EU economic forecasts paint grim picture for Italy, Spain

By Alvise Armellini Feb 23, 2012, 13:36 GMT

Brussels - Italy and Spain, the countries most at risk of contagion from the eurozone debt crisis, face a grim economic forecast, an EU report showed Thursday, even as it predicted only a 'mild recession' in 2012 for the rest of the single currency bloc.

The eurozone's gross domestic product (GDP) will contract by 0.3 per cent in 2012, the European Commission said. In November, it had predicted a 0.5-per-cent expansion.

For the 27-member European Union, the commission expected GDP growth to remain flat, whereas it had forecast a 0.6-per-cent increase last autumn.

But Italy and Spain - despite having won acclaim for reforms introduced by their new governments - were exposed as having the worst growth prospects - after bailed-out Greece and Portugal -for 2012.

The Italian economy was expected to contract by 1.3 per cent, rather than expand by 0.1 per cent. For Spain, GDP prospects were downgraded from 0.7 per cent growth to a 1-per-cent contraction.

Figures for Greece were almost twice as bad than the previous ones, with GDP expected to contract by 4.4 per cent, rather than 2.8 per cent. Portugal's prospects worsened from a contraction of 3 per cent to one of 3.3 per cent.

Presenting the figures, EU Economy Commissioner Olli Rehn strived to suggest that news was not all bad.

'Although growth has stalled ... stress in financial markets is easing,' he said, pointing to falling risk premiums on the bonds of Italy and Spain, and to liquidity measures from the European Central Bank which have staved off a credit crunch.

But worsening recessions in Rome and Madrid will make it harder to meet EU-mandated targets for deficit reduction and may reawaken market fears about the two countries' solvency.

Spain's deficit is believed to have reached 8 per cent of its GDP in 2011, two percentage points higher than its EU target. That has fueled expectations that it would seek a relaxation of this year's target of 4.4 per cent.

'We can only come back to this issue once we have full information' on the extent of the 2011 deficit and the corrective measures foreseen for 2012, Rehn said, noting that last year's deficit figures would be published in April.

Meeting the 4.4-per-cent target in 2012 would require a 40-billion-euro austerity package - a huge effort that would weigh down an already depressed economy. The Spanish newspaper El Pais said Thursday the EU may be 'slightly flexible' on the matter.

Rehn also highlighted that the EU's Economic Sentiment Indicator had turned positive in January for the first time in eight months. This could be 'a turning point' if the right policy decisions were taken, he said.

Without mentioning Berlin directly, Rehn took issue with German resistance to scrapping a 500-billion-euro (665-billion-dollar) cap on eurozone bailout funds, a move upon which the International Monetary Fund (IMF) is insisting as a way to contribute to eurozone rescue efforts.

'There is a clear need to further strengthen the euro area financial firewalls in order in order to equip Europe to contain contagion and counter speculative pressures,' Rehn said.

Mentioning the fiscal compact on budget discipline - a German pet project - and the new Greek bailout which was designed with strict conditions inspired by Berlin, Rehn said much progress had been made. But it was not enough, he stressed.

The main rationale for having bigger eurozone firewalls is to shield Italy and Spain from the fate that has befallen Greece, Portugal and third bailout victim Ireland.

The other eurozone countries with expected negative growth this year were the Netherlands (-0.9 per cent), Cyprus (-0.5 per cent), Belgium and Slovenia (both -0.1 per cent).

Germany and France - the currency bloc's biggest economies - were predicted to grow respectively by 0.6 per cent and 0.4 per cent.

Among non-eurozone economies, Britain was forecast to grow by 0.6 per cent and Poland by 2.5 per cent - the best result across the bloc. Hungary, which is seeking an EU-IMF loan, was expected to contract by 0.1 per cent.

The EU executive also said that eurozone inflation would fall to 2.1 per cent, down from 2.7 per cent in 2011, but slightly higher than the 2012 forecast published in November, due to high energy prices and austerity-linked tax rises in many countries.

Average inflation in the EU was expected to drop from 3.1 per cent to 2.3 per cent.