Slow recovery next year and 2011 predicted for eurozone but only if debt crisis does not worsen

News - Banking

Written by Ray Clancy

Monday, 29 November 2010 09:17

The British economy is expected to grow below trend in 2011 and the year beyond but could be worse if the eurozone debt crisis escalates, economists are warning.

Overall there will be a tentative recovery in the eurozone with Gross Domestic Product increasing by 1.6% in 2011 and 1.l7% in 2012, according to the Economic Assessment of the Euro Area report from EUROFRAME, a group of the ten of the most respected economic forecasting and research institutes in Europe.

The report contains projections of key economic variables for the major European Union countries and the US. It analyses the effects on the euro area of the fiscal consolidation measures to be implemented over the period 2010 to 2012.

‘The persistence of elevated risk premiums and the sovereign debt problems in Europe are obstructing the return to normality in financial markets which is necessary to underpin a broad-based economic recovery. High unemployment and the implementation of austerity measures to reduce large fiscal deficits built up during the crisis will weaken the pick-up in aggregate demand,’ the report says.

While growth is picking up more strongly than expected in Germany, the outlook for countries with severe debt and competitiveness problems, notably Greece, but also Ireland, Portugal, Spain and to some extent Italy, is more subdued, it says.

‘The recovery from the global economic crisis is losing momentum. Nearly two years have passed since world output reached the low point. Since then emerging economies have been recovering forcefully; the United States, after a strong start, have seen a modest recovery, while in Europe the recovery has been wildly uneven,’ the report continues.

It expects the UK economy to grow below trend at 1.7% both this year and next. It says that the British domestic economy has driven the economy forward through most of this year. Next year as the inventory cycle ends and fiscal retrenchment bites it will be the external sector that drives growth.

The improvement in net export performance seen in the third quarter is expected to continue, but given our projection for weaker growth in the euro area the prospects for output growth in 2011 and 2012 have not significantly improved.

Generally the gradual weakening of the recovery seen in recent months is expected to continue into 2011 with a modest acceleration in growth anticipated in 2012 as economic conditions gradually improve.

The report contains the results of a simulation exercise which estimates the effects of fiscal policy changes on GDP in the Euro Area. The planned consolidation measures for 2011 to 12 improve the public finances in the euro area by 1.7% of GDP but reduce GDP growth by about 0.5% in both 2011 and 2012.

The forecasts contained in this report are critically based on the assumption that the European sovereign debt crisis is contained and is resolved swiftly. It is hoped that the authorities’ recent intervention in Ireland will prevent further contagion. Nonetheless, there remains considerable uncertainty which, if not resolved, could have a negative impact on the euro area economy.

Labour market conditions are expected to remain challenging over the forecast horizon with the unemployment rate projected to stand at 9.7% in 2012. The case of Germany illustrates the importance of wage moderation in reducing the unemployment rate, the report says.

Given the moderate outlook for inflation, the European Central Bank is expected to raise the main refinancing rate raise slowly in the course of 2011 and 2012 in line with the forecast recovery. ‘We anticipate the ECB will raise the main refinancing rate to 1.6% by the end of 2012,’ it adds.