Euro zone headed for recession, report says

BERLIN — Countries that use the euro are headed for a mild recession this year, the European Commission said Thursday, the region’s second economic contraction since 2008, despite years of attempts to solidify the euro zone’s economic standing.

The announcement was more pessimistic than a November estimate that predicted slight growth in 2012. And it came days after European officials agreed to hand Greece a $172 billion bailout, its second in two years.

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Patterns of growth in the U.S. and the European Union.
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Patterns of growth in the U.S. and the European Union.

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Countries such as Portugal, Ireland and Spain also are struggling to get their economies back on track, and leaders and economists are questioning whether Europe’s response to the crisis has focused too much on austerity and too little on growth.

Across the full 27-country European Union, the largest single market in the world, growth will be flat this year, the estimate said. The slowdown could reverberate far beyond the continent’s borders, as fewer companies make large purchases and investments and banks stay cautious about lending.

For the 17 countries that share a common currency, the economy will contract by 0.3 percent, the commission forecast.

“Prospects have worsened, and risks to the growth outlook remain,” E.U. Economic and Monetary Affairs Commissioner Olli Rehn told reporters in Brussels on Thursday. “But we are seeing signs of stabilization.”

The heads of 12 countries in the European Union this week sent a letter to top E.U. officials urging that Europe do more to promote economic expansion.

Economists say the European troubles will put a drag on the U.S. economy, though the magnitude of the impact depends on how poorly the European economy fares.

“If the problems in Greece are contained and the European recession is mild, as we believe it will be, the U.S. should be able to withstand without going into a recession,” said Gus Faucher, senior economist at PNC Financial Services.

In the past, European countries have sustained recessions without triggering one in the United States. In 1993 and 2003, Germany suffered mild economic contractions while the American economy continued to grow.

Other times,  however, as in 1975 and 1982, the United States and Germany had to deal with recessions at the same time.

Faucher said that even if Europe’s financial crisis does not set off a U.S. recession, it will hurt the economy, partly because the European demand for American products will decline. If, however, the troubles abroad trigger a domino effect, spreading the financial crisis far beyond the region, the United States face a recession, Faucher said.

“The nightmare scenario is that there is a financial crisis in Europe, and it spreads, with lending freezing up,” Faucher said. “That could put us into a recession. I don’t expect that to happen, but it could.”

In some ways, Europe’s economic situation appears less dire than it did a few months ago. Last fall, borrowing costs of some of the region’s largest countries kept rising, putting those nations at risk of bankruptcy even though their underlying economies were robust enough to maintain spending under ordinary circumstances. Italy and Spain changed leaders, and the European Central Bank loosened lending terms, helping to ease the immediate pressure.

But the new estimates show that the region’s stability remains shaky. Tuesday’s agreement on Greece was in some ways an acknowledgment of Europe’s overall vulnerability, analysts said, since few believe the country will reach sustainable borrowing and spending levels by 2020, the stated goal of the bailout deal.

Instead, analysts said, European leaders made the deal because they feared that the alternative — a sudden Greek default when a massive debt payment comes due in March — could set off a chain reaction that would first threaten small, vulnerable countries such as Portugal and Ireland, then could spread to Spain, Italy and beyond.

A permanent $660 billion bailout fund may be operational by July. That would help Europe defend countries it sees as fundamentally solvent from the ill effects of pulling the plug on Greece.

The new estimates also show the widening gap between the healthiest countries and those struggling the most. Germany’s economy is predicted to grow by 0.6 percent this year, and France’s by 0.4 percent. But more countries are slated for a decline than predicted last year, potentially exacerbating conflicts about how best to solve the crisis.

“You see a big divide between the member states in Europe,” said Fredrik Erixon, the head of the Brussels-based European Center for International Political Economy. “It’s going to be even more difficult in the future to come up with a policy that reflects 27 different countries.”

Greece’s economy will contract by 4.3 percent this year, the estimates said, “markedly lower than forecast in the autumn and with substantial downside risks.” It would be Greece’s fifth year of recession, an extraordinarily long time for a country not at war.

In several struggling euro-zone countries, European officials have pressed for sweeping cuts to government spending that they say will help put finances on a more sustainable track. The measures have slashed public workers’ paychecks, trimmed pensions and whittled away at cherished social programs.

The commission’s report referred to those painful cutbacks, saying that if countries keep cutting their spending, short-term growth would probably slow more than current estimates. But it added that budget-tightening “appears to be needed” and could boost market confidence.

In their letter to European officials this week, the leaders of Britain, Spain, Italy and nine other countries called on Europe to eliminate trade barriers as a way to stimulate the economy.

“The crisis we are facing is also a crisis of growth,” the letter said.

France and Germany, the two biggest drivers of the austerity policies circulating in Europe, did not sign the letter.

The United States remains on its slow path to recovery even as Europe falters, something the leaders noted in their letter.

“As many of our major competitor economies grow steadily out of the gloom of the recent global crisis,” the letter said, “financial market turbulence and the burden of debt renders the path to recovery in Europe much harder to climb.”

 
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