Euro Zone Recession Deemed More Likely: Reports

Bottom line: Euro zone nations will probably see a recession this year

  • A machine counts and sorts out euro notes at the Belgian Central Bank in Brussels
    A machine counts and sorts out euro notes at the Belgian Central Bank in Brussels December 8, 2011.
  • Euro Zone
    Expectations that the euro zone will fall into recession this year or, at best, post anemic growth are growing.
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Expectations that the euro zone will fall into recession this year or, at best, post anemic growth are growing.

Two forecasts for the euro zone's gross domestic product, or the GDP of its member states, this year from the European Central Bank and global accounting firm Ernst & Young both raise the specter of contraction.

The ECB said Thursday it sees the economies of the 17-nation euro zone recovering gradually in the course of this year, at best growing at an anemic 0.3 percent annualized rate.

The predicted growth rate, down from previous forecasts that saw a potential 1 percent annualized growth rate, is not news: The central bank announced that figure after the March 8 meeting of its governing council. However, the full statement regarding that meeting, released Thursday, made it seem like the bank was expecting most of the growth to come in the second half of 2012, opening the door for a recession in the early part of the year.

The outlook for economic activity should be supported by foreign demand, the very low short-term interest rates in the euro area, and all the measures taken to foster the proper functioning of the euro area financial sector, the statement from the ECB read. However, the remaining tensions in euro area sovereign debt markets and their impact on credit conditions, as well as the process of balance sheet adjustment in the financial and non-financial sectors, are expected to continue to dampen the underlying growth momentum.

This outlook remains subject to downside risks, the statement added.

Also notable in the ECB text is the increasing interest policymakers there are taking on creeping inflation, which they said would likely overshoot short-term targets.

Nevertheless, the Governing Council expects price developments to remain in line with price stability over the policy-relevant horizon, the statement said.

The prospect of stoking inflation from excessive expansion of the monetary base seems to have returned to the forefront of the central bankers' concerns, particularly as they await results of the latest round of liquidity boosting long-term refinancing operation, which last month pumped hundreds of billions of euros into continent's financial system.

Similarly, Ernst & Young said it expects euro zone nations to shrink this year by a combined 0.5 percent, a view that matches the European Central Bank's worst-case scenario. Ernst & Young's previous' view, from December, forecast a jump this year of 0.1 percent in GDP.

But unlike the ECB, the firm sees the potential for a credit crunch -- not inflation -- as Europe's biggest risk this year. The firm argues the upcoming implementation of bank liquidity regulations, as well as a broken consumer credit system, could hinder the ECB's liquidity boosting efforts.

Liquidity is the key challenge we face  -- not just for countries but for many organizations. In addition to the rollover of state debt -- estimated at €1.1 trillion ($1.44 trillion) -- there is a further €1.4 trillion of corporate debt to be refinanced in (2012). Banks are further stretched by the impact of regulations that require recapitalizing their balance sheet and we estimate a further €500 billion will be 'taken out' of the market as this is implemented, the company stated.

Ernst & Young argued the liquidity crunch is likely to be worse in the first half of the year as a large amount of sovereign debt, particularly expensive Italian debt, matures. 

Unemployment will remain high, the accounting firm stated in its report, and is a political wildcard.

For those countries where youth unemployment is particularly high, this could cause already acute social problems to worsen, the report stated.

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