Europe may be slipping into a “deep and prolonged recession” as high levels of government debt, financial market turmoil and political paralysis stoke a dangerous downward cycle, the European Commission said Thursday.
Growth has already stagnated across the region, a major economic zone that includes the 17 countries that use the euro as well as others, such as Britain, that don’t.
The commission slashed its 2012 growth forecast for the region to a mere 0.6 percent but said there was a high probability that growth could slow even further.
As Greece and Italy continued struggling with leadership crises, the report offered a pointed analysis of the depth of the economic dilemma Europe faces and the potential cost to the world economy. The region’s problems have become self-reinforcing — with weak government finances, weak banks, and weak private demand all feeding off of one another, and a weak political response that’s so far been unable to stem the decline.
Unchecked, a slowdown or new recession in Europe would threaten the rest of the world through numerous channels. The flow of imports and exports with major trading partners such as the United States is already dropping. Investment in fast-growing eastern European economies could dry up, undercutting a part of the region that has been a top performer. China and other Asian countries would lose important customers. Bank failures could add to the shock in broad and unexpected ways.
World stock markets reacted modestly to the grim forecast. European exchanges were largely flat. U.S. indices recovered somewhat from a Wednesday sell-off triggered by concerns over Italy’s financial condition.
Several developments helped calm the markets. Greece appointed economist Lucas Papademos as prime minister of a unity government, which is being formed to keep an international rescue program on track. And Italy moved toward appointing respected politician Mario Monti to head an interim government meant to speed economic reform.
Italian bond rates dipped slightly after they jumped to more than 7 percent on Wednesday. Financial analysts interpreted the decline in rates as evidence that the European Central Bank had ramped up its purchases of Italian bonds in an effort to hold down the country’s borrowing costs.
But it may only be a lull.
Whether highly indebted Italy or frugal Finland, the European countries will now be fighting to trim their government deficits and strengthen their banking systems in an increasingly challenging economy.
Even modest growth can help ease a country’s debt burdens, spreading the load across a larger economic base and providing increased tax receipts that reduce the need to borrow.
But stagnation — or worse, an outright economic contraction — would make it harder for even well-performing countries to keep their government budgets on track, keep their banks healthy and avoid another spike in Europe’s already high unemployment.
The commission’s latest survey emphasized that there is no safe haven from the slowdown. Even the euro region’s large economic stalwarts, France and Germany, will see growth plummet to less than 1 percent in 2012, far slower than the commission forecast in the spring.
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