The European Commission said the euro-zone economy willvirtually grind to a halt next year as the debt crisis ravagessouthern Europe and gnaws at the economic performance ofexport-driven Germany.

The 17-nation euro economy will expand 0.1 percent in 2013, downfrom a May forecast of 1 percent, the commission said today. It cutthe forecast for Germany, Europe's largest economy, to 0.8 percentfrom 1.7 percent.

“Europe is going through a difficult process of macroeconomicrebalancing and adjustment which will last for some time still,”European Union Economic and Monetary Commissioner Olli Rehn toldreporters in Brussels. The economy is “sailing forward throughrough waters.”

The economic falloff may make it harder for European governmentsto pull Greece back from the brink and deal with a possible aidprogram for Spain, leaving the debt crisis to fester for a fourthyear.

Technically, the euro area will avert a recession, defined astwo consecutive quarters of contraction, though the overall economywill still shrink 0.4 percent in 2012, ending a two-year expansion,the commission said.

The euro fell after the downbeat forecast and a warning byEuropean Central Bank President Mario Draghi that debt-related“difficulties” are “starting to affect the German economy.” Thecurrency fell to $1.2761 at 1:50 p.m. Brussels time, a drop of 0.4percent today.

Next year's near-stagnation across Europe masks a north-southdivide, in which the economy ekes out positive numbers along an arcfrom Finland through the Low Countries to France, and contractiongrips Greece, Cyprus, Slovenia, Italy, Spain and Portugal.

North-south tensions over the debt crisis will bubble up on Nov.12, when finance ministers judge whether Greece has made enoughbudget cuts and economic reforms to deserve the next installment of240 billion euros ($308 billion) in aid offered since 2010.

Dilemmas facing Greece and its creditors were highlighted by acommission forecast that Greek debt will rise to 188.4 percent ofgross domestic product in 2013, higher than the 168 percentpredicted in May. Euro governments are aiming to wrestle it down to120 percent by 2020.

Germany is becoming less resistant to the economic woes ofsouthern Europe just as Chancellor Angela Merkel, the dominantfigure in the handling of the debt crisis, embarks on a campaignfor a third term in elections in late 2013.

'Cross-CountryDivergences'

The commission pointed to “wide cross-country divergences ineconomic activity and labor-market dynamics” in a common- currencyarea meant to bring Europe together, not fracture it. Thecommission predicted “moderate” growth of 1.4 percent in 2014 thatleaves Cyprus alone in negative territory.

Data from the commission perch France, Germany's traditionalpartner in managing European affairs, in the middle between thehealthier economies of the north and the depressed, deficit-riddensouthern countries that have been forced to fall back oninternational aid.

European forecasters put growth at 0.4 percent in France in2013, more pessimistic than a French government prediction of 0.8percent. As a result, the commission said, France will miss itstarget of cutting the budget deficit to the euro-area limit of 3percent of GDP in 2013 and keeping it there in 2014.

The worsening fiscal outlook may lead to a reckoning betweennorthern anti-deficit countries and French President FrancoisHollande, who took office in May with a pledge to soften theausterity-first policies that have marked Europe's response to thedebt crisis.

“The fact that GDP will again grow significantly below itspotential will have a negative impact on the headline deficit,” thecommission said.

Pressure will also mount on Spain, already tapping a 100billion-euro aid program for its banks and potentially seeking morefor its public balance sheet. The commission warned that PrimeMinister Mariano Rajoy's deficit-reduction strategy is based onrosy economic assumptions.

Spain's economy is likely to shrink 1.4 percent in 2013, thecommission said, worse than the government's forecast of minus 0.5percent. The grimmer outlook will cut tax receipts and boostwelfare payments, pushing Spain's deficit out to 6 percent of GDPnext year and 6.4 percent in 2014, the deadline for bringing itunder 3 percent.

Spain's deficit “risks are tilted to the downside,” thecommission said. It said the costs of recapitalizing Spanish banksaren't yet known, and the overhaul of the economy could crimp taxrevenues.

Rajoy has sent mixed signals whether Spain will seek Europeanhelp in financing its deficits. Since July, a bond- buying pledgeby the central bank has trimmed Spain's borrowing costs in bondmarkets, enabling the government to get by without an aidpackage.

The forecasts showed Italy, the euro area's third-largesteconomy, in better fiscal shape than its Mediterranean neighbors.Italy's deficit will remain under the limit this year, at 2.9percent, dipping to 2.1 percent in 2013, the commission said.

Bloomberg News

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