The euro-area economy will shrink in back-to-back years for the first time, driving unemployment higher as governments, consumers and companies curb spending, the European Commission said.

Gross domestic product in the 17-nation region will fall 0.3 percent this year, compared with a November prediction of 0.1 percent growth, the Brussels-based commission forecast today. Unemployment will climb to 12.2 percent, up from the previous estimate of 11.8 percent and 11.4 percent last year.

Economic and Monetary Affairs Commissioner Olli Rehn said authorities must press on with reforms to end the region's debt crisis and help the recovery. While “hard data” has been disappointing, there also has been more encouraging “soft data” that points to better times, he told reporters today.

A strengthening of the euro economy later this year may be led by Germany, where investor confidence rose in February to a 10-month high. The commission's weak outlook reflects government austerity measures and efforts by companies and consumers to reduce debt. The European Central Bank said today banks will next week return 61.1 billion euros ($80.5 billion) of its second three-year loan, a measure introduced to aid lending at the depths of the financial crisis.

“We clearly have a decoupling with different recovery trends, with Germany certainly recovering at a much faster pace,” said Marco Valli, chief euro-area economist at UniCredit Global Research in Milan. “We still have a lot of noise and volatility in the monthly data, but the bottom line is that the euro zone as a whole has already turned.”

The commission cut its forecast for the German economy, Europe's largest, to 0.5 percent growth this year, from 0.8 forecast in November, due to a drop in euro-area demand that damps export and investment.

In a sign that Europe's largest economy is anticipating better times, the Ifo institute in Munich said its business climate index climbed to 107.4 from 104.3 in January. That's the biggest increase since July 2010 and the fourth straight monthly gain. Earlier this week, the ZEW gauge of investor sentiment rose to the highest in almost three years.

Separately today, the ECB said 356 financial institutions will repay money on Feb. 27 from its second long-term loan. The 61.1 billion-euro figure is about half the 122.5 billion euros forecast by economists. The ECB flooded markets with more than 1 trillion euros in three-year loans a year ago and banks have the option of repaying after 12 months. They started returning the initial loan last month.

“The second LTRO was used by a wider range of institutions with poorer collateral and given the positive carry still on offer, it makes sense for many of these institutions to hold on to these funds,” said Elsa Lignos, a currency strategist at Royal Bank of Canada in London. “We wouldn't take this as a sign that financial tensions are returning.”

Budget Deadlines

The Stoxx 600 Index rose 1.1 percent as of 12:33 p.m. London time, bringing its advance for the year to 3 percent after a 14 percent gain last year. The euro slipped 0.1 percent versus the dollar to $1.3172. It has strengthened 6 percent over the past six months.

On the euro area, Marco Buti, head of the commission's economics department, said the labor market “is a serious concern.”

“This has grave social consequences and will, if unemployment becomes structurally entrenched, also weigh on growth perspectives going forward,” he said.

The commission said domestic demand won't improve until 2014, when it should take over as the main driver of growth. Investment is expected to be a drag on the economy this year, subtracting 0.3 percent from GDP, before offering a 0.4 percent contribution in 2014.

Seven euro-area economies are expected to contract in 2013, with the Netherlands joining Italy, Spain, Portugal, Greece, Cyprus and Slovenia in the new forecast.

The EU's outlook for next year was more upbeat, with 2014 forecasts of 1.4 percent growth and 12.1 percent unemployment in the euro area. Across the 27-nation European Union, the commission projected 0.1 percent growth for 2013 and 1.6 percent growth in 2014, after the bloc shrank 0.3 percent last year.

“Some signs of a turnaround are now discernible,” Buti said. “The present forecast projects a return to moderate growth in the course of this year, as confidence gradually recovers and the global economy becomes more supportive.”

Budget Shortfalls

Rehn urged nations to keep cutting budgets and overhauling their economies in the face of slowing growth. In a statement, he said any shift away from fiscal consolidation would prolong the downturn.

“The decisive policy action undertaken recently is paving the way for a return to recovery,” Rehn said. “We must stay the course of reform and avoid any loss of momentum, which could undermine the turnaround in confidence that is under way, delaying the needed upswing in growth and job creation.”

Still, he said deadlines may be extended because of the poor short-term economic outlook, giving deficit violators such as Spain and France room to avoid penalties or draconian cuts.

The EU is close to agreement on how to install the ECB as a common bank supervisor for the euro area, as well as how it will apply new global standards on how much protective capital banks should hold, Rehn said. These steps also will help set the stage for improvement in future years, he said.

The euro area as a whole is expected to post a budget deficit of 2.8 percent in 2013, according to the EU report. Spain is projected to show a 10.2 percent deficit for 2012, falling to 6.7 percent in 2013. The Spanish economy is projected to shrink 1.4 percent in 2013, the same as in 2012, with unemployment rising to 26.9 percent in 2013.

France, where President Francois Hollande has tussled with EU calls for more austerity, is projected to post a 4.6 percent deficit in 2012 and a 3.7 percent gap in 2013, the commission said. Without any changes, France's deficit would rise to 3.9 percent in 2014 and Spain's would rise to 7.2 percent, the commission said.

Rehn said it's too soon to determine whether the commission will call for France to take additional steps.

Bloomberg News

Instant Insights /

Euro Region to Shrink Again This Year

Related Stories

Recommended For You