Autumn forecast: EU economy in ‘dangerous territory’

The document did not mince words: “The EU economy is moving in dangerous territory. The recovery has already come to a standstill and a slew of forward looking indicators paint a rather gloomy picture.”

“Any further bad news could amplify adverse feedback loops pushing the EU economy back into recession,” it said.

Already, the EU economy is “set to stagnate for some quarters before anaemic growth gradually returns.”

The report recounts how only after a number of quarters of zero or close-to-zero growth, will the bloc see a “feeble” uptick in its economic fortunes.

The final quarter of 2011 will see “nil” growth and predictions for growth for 2012 have been ratcheted downward “substantially”, by 1.25 percentage points to just 0.5 percent in both the EU and the eurozone.

Quarterly growth in 2012 will slowly increase from zero to 0.4 by the end of next year and then languish at the same rate throughout 2013.

Signs of domestic demand, particularly in core eurozone countries, in the spring were predicted by the commission to provide the key engine of a moderate recovery.

“These hopes have been dashed,” the document continued, saying that domestic demand has “shrivelled”.

Fearful of losing their jobs - or having lost them already - consumers are pulling back on spending and attempting to pay down household debts.

Companies are frightened that in the current climate they will not profit from new investments and are engaged what is in effect an investment strike. Even though firms are in a “generally strong financial position” and are able to borrow at very low rates, they are just sitting on the cash and refusing to invest.

Banks for their part are increasingly reluctant to lend and the report’s authors even warn of a potential credit crunch early next year.

Meanwhile, the abysmal state of the global economy means that export markets have weakened. The US recovery lost steam over the summer and growth in emerging economies has moderated.

In such a situation, there are few directions in which to look that will jump-start the EU economy.

A flatlining real economy, fragile public finances and a banking sector that is in need of recapitalisation are beginning to create “feedback loops”, mutually affecting each other in a “vicious circle”.

The analysis predicts that uncertainty in the markets related to the eurozone crisis, which destroys confidence and intensifies financial turmoil, will “gradually fade over the forecast horizon” so long as austerity measures and structural adjustment policies are implemented.

Also, once “uncertainty dissipates”, Germany, which will see “strongly” weakened investment, consumption and exports in the fourth quarter of this year, will see a resumption of “robust growth”.

Yet at the same time, the report says that these very measures are “weighing on domestic demand” and will have a “moderately negative impact in 2012.”

In essence, the document says that the medicine is as bad as the disease: austerity is necessary to end uncertainty, it argues, but this also depresses demand.

And the downward affect on GDP as a result of austerity is likely to be still more profound than the figures in the report, as fresh spending cuts and structural adjustment measures in France and Italy had yet to be announced when the report went to press, while a likely change in the Spanish administration shortly will almost certainly deepen the existing austerity there.

No countries will escape the slowdown, although some states will be hit worse than others, with those that grew the fastest from 2010-2011 will now decelerate the fastest.

France for its part, is struck with poor corporate investment although private consumption is softening to a lesser extent, but both will nevertheless produce a contraction at the end of this year. Moderate growth is expected to return in the second half of 2012.

Italy will see two quarters of slight contraction around the turn of the year, to be followed by “frail” growth thereafter as a result of subdued domestic demand. And Spain will stagnate in late 2011 and early 2012 before growth “gradually” returns.

Outside the eurozone, the UK like Spain will also stagnate in late 2011 and the first half of next year, while Poland will experience a “comparatively benign” slowdown as the year closes.