EU lowers euro-area growth outlook as debt crisis lingers

The European Union trimmed its forecast for euro-area growth next year as the economy struggles to gain momentum with the debt crisis dragging into a fifth year and unemployment at a record.

Gross domestic product in the 17-nation currency bloc will rise by 1.1 percent in 2014, less than the 1.2 percent forecast in May, the Brussels-based commission said on Tueday. Unemployment, now at its highest rate since the euro was introduced, will be 12.2 percent in 2014, higher than the 12.1 percent predicted six months ago.

“The fiscal consolidation and structural reforms undertaken in Europe have created the basis for recovery,” EU Economic and Monetary Affairs Commissioner Olli Rehn said in a statement. “But it is too early to declare victory. Unemployment remains at unacceptably high levels. That’s why we must continue working to modernize the European economy.”

The gloomier outlook deals a blow to the growing sense of optimism that the euro area is emerging from the sovereign-debt crisis and may make it more difficult for European governments to convince financial markets that they are tackling the turmoil through deficit reduction and structural reforms. While the commission’s gauge of economic confidence is at a two-year high, services and manufacturing output unexpectedly slowed in October and unemployment is at a record 12.2 percent.

Single currency

The strengthening euro also may drag on the recovery by crimping exports. While the euro sank last week after the bloc’s annual inflation rate fell to 0.7 percent in October, the common currency is up more than 5 percent against the dollar in the last four months.

Next year’s projected return to growth will come after the euro-area economy contracts an estimated 0.4 percent in 2013, the commission said in Tuesday’s report. That follows a decline in GDP of 0.7 percent in 2012, the first time output has fallen in two consecutive years since the introduction of Europe’s single currency in 1999.

Signs of a fragile recovery in 2014 disguise a north-south divide in the euro area, in which the economies of Germany, Belgium, Estonia and Ireland are predicted to gain momentum next year, while Spain, Greece, Italy and Portugal are projected to experience much weaker growth rates. The exceptions are Finland and the Netherlands, whose growth figures now lag behind their northern neighbors.

Tension between the EU and national governments on the best way to deal with the debt crisis could resurface on Nov. 15 when the commission will issue opinions on euro-area draft budgets for the first time.

While the euro area has enjoyed a year-and-a-half of relative calm on financial markets, governments are wrestling with how to cut debt and deficit levels while boosting economic output and creating jobs.

“Whereas one-and-a-half years ago a risk of catastrophic outcomes was tangible, and even a break-up of the euro area seemed imaginable, such tail risks have now all but disappeared,” Marco Buti, the head of the commission’s economics department, said in a statement. “But also within the EU, the recovery occurs at multiple speeds, and the previous ‘core-periphery’ pattern has become more diversified. Growth in the coming quarters will still be held back by the deleveraging needs, financial fragmentation, sectoral adjustment and high unemployment associated with the crisis legacy.”

Budget cuts

The commission forecasts euro-area annual inflation to be 1.5 percent in 2014, slowing to 1.4 percent in 2015, adding further pressure on the European Central Bank to cut interest rates further from already record-low levels.

Spain, the fourth-largest economy in the euro area which exited a two-year recession in the third quarter of this year, had its 2014 growth downgraded from a forecast of 0.9 percent in May to 0.5 percent.

Prime Minister Mariano Rajoy, who is betting on exports to reignite the economy, has imposed the deepest budget cuts in the country’s democratic history as well as receiving EU loans to shore up its banks.

“Large adjustment needs will constrain the strength of the recovery,” the commission said. “Credit continues contracting, driven to a large extent by weak demand but also by some frictions on the supply side.” The commission said that financing conditions for households and companies remain relatively tight, in particular for smaller borrowers.

Unpopular president

France, the euro area’s second largest economy after Germany, will see growth of 0.9 percent in 2014, according to the commission’s forecast. While this is lower than the 1.1 percent forecast in May, it is in line with the French Finance Ministry’s predictions.

President Francois Hollande, who has clashed with the EU over his resistance to implement pension reform and introduce tougher austerity measures, faces pressure to cut France’s budget deficit, at a time when opinion polls show him to be the most unpopular French president on record.

The commission sees France missing its extended deadline to meet the EU’s 3 percent of GDP deficit target. In May the commission gave the country until 2015 to get the deficit below 3 percent. Tuesday’s forecasts show France will post a deficit of 4.1 percent of GDP in 2013, 3.8 percent in 2014 and 3.7 percent in 2015.

“GDP growth significantly below potential and revenue shortfalls, which may be due to unusually low tax elasticity with respect to GDP, are having a negative impact on the nominal deficit,” the commission said.

‘Positive assessment’

Italy, the euro area’s third-largest economy, which remains in a record-long recession, is forecast to grow by 0.7 percent in 2014. The commission predicted Italy’s deficit to be 3 percent of GDP in 2013 and below that, at 2.7 percent, in 2014, which may give a boost to the government of Prime Minister Enrico Letta.

“Improved business confidence since the early summer, mainly driven by a positive assessment of export orders, foretells a gradual mild recovery,” the commission said.

Export-driven Germany is succumbing to some of the problems from the south, as Chancellor Angela Merkel, the euro-area’s dominant politician in handling the euro crisis, negotiates with the Social Democrats over the formation of a new government following a Sept. 22 election. Merkel will oversee growth of 1.7 percent in 2014, according to the commission. In May it forecast it to be 1.8 percent. The commission revised upwards its predictions for Germany’s current account surplus from 6.3 percent of GDP to 7 percent for 2013 and from 6.1 percent to 6.6 percent for 2014.

Looking ahead to 2015, the commission on Tuesday predicted growth of 1.7 percent in the euro area with no countries in negative territory. [Bloomberg]