European Commission report sees euro-area economy lagging behind competitors

The euro-area economy will continue to lag behind its main competitors, the U.S. and China, this year and next as high levels of unemployment and debt hinder the currency bloc’s recovery.

Gross domestic product in the 18-nation eurozone will rise by 1.2 percent in 2014, an improvement from a 1.1 percent forecast in November, the Brussels-based European Commission said on Tuesday. While the unemployment rate will decrease to 12 percent this year, that’s still the second-highest level in the euro era. And gross government debt will rise slightly to 95.9 percent of GDP.

“As long as debt in several sectors of the economy remains too high, unemployment is at record levels and the adjustment of previous imbalances is incomplete, there is a serious risk of growth remaining stuck in low gear,” Marco Buti, the head of the commission’s economics department, said in a statement.

The latest outlook confirms that the scars from the ravages of the sovereign-debt crisis are healing slowly. While bond markets have stabilized and economic confidence is picking up, policy makers from Helsinki to Madrid are still grappling with slower growth and a higher unemployment rate than before the crisis started in 2008.

Tuesday’s euro-area forecasts don’t come close to matching the predicted expansion in the world’s other largest economies. The commission forecasts 2.9 percent growth in the U.S. this year and 7.4 percent in China.

“The recent string of positive economic news has helped to balance the risks to the growth outlook since the autumn forecast, but on the whole downside risks continue to prevail,” the commission said in Tuesday’s report. The main risks to the forecast are stalling reforms, lower-than-expected inflation and heightened instability in emerging markets.

The predicted return to growth in the euro area in 2014 will come after it contracted 0.4 percent in 2013 and 0.7 percent in 2012, the first time output had fallen in two consecutive years since the introduction of the single currency.

“As is typical following a deep financial crisis, the recovery remains modest, too modest,” EU Economic and Monetary Affairs Commissioner Olli Rehn told the European Parliament in Strasbourg on Tuesday. “In many parts of Europe, unemployment remains at intolerable levels.”

The forecasts show that Europe’s recovery “will continue gaining strength and spreading across countries, while at the same time becoming more sustained and balanced,” Rehn said.

Low inflation is adding to the drag on growth in the euro- area and could persuade European Central Bank President Mario Draghi to introduce further economic-stimulus measures. Consumer prices probably increased 0.7 percent in February, according to a Bloomberg News survey of economists, less than half the ECB’s ceiling. The commission forecasts inflation at 1 percent this year, revised down from November’s forecast of 1.5 percent, and 1.3 percent in 2015.

“Disinflation may have the positive effect of improving real incomes and supporting demand,” Buti said. “However, it also makes the competitiveness adjustment in vulnerable member states more challenging, as the required negative inflation differential to the rest of the euro area could adversely affect debt dynamics.”

As the euro area stutters to recover, the dividing line between the region’s north and south, which has characterized the debt crisis, has started to blur, making for an uneven return to health.

The Finnish economy, is predicted to be the third-worst performer of the region in 2014, growing 0.2 percent, behind Greece, Portugal, Ireland and Spain, which all received financial aid during the crisis. The Netherlands, which along with Finland and Germany took the hardest line in dealing with southern euro nations that pleaded for leniency during the crisis, is predicted to grow 1 percent, revised up from November’s forecast of 0.2 percent, and now the same as France and Spain.

Still, economies that were hit hardest by the crisis, such as Greece, Portugal and Italy, continue to experience weak growth rates and high unemployment rates, as governments have to contend with cutting debt and deficit levels at the same time as attempting to boost growth.

The report underscores the scale of the challenge facing Matteo Renzi, who was sworn in as Italy’s prime minister on Feb. 22, and his new Finance Minister Pier Carlo Padoan.

Italy, the third-largest economy in the euro area, sees a growth rate of 0.6 percent in 2014, according to Tuesday’s forecast. Debt is expected to peak at 133.7 percent of GDP this year, the second-highest in the euro area after Greece.

“It’s not Mrs. Merkel or President Draghi asking us to be serious about our public debt, it’s the respect we owe our children,” Renzi told the Italian parliament on Monday.

Spain is expected to post 1 percent GDP growth in 2014, a much more positive outlook than the 0.5 percent predicted in November. Growth in 2015 is set to be 1.7 percent in 2015. At the same time, Spain’s budget deficit is expected to grow from 5.8 percent in 2014 to 6.5 percent in 2015, while the unemployment rate is projected to edge down from 25.7 percent this year to 24.6 percent next year.

The high unemployment, combined with high debt levels, weighs on growth and makes the country more vulnerable to shocks, the EU said. At the same time, Spain’s forecast has been upgraded from the EU’s November outlook, and the new forecast cites an improvement in financing conditions and more stable market access for the country’s bonds.

“Downside risks to the growth forecast include a possible stronger-than-expected slowdown of emerging economies and in particular South America, where the exposure of the banking sector is significant,” the EU said. “On the upside, a faster- than-expected easing of financing conditions could boost domestic demand.”

France, the second-largest economy in the single-currency region after Germany, will see growth of 1 percent, according to Tuesday’s forecast.

In May the commission gave the country until 2015 to get its deficit below 3 percent. Tueday’s forecasts show France will post a deficit of 4 percent of GDP in 2014 and 3.9 percent in 2015, larger than the 3.8 percent and 3.7 percent it predicted in November.

“The incipient recovery is expected to firm up somewhat in the course of 2014 and in 2015, mainly supported by a timid pick-up in domestic demand, on the back of increasing confidence,” the commission said.

The commission upgraded its forecast for export-driven Germany. Chancellor Angela Merkel, elected for a third term in office after elections on Sept. 22, will oversee growth of 1.8 percent in 2014, according to the commission, compared with 1.7 percent forecast in November.

Economic expansion in Germany, whose current-account surplus is under investigation by the commission, will be driven by domestic demand, the commission said.

“Business expectations reveal high optimism in the economy as a whole and orders as well as production expectations indicate significant growth contributions from manufacturing,” the report said.

[Bloomberg]