* Euro zone to contract 0.3 pct in 2012 - Commission
* EU to show zero growth, economy fragile
* Report shows growing regional divide
* EU says must cut deficits; may show leniency in Spain
By Robin Emmott and Julien Toyer
BRUSSELS, Feb 23 The euro zone economy is
heading into its second recession in just three years and the
wider European Union will stagnate, the EU's executive said on
Thursday, warning that the currency area has yet to break its
vicious cycle of debt.
The European Commission forecast that economic output in the
17 nations sharing the euro will contract 0.3 percent this year,
reversing an earlier forecast of 0.5 percent growth in 2012.
The wider, 27-nation European Union, which generates a fifth
of global output, will not manage any growth this year.
Battered Greece will enter its fifth year of economic
contraction and Spain and Italy, w hich
saw their financing costs pushed up to near
unaffordable levels last year, will shrink by around 1
percent , it forecast.
With the euro zone's sovereign debt
crisis moving from a chronic to an acute phase, the EU's
top economic official warned that there would be little
clemency for heavily-indebted countries who must meet strict
budget targets even as their economies stall.
There seemed to be some leniency when it came
to Spain, however.
" Member states facing close market scrutiny
should be ready to meet budgetary targets," said Economic
and Monetary Affairs Commissioner Olli Rehn defending his
strategy of tough love for countries that live beyond their
But he suggested Spain's 2 012 deficit target
of 4.4 percent may be allowed to rise o nce
all available data was gathered by the EU's statistics agency
"The full information of budgetary figures will be
available in the March notification, which will be then
validated and (published) by Eurostat in April. On that basis,
we work with the Spanish authorities and decisions will be taken
once we have a full picture," Rehn said.
Economists are increasingly questioning the EU's
strategy for southern Europe as austerity reaches such extremes
that some indebted town halls are unable to pay staff, social
services shutter and joblessness reaches record levels.
But the Commission said budget cuts were the way to
regain investor confidence. "Negative feedback loops
between weak sovereign debtors, fragile financial markets, and a
slowing real economy do not yet appear to have been broken.
Separately, European Central Bank President Mario Draghi
told a German newspaper that the euro zone economy is bouncing
back after a very weak end to last year and positive signals
have increased since the ECB's rate decision meeting two weeks
The euro zone was last in recession in 2009, dubbed the
Great Recession worldwide, when the economy contracted 4.3
percent during the deepest global slump since the 1930s.
ANOTHER BRICK IN THE FIREWALL
A poisonous mix of high public debt, evaporating investor
and business confidence and rising unemployment killed off the
two-year recovery from the global financial crisis. Despite
signs of stabilisation this year, economists polled by Reuters
only expect growth to return in 2013.
Inflation for the euro zone this year should come to nearer
to what the European Central Bank judges about the right level
for stable prices and a healthy economy: 2.1 percent, the
The growth forecast for the euro zone is a shade more
optimistic than the International Monetary Fund's view that
output in the currency area will dip 0.5 percent this year. But
both agree the bloc will manage only a modest recovery in the
final months of 2012.
The forecasts could still worsen. They rely on the
assumption that EU leaders will act to resolve the sovereign
debt crisis, which is now in its third year and has shattered
investor confidence in a region once regarded as one of the
world's safest havens.
"The balance of risks to GDP growth remains tilted to the
downside amid still-high uncertainty," the Commission said. "The
interim forecast continues to rely on the assumption that
adequate policy measures are decided and implemented."
EU leaders hold a summit in Brussels next week where
investors hope they will agree to raise the ceiling of the euro
zone's joint rescue funds and pave the way for more IMF funds to
stand behind heavily indebted southern European economies.
But the German government said this week it sees no need to
beef up the funds and Rehn called on leaders to strengthen
"We need to reinforce our financial firewalls so that
we're fully equipped to overcome the current crisis and return
to recovery," Rehn said.
Adding to the difficulties, the downturn is widening the gap
between the wealthy economies of northern Europe and those of
the south that are most in need of growth to pay off debt.
Germany and France, the euro zone's two largest economies,
are likely to escape recession this year, growing 0.6 percent
and 0.4 percent respectively, the Commission said.