EU Slashes Growth Forecasts

The European Union has dramatically cut its growth forecast for the euro zone in 2012, down from 1.8% to just 0.5%. “Growth has stalled in Europe and there is a risk of a new recession,” said European Commissioner Olli Rehn.

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“The outlook is unfortunately gloomy,” Rehn told reporters in Brussels today. “The forecast is in fact the last wake-up call. The recovery has now come to a standstill and there’s the risk of a new recession unless determined action is taken.” In its report, the European Commission identified the region’s sovereign debt crisis as being among the main threats to the economy.

In announcing its revised growth forecasts today, the commission predicted that, without any change in political policy, Italian public debt would remain unchanged at 120.5% of gross domestic product next year, before falling to 118.7% in 2013. The commission also forecast that Greece would see its debt level rise to 198.3% of GDP.

Rehn told five EU nations to speed up their deficit-cutting efforts or face sanctions. Belgium, Cyprus, Hungary, Malta, and Poland need to provide “convincing evidence of permanent fiscal measures and preferably full 2012 budgets” by mid-December, said Rehn. “I am sending letters to specify our requests to the finance ministers of these five countries in the course of today.” Greece and Italy have both already received their due warning.

The euro zone’s gross debt may average 90.4% of GDP next year, up from 88% in 2011, according to today’s report. In 2013, government debt may climb further, to 90.9%. The region’s budget deficit is expected to reach 4.1% of GDP this year, declining to an average of 3.4% in 2012, according to the commission. Both figures are above the region’s 3% limit for budget shortfalls.

Concern that countries may not be able to pay their debts has pushed up borrowing costs across the region. Italian government bond yields reached a euro-era high yesterday, topping 7%. Referring to the rising yields on Italian bonds, Rehn said, “While in the very short term the impact on the sovereign is not as such dramatic, relatively soon toward next year and the medium term it would have a significant impact on financing conditions and thus on the real economy.”

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Economists remain concerned that the global banking system could still be affected by the region’s fiscal crisis, regardless of whether there is a resolution in the near future.

“Whatever they come up with, it doesn’t avoid a European recession,” said Su-Lin Ong at RBC Capital Markets. “Increasingly, there is a risk that it spills into the banking system and becomes an issue of credit, and the lifeline of economies freezes up again.”

The threat to the global financial system led European leaders last month to call on banks to raise more capital in order to protect themselves against any losses resulting from defaults. Banks were also asked to accept a 50% loss on their holdings of Greek debt.

Europe’s sovereign debt crisis has the potential to spiral into a broader crisis for the global financial system, as half of Europe’s bank bonds are held by lenders in the region. France’s third-largest bank, Credit Agricole SA, said today that third-quarter profit slumped 65%, hurt by provisions on Greek sovereign debt.

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“Financial sector fragilities are likely to restrict lending, thus curtailing the prospects for investment and consumption further,” said Rehn. “Firms are projected to cancel or postpone investment amid increasing uncertainty.”