EU says eurozone economy will shrink this year

The European Union predicted Friday that the economy of the 17 member countries that use the euro will shrink again in 2013 even though it will see its fortunes improve in the second half of the year.

In its winter forecast, the EU Commission, the EU's executive arm, said the eurozone is likely to shrink a further 0.3 percent this year, in contrast to November's prediction of 0.1 percent growth.

Across the eurozone, it said the debt crisis and the associated belt-tightening are weighing on activity — official figures showed the eurozone contracted 0.6 percent in the final quarter of 2012 from the previous three-month period. The eurozone has been in recession — officially defined as two consecutive quarters of negative growth — since the second quarter of 2012, when concerns about the future of the euro were particularly acute.

Many countries are in deep recessions, such as Greece and Spain, as they push spending cuts and tax increases to deal with their public finances. Others have suffered in the fallout, such as export powerhouse Germany, Europe's largest economy, which contracted by a quarterly rate of 0.6 percent in the final quarter of 2012.

Despite what it terms "headwinds," the Commission expects the eurozone recession to bottom out over the first half of 2013. By the fourth quarter, it forecast that the eurozone economy will be 0.7 percent bigger than the same period in 2012. In 2014, growth of 1.4 percent was penciled in.

"The decisive policy action undertaken recently is paving the way for a return to recovery," said Olli Rehn, the Commission's top economic official.

A number of recent economic indicators have pointed to an improving outlook, particularly in Germany. Much of the recent calm in financial markets with regard to the eurozone has been credited to the debt-reduction measures and a commitment by European Central Bank President Mario Draghi to do "whatever it takes" to save the euro.

The wider economy of the 27-nation EU, which includes non-euro members such as Britain and Poland, is also bottoming out, according to the Commission. Here too, it lowered its 2013 growth forecast from 0.4 percent to 0.1 percent. And in 2014, it expects the world's largest economic bloc with 500 million people to grow 1.6 percent.

One of the key problems afflicting Europe is unemployment, and the Commission said an improvement was unlikely soon, with the jobless rate in the eurozone rate swelling to a record 12 percent.

While unemployment is high, the trend is not uniform: Germany has seen unemployment falling while Greece and Spain have seen their rates spike to around 26 percent. The Commission expects them to rise to around 27 percent.

The Commission forecast that Germany will grow 0.5 percent this year, but France, Europe's second-largest, will record only 0.1 percent growth. Italy and Spain are expected to decline 1 percent and 1.4 percent respectively.

Meager growth means some governments might have to tighten their belts further — possibly in France, where the 2013 budget is predicated on a growth rate of 0.8 percent.

The Commission said France was likely to miss its target of getting its deficit below 3 percent of its annual gross domestic product. Instead, it predicted the deficit will rise from 3.7 percent this year to 3.9 percent next. And it forecast that France's debt burden will rise from 90 percent of GDP last year to 95 percent in 2014.

Rehn urged the French government to push ahead with measures to reduce its deficit and implement reforms to the labor market and to pensions. "France faces significant challenges," he said.

Tom Rogers, senior economic adviser at Ernst & Young, said he was encouraged with the message coming from the Commission.

"Reforms are already bearing fruit in a number of peripheral economies, and this should be an incentive for other governments to follow suit," said Rogers.

Rehn also urged Italy — which holds national elections this weekend — to continue tackling its debt and strengthening its competitiveness.

"With the elevated level of public debt, it is essential that the country stays on the reform course and maintains a consistent strategy of fiscal consolidation," he said.

Some countries, however, might be granted time by the Commission in the coming months to bring their finances under control.

Rehn said as long as member states "have a credible medium term strategy for fiscal consolidation," then "it can make sense to take into account weaker growth to have more time for the fiscal adjustment."

Chris Williamson, economist with London-based Markit, welcomed the likely flexibility.

"This will clearly help to ease some of the political and social tensions that are apparent in the peripheral countries of Italy, Spain, Portugal and Greece," Williamson said.

Greece has faced the toughest hurdles and the Commission forecasts for the country show it's still got a struggle ahead.

The country is expected to shrink 4.4 percent this year — Greece's sixth year in recession — before posting growth of 0.6 percent in 2014.

One bright spot is that the Commission expects Greece to achieve a primary budget surplus — whereby revenues are higher than spending excluding interest payments — sometime this year. However, given the depth of its recession, Greece's debt burden will rise from 162 percent of annual GDP in 2012 to 175 percent this year and next.