Waning European growth and inflation will put pressure on the European Central Bank (ECB) to cut interest rates in an effort to keep the fragile recovery intact.
The autumn economic update released on Tuesday by the European Commission (EC) showed that the euro-zone economy will return to growth in 2014, after two years of recession, but at a slower pace than was forecast in the spring. Inflation in the euro zone fell to just 0.7 per cent in October, the lowest rate since 2009, when the financial crisis was at its peak.
The euro slid again Tuesday as the euro zone's inflation measure fell, as did inflation-linked bonds. The ECB meets on Thursday to set interest rates. But with rates already close to rock-bottom, it has little room to manoeuvre, though it might devise ways to boost market liquidity.
The EC said the 17-country euro zone will expand by only 1.1 per cent next year. While the downgrade is relatively minor (its previous forecast called for 1.2-per-cent growth), the new number represents the second negative revision this year. At the start of the year, the EC had estimated 2014 growth at 1.4 per cent, a rate that would probably have been strong enough to prevent unemployment from rising. "Overall, the general story remains one of a slow recovery in Europe," RBC Capital Markets' European economist Timo del Carpio said in a note.
In a statement, Olli Rehn, the EC's economics commissioner, said: "There are increasing signs that the European economy has reached a turning point. But it is too early to declare victory: Unemployment remains at unacceptably high levels. That's why we must continue to modernize the European economy."
The euro-zone contraction forecast for 2013 was left unchanged, at 0.4 per cent, following a 0.7-per-cent contraction in 2013.
Double-digit unemployment, the austerity programs designed to bring down budget deficits and overall sovereign debt and the rising euro (it's up about 4 per cent against the U.S. dollar over four months) appear to be dampening the growth outlook. Some economists think decelerating credit growth, or negative credit growth in some countries, is also removing growth momentum.
In a note published ahead of the euro-zone growth forecasts, Société Générale said it remains pessimistic about the pace of the European recovery. It cited "financial fragmentation, the slowdown in the pace of structural reforms, and a likely return of fiscal austerity because of the minimal progress made in the deleveraging process" for its less-than-bullish outlook.
The 2014 growth forecasts for all of the euro zone's big economies, except for Italy, were trimmed. Italy, which is in deep recession, is expected to grow by a mere 0.7 per cent next year, unchanged from the spring forecast.
The countries to be hit with the biggest growth downgrades were France, the region's second-largest economy, and Spain, the fourth-largest. France is now expected to grow by only 0.9 per cent in 2014, down from the previous estimate of 1.1 per cent. Spain is forecast to expand by 0.5 per cent, compared with 0.9 per cent previously.
Even German growth is slowing as its European trading partners go from a trot to a slow walk. Its growth is forecast at 1.7 per cent next year, down from the spring forecast of 1.8 per cent.
The slowing European recovery does not bode well for global trade. Exports to Europe from Canada and the United States, which are hammering out free-trade agreements with the European Union, may slow.
Greece was the one bright spot among the EC's new numbers. After six years of grinding recession, it should grow by 0.6 per cent next year and a strong 2.9 per cent in 2015. Portugal is also emerging from a recession that saw its economy shrink in four of the last five years.
The slower growth forecasts is bad news for employment growth. Economists generally think that growth of about 2 per cent is required to significant numbers of jobs, though the figure would vary country by country. The euro zone's unemployment rate, predicted to be 12.2 per cent in 2014, is at its highest level since the currency was launched in 1999. Earlier this year, the forecast was for 12.1 per cent unemployment. Youth unemployment is 40 per cent in Italy and more than 50 per cent in Spain and Greece.