Eurozone to shrink again in 2013

The euro-area economy will shrink in back-to-back years for the first time, driving unemployment higher as governments, consumers and companies curb spending, the European Commission said.

Gross domestic product in the 17-nation region will fall 0.3 per cent this year, compared with a November prediction of 0.1 per cent growth, the Brussels-based commission forecast on Friday. Unemployment will climb to 12.2 per cent, up from the previous estimate of 11.8 per cent and 11.4 per cent last year.

Economic and Monetary Affairs Commissioner Olli Rehn said authorities must press on with reforms to end the region’s debt crisis and help the recovery. While “hard data” has been disappointing, there also has been more encouraging “soft data” that points to better times, he told reporters on Friday.

A strengthening of the euro economy later this year may be led by Germany, where investor confidence rose in February to a 10-month high. The commission’s weak outlook reflects government austerity measures and efforts by companies and consumers to reduce debt. The European Central Bank said on Friday banks will next week return €61.1 billion ($80.5 billion) of its second three-year loan, a measure introduced to aid lending at the depths of the financial crisis.

The commission cut its forecast for the German economy, Europe’s largest, to 0.5 per cent growth this year, from 0.8 forecast in November, due to a drop in euro-area demand that damps export and investment. In a sign that Europe’s largest economy is anticipating better times, the Ifo institute in Munich said its business climate index climbed to 107.4 from 104.3 in January. That’s the biggest increase since July 2010 and the fourth straight monthly gain. Earlier this week, the ZEW gauge of investor sentiment rose to the highest in almost three years.

Separately on Friday, the ECB said 356 financial institutions will repay money on February 27 from its second long-term loan. The €61.1 billion figure is about half the €122.5 billion forecast by economists. The ECB flooded markets with more than €1 trillion in three-year loans a year ago and banks have the option of repaying after 12 months. They started returning the initial loan last month.

“The second LTRO was used by a wider range of institutions with poorer collateral and given the positive carry still on offer, it makes sense for many of these institutions to hold on to these funds,” said Elsa Lignos, a currency strategist at Royal Bank of Canada in London. “We wouldn’t take this as a sign that financial tensions are returning.”

On the euro area, Marco Buti, head of the commission’s economics department, said the labour market “is a serious concern.”

“This has grave social consequences and will, if unemployment becomes structurally entrenched, also weigh on growth perspectives going forward,” he said.

The commission said domestic demand won’t improve until 2014, when it should take over as the main driver of growth. Investment is expected to be a drag on the economy this year, subtracting 0.3 per cent from GDP, before offering a 0.4 per cent contribution in 2014.

Seven euro-area economies are expected to contract in 2013, with the Netherlands joining Italy, Spain, Portugal, Greece, Cyprus and Slovenia in the new forecast.

The EU’s outlook for next year was more upbeat, with 2014 forecasts of 1.4 per cent growth and 12.1 per cent unemployment in the euro area. Across the 27-nation European Union, the commission projected 0.1 per cent growth for 2013 and 1.6 per cent growth in 2014, after the bloc shrank 0.3 per cent last year.

“Some signs of a turnaround are now discernible,” Buti said. “The present forecast projects a return to moderate growth in the course of this year, as confidence gradually recovers and the global economy becomes more supportive.”

Rehn urged nations to keep cutting budgets and overhauling their economies in the face of slowing growth. In a statement, he said any shift away from fiscal consolidation would prolong the downturn.

“The decisive policy action undertaken recently is paving the way for a return to recovery,” Rehn said. “We must stay the course of reform and avoid any loss of momentum, which could undermine the turnaround in confidence that is under way, delaying the needed upswing in growth and job creation.”

Still, he said deadlines may be extended because of the poor short-term economic outlook, giving deficit violators such as Spain and France room to avoid penalties or draconian cuts.

The EU is close to agreement on how to install the ECB as a common bank supervisor for the euro area, as well as how it will apply new global standards on how much protective capital banks should hold, Rehn said. These steps also will help set the stage for improvement in future years, he said.

The euro area as a whole is expected to post a budget deficit of 2.8 per cent in 2013, according to the EU report. Spain is projected to show a 10.2 per cent deficit for 2012, falling to 6.7 per cent in 2013. The Spanish economy is projected to shrink 1.4 per cent in 2013, the same as in 2012, with unemployment rising to 26.9 per cent in 2013.

France, where President Francois Hollande has tussled with EU calls for more austerity, is projected to post a 4.6 per cent deficit in 2012 and a 3.7 per cent gap in 2013, the commission said. Without any changes, France’s deficit would rise to 3.9 per cent in 2014 and Spain’s would rise to 7.2 per cent, the commission said.

Rehn said it’s too soon to determine whether the commission will call for France to take additional steps.