May 5 (Bloomberg) -- The European Commission predicted low inflation will remain a threat to euro-area expansion for at least the next two years as it trimmed its economic-growth forecast and warned of the impact of tensions with Russia.
The 18-nation euro zone’s inflation rate will be 0.8 percent this year and 1.2 percent in 2015, both lower than forecast in February and well below the European Central Bank’s target of just below 2 percent, the Brussels-based commission said today. Gross domestic product is projected to rise 1.7 percent in 2015, compared with the commission’s previous forecast of 1.8 percent.
“Price pressures are expected to remain subdued as we expect energy prices to continue to decline and as demand is only gradually firming and unemployment is still high,” Commission Vice President Siim Kallas told reporters in Brussels. “When we consider what are the main risks for the European economy at this stage, the one main risk is clearly the external tensions and uncertainty which surrounds us, especially related to the crisis in Ukraine.”
Less than a year after emerging from its longest-ever recession, the euro area remains vulnerable as fragile public finances, volatility in emerging markets and a strong euro keep a lid on the recovery. While bond-market confidence has returned, the economy is still generating less output and providing work for fewer people than before the financial crisis started in 2008.
The ECB, which is considering taking unprecedented steps to avert the risk of deflation, including negative interest rates or implementing quantitative easing, could take action as early as this week when its Governing Council meets in Brussels. Continued low inflation would slow economic recovery further since it makes the repayment of debt more difficult and can subdue consumer demand.
ECB President Mario Draghi said last month that his “biggest fear” is a protracted stagnation in the euro area that leads to high unemployment becoming structural.
Today’s forecast showed joblessness gradually reducing over the next two years from a record high of 12 percent, to 11.8 percent this year and 11.4 percent in 2015, a more optimistic prediction than the commission made in February.
The crisis in Ukraine, which has seen the European Union impose a series of sanctions on Russia since President Vladimir Putin annexed Crimea, could also be a threat to economic growth across Europe, particularly in those countries which border Russia or which are dependent on Russian energy, the commission said.
“There’s always the fear of external shocks,” Irish Finance Minister Michael Noonan told reporters on the way into a meeting with his euro-area counterparts in Brussels today. “Political instability on the periphery, whether it’s North Africa, the Middle East or the borderlands with Russia is always a concern, but we don’t control them.”
Tension between Europe and Russia meant “new geopolitical risks” have emerged, the commission said.
“While growth in advanced economies is generally firming, emerging-market economies register a moderate deceleration, and world trade has hit a soft patch amid a continued appreciation of the euro exchange rate,” the commission said.
Four years on from Greece’s first bailout, the commission expects euro-area growth to be 1.2 percent this year, matching forecasts made in February, helped by an upward revision in growth for Spain and the Netherlands.
The upturn predicted across Europe conceals a splintered recovery, in which smaller, eastern European countries like Estonia, Latvia and Slovakia, which joined the currency union within the past five years, look toward growth of at least 3 percent in 2015 while some of the euro’s larger founding nations in the west like France and Italy lag further back.
Tension about the way the EU handled the debt crisis could erupt this month when voters from all of its 28 nations elect members of the European Parliament for the first time since Greece’s public finances nearly brought the euro currency bloc to its knees, triggered aid pledges of as much as 496 billion euros ($688 billion) and unleashed a wave of German-led austerity demands.
“Overall, the outlook has improved, but it remains conditional on continued credible action on several fronts at national and EU levels,” Marco Buti, the head of the commission’s economics department, said in a statement accompanying today’s forecasts. “The necessary competitiveness adjustment and debt reduction in vulnerable countries are more difficult to achieve with very low EU-wide inflation, in particular if it were to persist over too prolonged a period.”
Only Cyprus, the last euro country forced into a bailout, will see its economy contract this year, according to the forecasts. The commission predicted that in 2015 no countries will have negative growth.
Government debt across the euro area, which was 70.2 percent of GDP in 2008, will grow to 96 percent in 2014, the forecasts showed, before dropping to 95.4 percent next year.
The predicted return to growth in the euro area this year will come after bloc’s economy contracted 0.4 percent in 2013 and 0.7 percent in 2012, the first time that output had fallen in two consecutive years since the introduction of the single currency.
The gradual pick-up in growth forecast today echoes other recent signs of recovery, including expansion in manufacturing, increasing consumer confidence and an easing of tension in the bond markets. Spain’s 10-year yield fell below 3 percent for the first time since 2005 last week and Italian 10-year bond yields dropped to a record low.
“The recovery has now taken hold,” Kallas said in a statement. “Deficits have declined, investment is rebounding and, importantly, the employment situation has started improving.”
German Chancellor Angela Merkel has proved unable to protect the euro area’s largest economy from some of the overspill of economic misery that afflicted much of southern Europe. The commission predicted that Germany will grow by 1.8 percent this year and 2 percent next year.
Italy, the third-largest economy in the bloc, will continue to have the second-highest ratio of debt to GDP after Greece this year and next, the commission said. Its debt is forecast to be 135.2 percent of GDP in 2014, before dipping to 133.9 percent next year, both figures higher than the commission forecast in February.
“After a severe recession in 2012 and 2013, a slow recovery mainly driven by external demand is projected in 2014,” the commission said of Italy. “With credit conditions set to ease over the forecast horizon, growth is expected to strengthen in 2015,” with inflation “forecast to reach a historical low in 2014, at 0.7 percent.”
France’s parliament voted through 50 billion euros of spending cuts last week as President Francois Hollande seeks to reduce the country’s deficit. Today, the commission forecast it will narrow to 3.9 percent of GDP this year and 3.4 percent in 2015. The commission revised its prediction for growth in France downward, forecasting it to be 1.5 percent next year, following its prediction of 1.7 percent in February.
“For more than 30 years we’ve lived beyond our means,” Prime Minister Manuel Valls said on France 2 television on April 16.
“Domestic demand is expected to be the only contributor to growth, while net trade is likely to dampen it over the forecast horizon,” the commission said.
The commission revised upwards it forecast for growth in Spain’s economy to 1.1 percent this year and 2.1 percent next.
“The mild economic recovery in Spain is expected to gain momentum amid improved confidence and further relaxation of financial conditions, as declining risk premia and better financing conditions for the sovereign and for banks are gradually passed on to final borrowers,” the commission said.
It predicted inflation in Spain to remain as low as 0.1 percent this year and 0.8 percent next because of a fall in energy prices and sluggish demand.
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