EU says euro area to shrink by 4 percent this year

[May 04, 2009]  BRUSSELS (AP) -- The European Union said Monday that Europe is suffering "a deep and widespread recession" and that unemployment will rise sharply over the coming two years.

The European Commission said both the 27-nation EU and the 16 countries that use the euro currency will shrink by 4 percent this year, more than double its January estimates, when it forecast a 1.8 percent contraction for the EU and a 1.9 percent decline for the euro area.

Because of the big drop in output, the Commission said some 8.5 million jobs will disappear in EU in 2009 and 2010, more than wiping out the number of new jobs created in the last two years. Euro-zone unemployment will hit a postwar record of 11.5 percent next year, it said.

The EU's executive predicted a "subdued recovery" next year with both the EU and euro-zone economies shrinking by 0.1 percent -- but warned that this would only happen if the banking sector and world trade start to recover. The new forecasts echo those made by other bodies such as the International Monetary Fund.

The EU said manufacturing and exports are suffering, with euro-zone exports "forecast to suffer one of the worst setbacks on record" with a 13-percent slump this year. Europe's manufacturers have been hit badly by the slide in global trade and the strength of the euro against the dollar and other currencies.

Germany, the EU's largest economy, is faring particularly badly in the current economic climate as demand for high-value exports such as cars and machinery dries up. The EU is forecasting that Germany will contract by 5.5 percent this year and only recover moderately when trade picks up next year.

Britain and Italy will shrink by between 4 percent to 4.5 percent, it said, while France, cushioned by heavy government spending that supports growth, will post a smaller 3-percent drop. Spain will also likely shrink by 3 percent.

Both Britain and France will see unemployment climb over 3 million next year -- with France reporting an 11 percent jobless rate. Spain is forecast to fare worse with one in five workers unable to find a job -- an unemployment rate of 20 percent.

The EU warned that even worse may be ahead and banks' efforts to deleverage -- shore up their financial position by putting more money aside to cover bad debt -- "may unravel with greater intensity than currently expected."

It said a bad debt spiral from falling house prices could trigger a wave of business bankruptcies that lift unemployment and lead to more debt defaults.

To avoid this, it called on European governments to shore up confidence in banks by moving swiftly to clean up banks' balance sheets by taking on hard-to-value assets that have racked up huge losses and launching new bank recapitalizations as needed.

EU banks have already written down euro290 billion in losses, it says, calling for close-monitoring of debt defaults, particularly in eastern Europe where many western banks may face bad loan books as housing prices collapse and unemployment rises.

It also warned of "disruptive exchange rate developments" and protectionist measures that could further cut global trade and remove one major crutch to an economic recovery next year.

The EU said Europe faces a limited risk of deflation -- a corrosive spiral of falling prices -- but that several countries will see "disinflation" for several months this year as energy prices plunge from record highs last summer.

The EU now expects euro-zone inflation of 0.4 percent this year -- far below the European Central Bank's guideline of just under 2 percent and said that lower inflation may help support the economy by giving people more money to spend via such things as lower mortgage payments.

The EU made no criticism of European government efforts to stimulate the economy by spending an extra euro135 billion this year- 1.1 percent of EU GDP -- and more than euro90 billion next year -- 0.7 percent of EU GDP.

But it said government investment and consumption is likely to be the main driver of growth and tax breaks and reductions -- particularly lower company tax rates -- will have little impact on the economy.

Stimulus spending and billions of euros to shore up banks with guarantees and capital injections will massively increase EU governments' debt and deficit, it said.

EU governments will jointly next year run a budget deficit of around euro900 billion -- or 7.25 percent of gross domestic product.

[Associated Press; By AOIFE WHITE]

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