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. The 17-nation euro zone's gross domestic product will fall 0.3 percent this year, compared with a November prediction of 0.1 percent growth, the Brussels-based commission forecast today. Unemployment will climb to 12.2 percent, up from the previous estimate of 11.8 percent and 11.4 percent last year. Europe's labor market “is a serious concern," Marco Buti, head of the commission's economics department, said in a statement. “This has grave social consequences and will, if unemployment becomes structurally entrenched, also weigh on growth perspectives going forward." The slump reflects policy makers' efforts to counter the financial crisis spawned in Greece in 2009. The 13-year-old euro area is hamstrung by fragile public finances and vulnerable banks, Buti said. The economic weakness contrasts with financial-market gains, as nations, banks and households improve their balance sheets. Economic and Monetary Affairs Commissioner Olli Rehn called the forecast a “building block" in the effort to regain investor trust. Even though “hard data" has been disappointing, there also has been more encouraging “soft data" that points to better times, he told reporters today. Deficit Deadlines Rehn said budget-cutting 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. For now, “credit demand is on average still weakening" as companies pull back amid slow growth, he said. The commission cut its forecast for the German economy, Europe's largest, to 0.5 percent 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, German business confidence rose more than economists forecast to a 10-month high in February. The Ifo institute in Munich today said its business climate index, based on a survey of 7,000 executives, climbed to 107.4 from 104.3 in January. That's the biggest increase since July 2010 and the fourth straight monthly gain. 2014 Outlook The EU's outlook for next year was more upbeat, with 2014 forecasts of 1.4 percent growth and 12.1 percent unemployment in the euro area. Across the 27-nation European Union, the commission projected 0.1 percent growth for 2013 and 1.6 percent growth in 2014, after contracting 0.3 percent last year. The Stoxx 600 Index (SXXP) rose 0.9 percemt at noon in Brussels, bringing its advance for the year to 3 percent after a 14 percent gain last year. The euro has strengthened 6 percent against the dollar the past six months. “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." 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 percent from GDP, before offering a 0.4 percent 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. Dutch Contraction The Dutch economy will shrink 0.6 percent this year, while Greece and Cyprus contract 4.4 percent and 3.5 percent respectively. Cyprus is the only euro-zone economy where falling GDP is forecast to continue into 2014, with growth next year expected for all other euro countries. 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 underway, delaying the needed upswing in growth and job creation." The EU is close to agreement on how to install the European Central Bank 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. Budget Shortfalls The euro area as a whole is expected to post a budget deficit of 3.5 percent of GDP in 2012 and 2.8 percent in 2013, down from 4.2 percent in 2011, according to the EU report. Spain is projected to show a 10.2 percent deficit for 2012, falling to 6.7 percent in 2013. The Spanish economy is projected to shrink 1.4 percent in 2013, the same as in 2012, the commission forecast said, with unemployment rising to 26.9 percent in 2013. France, where President Francois Hollande has tussled with EU calls for more austerity, is projected to post a 4.6 percent deficit in 2012 and a 3.7 percent gap in 2013, the commission said. Without any chancgs, France's deficit would rise to 3.9 percent in 2014 and Spain's would rise to 7.2 percent, the commission said. Rehn said it's too soon to say whether the commission will call for France to take additional steps. Bloomberg
