Euro zone needs rate cuts, quantitative easing-OECD

BRUSSELS, March 31 (Reuters) - The euro zone will sink deep into recession this year with inflation below one percent this year and next, the OECD forecast on Tuesday, as it called for more European Central Bank rate cuts and quantitative easing.

The Organisation for Economic Cooperation and Development said the euro zone economy would shrink 4.1 percent this year and a further 0.3 percent in 2010 -- the most pessimistic outlook of all institutional forecasters so far.

The International Monetary Fund expects the economy of the 16 countries using the euro to contract 3.2 percent this year and grow 0.1 percent in 2010, while the ECB sees the recession this year in a range of -3.2 to -2.2 percent and -0.7 percent to +0.7 percent growth in 2010.

The sharp economic contraction will boost euro zone unemployment to 10.1 percent of the workforce this year from 7.5 percent in 2008 and to 11.7 percent in 2010, the OECD said.

As a result, inflationary pressures will be very small over 2009-2010 and core inflation, which excludes food, energy, alcohol and tobacco prices, will be close to zero, it said.

Consumer price growth this year is likely to be only 0.6 percent against 3.3 percent last year and 0.7 percent in 2010 against the ECB’s target of below, but close to 2 percent.

“The growing disinflationary pressure anticipated during the next two years implies that the remaining scope for cutting policy rates should be used quickly and quantitative easing policies implemented,” the OECD said.

The ECB, which expects inflation in a range of 0.1 to 0.7 percent this year and 0.6 to 1.4 percent in 2010, meets on interest rates on Thursday with markets expecting a 50 basis-point cut in its main interest rate to 1.0 percent.

But with rates falling quickly, pressure is growing on the bank to follow in the footsteps of the Federal Reserve or the Bank of England and take unconventional steps to ease policy, like buying government or corporate debt.

The OECD said discretionary fiscal stimulus measures taken by euro zone countries to boost growth amounted to almost 1 percent of GDP this year and a smaller impact in 2010, but that those countries that can afford it, should do more.

“Additional discretionary fiscal measures are also warranted in member countries that have sufficient budgetary scope,” it said, pointing to the euro zone’s biggest economy Germany, whose economy it expects to shrink 5.3 percent this year before it rebounds with 0.2 percent growth in 2010.

“Government finances are set to worsen notably on account of cyclical factors and the fiscal stimulus packages,” the OECD said forecasting a budget deficit of 6.8 percent of GDP in 2010.

It said Germany was already spending 3.5 percent of its GDP in discretionary fiscal stimulus over 2009 and 2010.

“Nevertheless, given the rapid deterioration in activity, further temporary stimulus measures are needed and should be implemented quickly,” it said.

Also the euro zone’s second biggest economy France should consider spending more if the outlook were to deteriorate further from the current contraction of 3.3 percent seen this year and a fall of 0.1 percent in 2010.

The OECD cautioned, however, that with a budget deficit seen at 6.6 percent this year and 8.3 percent in 2010, Paris needed a credible plan to restore healthy public finances when the economy recovers.

The third biggest economy Italy, however, which has the highest debt in Europe of more than 100 percent of GDP, can ill-afford large fiscal stimulus even though its economy is set to contract 4.3 percent this year and 0.4 percent in 2010.

“Over the projection period the deficit widens substantially as the government should allow automatic stabilisers to work; with such high public debt, and so long as debt markets are nervous, not much more can be done,” the OECD said.

Italy’s budget gap would still widen to 4.7 percent of GDP this year from 2.5 percent in 2008 and to 5.9 percent in 2010.

Reporting by Jan Strupczewski, editing by Patrick Graham