The European Commission said the euro-zone economy will virtually grind to a halt next year as the debt crisis ravages southern Europe and gnaws at the economic performance of export-driven Germany.

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

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

The economic falloff may make it harder for European governments to pull Greece back from the brink and deal with a possible aid program for Spain, leaving the debt crisis to fester for a fourth year.

Technically, the euro area will avert a recession, defined as two consecutive quarters of contraction, though the overall economy will 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 by European Central Bank President Mario Draghi that debt-related “difficulties” are “starting to affect the German economy.” The currency fell to $1.2761 at 1:50 p.m. Brussels time, a drop of 0.4 percent today.

Next year's near-stagnation across Europe masks a north-south divide, in which the economy ekes out positive numbers along an arc from Finland through the Low Countries to France, and contraction grips 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 enough budget cuts and economic reforms to deserve the next installment of 240 billion euros ($308 billion) in aid offered since 2010.

Dilemmas facing Greece and its creditors were highlighted by a commission forecast that Greek debt will rise to 188.4 percent of gross domestic product in 2013, higher than the 168 percent predicted in May. Euro governments are aiming to wrestle it down to 120 percent by 2020.

Germany is becoming less resistant to the economic woes of southern Europe just as Chancellor Angela Merkel, the dominant figure in the handling of the debt crisis, embarks on a campaign for a third term in elections in late 2013.

'Cross-Country Divergences'

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

Data from the commission perch France, Germany's traditional partner in managing European affairs, in the middle between the healthier economies of the north and the depressed, deficit-ridden southern countries that have been forced to fall back on international aid.

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

The worsening fiscal outlook may lead to a reckoning between northern anti-deficit countries and French President Francois Hollande, who took office in May with a pledge to soften the austerity-first policies that have marked Europe's response to the debt crisis.

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

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

Spain's economy is likely to shrink 1.4 percent in 2013, the commission said, worse than the government's forecast of minus 0.5 percent. The grimmer outlook will cut tax receipts and boost welfare payments, pushing Spain's deficit out to 6 percent of GDP next year and 6.4 percent in 2014, the deadline for bringing it under 3 percent.

Spain's deficit “risks are tilted to the downside,” the commission said. It said the costs of recapitalizing Spanish banks aren't yet known, and the overhaul of the economy could crimp tax revenues.

Rajoy has sent mixed signals whether Spain will seek European help in financing its deficits. Since July, a bond- buying pledge by the central bank has trimmed Spain's borrowing costs in bond markets, enabling the government to get by without an aid package.

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

Bloomberg News

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EU Cuts Forecast for European Growth

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