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IMF forecasts eurozone economy to contract 4.2 pct

WASHINGTON - The eurozone economy will contract by 4.2 percent this year as Europe suffers its worst recession since World War II, the IMF said Wednesday in a dramatic mark-down of its previous forecast.

Only one month ago the International Monetary Fund had forecast that the eurozone economy would contract by 3.2 percent this year.

Lamenting Europe’s lack of coordination in response to the financial crisis, the IMF warned that the situation could turn out worse than its latest forecast, especially if big cross-border banks ran into serious trouble.

It forecast in its twice yearly World Economic Outlook only a gradual recovery in Europe, estimating that the eurozone economy would contract a further 0.4 percent next year.

With eurozone inflation forecast to remain “well below” the European Central Bank’s comfort zone of a rate close to but less than 2.0 percent, the IMF said that “there is room to further cut” the main interest rates.

The ECB has been steadily cutting its main interest rate since last summer to 1.25 percent and one governing council member said on Monday that there was consensus in the bank to cut interest rates one last time to 1.0 percent.

The IMF said that European government finances were deteriorating sharply as they tried to prop up their ailing economies, with budget deficits of the eurozone economies set to balloon from about 0.75 percent in 2007 to 5.5 percent this year and 6.0 percent in 2010.

It warned that countries heading into the recession with weak public finances such as Greece, Italy, and Portugal had little room for stimulus measures.

However, the IMF said that coordination between European countries in responding to the financial crisis had been “far from optimal.”

“Stanching the much broader problems that are building in Europe’s financial systems—notably those related to deteriorating prospects for loan books, particularly for exposures to emerging Europe—requires a far more forceful and coordinated financial policy response to the crisis,” it said.

In particular, the IMF said that the EU had to beef up emergency lending measures available to countries that become incapable of meeting their foreign financial obligations in order to ensure they do not “drag down others.”

Looking further ahead, it said that Europe needed more coordination and integration between the various regulatory bodies overseeing the financial sector, welcoming tentative steps under way.

“Ultimately, what is needed is an institutional structure for regulation and supervision that is firmly grounded on the principle of joint responsibility and accountability for financial stability, including the sharing of crisis-related financial burdens,” the IMF said.

“Otherwise, deleterious national reflexes will continue to prevail during crises,” it added.