing output fell.

The latest growth projections went along with a euro-region inflation forecast of 2.4 percent for this year, curbing the European Central Bank?s scope for a further cut in its benchmark interest rate from 1 percent. The central bank aims to keep annual consumer-price gains just below 2 percent.

ECB President Mario Draghi said on May 3 that the region?s economic outlook has become ?more uncertain? and left open the option of further stimulus. The central bank has injected more than 1 trillion euros ($1.3 trillion) into the banking system to fight the crisis and restore lending.

In elections in Greece last weekend, voters flocked to parties opposed to austerity measures backed by German Chancellor Angela Merkel, denying the two main parties a combined majority and spurring calls for policies to boost growth. German Finance Minister Wolfgang Schaeuble said on May 9 that ?if Greece decides not to stay in the eurozone, we cannot force? them.

?The best-case scenario at this stage seems to be one whereby Greece scrambles together some form of unity government, though its shelf life will be in doubt from the outset,? said Gillian Edgeworth, an economist at UniCredit in London in an e- mailed note. Elections may have ?significantly escalated even the near-term outlook for Greece.?

Eighty percent of the 1,253 investors, analysts and traders who are Bloomberg customers said they expected more pain for Europe?s bond markets this year. Respondents to the May 8 survey were also increasingly worried Spain will default and 84 percent forecast the euro-region economy to worsen.

Greece?s slump may weaken after the economy contracted 6.9 percent in 2011, the commission said. Portugal?s GDP is seen declining for a second straight year, while the Irish economy may expand 0.5 percent in 2012. All three countries received external aid over the past two years.

In Spain, which is suffering from the aftershocks of the burst housing bubble, compounded by fiscal austerity and surging unemployment, the economy will probably continue to shrink next year, with GDP seen falling 0.3 percent, Friday?s report showed. That makes Spain the only euro nation with a projected contraction in 2013.

Investor concern over Spain?s ability to reduce its budget shortfall has increased since Prime Minister Mariano Rajoy announced in March that the country will miss a 2012 deficit goal set by the EU. That pushed Spanish 10-year yields above 6 percent last month and propelled the cost of insuring the country?s bonds against default to a record.

Germany?s economy has helped soften the region?s slump as the lowest unemployment in two decades encouraged consumer demand and companies including carmaker Volkswagen AG (VOW) benefiting from thriving demand in emerging markets. German exports unexpectedly increased for a third month in March and business confidence jumped to the highest in nine months in April.

German GDP may rise 0.7 percent this year and 1.7 percent in 2013, according to the commission forecasts. In France, where Francois Hollande last weekend defeated Nicolas Sarkozy, becoming the first Socialist to win the presidency in 17 years, the economy is seen growing 0.5 percent and 1.3 percent this year and next, respectively. [Bloomberg]