News Room - Business/Economics

Posted on 20 Jan 2009

EU: recession will be deep and long-lasting

The European Union said Monday it is facing a ''deep and protracted recession'' and slashed growth forecasts, while Britain announced its second massive bank bailout in just over three months in another wave of bad economic news in Europe.

 

The economy in the 16 nations that use the euro will shrink by 1.9 percent in 2009, with the entire EU contracting 1.8 percent, the European Commission said, drastically cutting earlier forecasts of 0.1 percent for the euro zone and 0.2 percent for the EU.

 

The 27-member bloc said 3.5 million jobs will disappear in the EU in the year ahead as business and household spending falls and banks tighten lending.

 

Government demand and investment will be the only source of growth - but that carries a heavy price tag.

 

Government deficits will hit the highest level in 15 years as they borrow heavily to stoke growth in order to combat the world economic crisis that began with bank losses on securities backed by shaky U.S. mortgages.

 

The EU executive raised warning flags about credit conditions, saying European states may need to inject more than the euro300 billion (US$398 billion) they have already put into banks ''to avoid a sustained drag on bank lending.''

 

It says the economy would be faring much worse without current EU nations' plans to boost growth by spending 1 percent of gross domestic product this year, which should bring an additional 0.75 percent growth.

 

Britain - an EU member which has not joined the euro - said it would launch its second bank bailout in just over three months by offering banks a chance to guarantee shaky securities for a fee in return for a requirment to increase lending to businesses and consumers.

 

It also set aside 50 billion pound (US$74 billion) for the Bank of England to buy troubled assets from banks.

 

Banks stocks plunged, and Royal Bank of Scotland shares fell 70 percent to only 10 pence after it announced massive losses and the government raised the 58 percent stake it took as part of the first bailout to around 70 percent.

 

The EU said the downswing will be particularly marked in Britain and more protracted in Spain.

 

It warned that the outlook was still exceptionally uncertain, describing the economic crisis as the worst faced by the world since the second world war.

 

The EU predicted a moderate recovery in 2010 when the EU could grow 0.5 percent.

 

The first green shoots could come in the second half of 2009 when the global economy may pick up.

 

European Central Bank President Jean-Claude Trichet was more gloomy saying this year would be ''very difficult'' and a rebound might only come in 2010.

 

In a speech in Paris, he said officials had underestimated the risks facing the economy in the last two years and growth this year would be substantially lower than the ECB's last forecast that the euro area would contract by up to 1 percent this year.

 

The EU warned that ''the main issue is whether the recovery will be a lasting one.''

 

In Europe, it warned that it could not rule out that ''very weak economic sentiment may continue for some time as concerns about a long and deep recession spread, particularly with unemployment now on the rise.''

 

Falling exports will hit Germany hard. Europe's largest economy is also the world's biggest exporter and will likely shrink 2.3 percent this year, it said.

 

It says the British economy will shrink 2.8 percent this year as the financial sector shrinks and a housing bubble deflates, while France will contract by 1.8 percent.

 

Spain and Ireland will also suffer sharply as recent booms go bust and jobless queues lengthen - with nearly one in five Spanish workers without a job by 2010.

 

But the EU's top economy official, EU Economic and Monetary Affairs Commissioner Joaquin Almunia, dismissed speculation that either nation's soaring public debt would force them to quit the euro currency - which limits the power governments have over fiscal policy.

 

Ratings agency Standard & Poors put euro nations Spain, Ireland and Portugal on negative watch last week and downgraded Greece as they see more risk that governments could default on borrowings as revenues slide.

 

''In the case of the euro area members, I don't think at all that the risks are high or are significant,'' Almunia told reporters.

 

He was more critical of Italy and Britain which missed the chance to pay off debt during good times.

 

For Italy, this means high interest payments and little room for economy and banking bailouts.

 

Governments will see debt and deficits soar as they spend billions of euros (dollars) to speed up the economy and save banks while unemployment benefits increase and tax revenues fall.

 

For euro nations, efforts to balance the books will be swept away as Ireland, Greece, Spain, France, Italy, Portugal and Slovenia will this year break a key EU budget rule to keep their deficits under 3 percent.

 

Germany, Belgium, Austria and Slovakia could join them in 2010.

 

Outside the euro area, Britain's deficit will climb sharply to 8.75 percent this year - and its debt will swell to nearly 72 percent by fiscal year 2010-2011, well above a 'golden rule' to keep debt under 40 percent.

 

Romania, Latvia, Estonia and Poland will also see deficits go above 3 percent.

 

The EU forecast sees bank lending falling further this year, saying that tighter conditions seem to be hurting large companies more than small businesses or households.

 

It was supportive of banking bailouts, highlighting the key role banks play in economic growth and warning that banks may need help because downsizing their balance sheets could shrink lending and short-term growth.

 

It did not have kind words for some governments' actions to stoke growth. Temporary cuts in corporate profit taxes had ''a negligible impact on growth'' and nations would be better off giving investment subsidies, it said.

 

Britain's move to boost consumption by slashing sales tax for a year was merely storing up problems for the future, it said, as shoppers were likely to spend now and keep their purses shut when the tax goes back up in 2010.