Euro zone set for record recession, inflation to vanish-Commission

BRUSSELS (Reuters) - The euro zone economy will contract by a record 7.7% this year because of the COVID-19 pandemic, inflation will almost disappear and public debt and budget deficits will balloon, the European Commission forecast on Wednesday.

As the economy contracts this year, consumer prices will almost stagnate, the Commission forecast. The inflation rate will slow to 0.2% in 2020, before accelerating to 1.1% next year, when the euro zone is to return to growth of 6.3%. Investment will plunge 13.3% this year, it said.

“Europe is experiencing an economic shock without precedent since the Great Depression,” European Commissioner for Economic and Financial Affairs Paolo Gentiloni said.

“Both the depth of the recession and the strength of recovery will be uneven, conditioned by the speed at which lockdowns can be lifted, the importance of ... tourism in each economy and by each country’s financial resources,” he said.

With government spending the main fuel for the economy, the effort to keep economies alive will widen budget gaps in the euro zone to an aggregate 8.5% of GDP this year from 0.6% last year, before the deficit shrinks again to 3.5% in 2021.

A surge in public debt will take longer to undo. The Commission forecast euro zone debt will jump to 102.7% of GDP this year from 86% last year, and recede only to 98.8% in 2021.

“We see governments running fiscal deficits ... as essential for a robust and broad recovery, and see European support as particularly important for the periphery to be able to participate in this recovery,” Morgan Stanley bank said in a research note on the Commission forecasts.

“Proposals for the next EU budget – which will encompass a recovery fund – are still being drafted. The details, particularly on size and breakdown of loans/grants, will be key,” the bank said.

Gentiloni said the Commission’s plan for financing the recovery would be ready “in weeks” and that it would be approved by EU leaders in June. It would be a mix of grants and long-term loans, he said, but declined to give more details.

Italy, Greece, Spain and Portugal will be among the hardest hit by the economic effects of the pandemic. Luxembourg, Malta and Austria will weather the shock better.

“Both the recession and the recovery will be uneven,” Gentiloni said.

Greek GDP will contract the most, by 9.7%. Italy will record the second deepest recession, 9.5%, and Spain 9.4%.

The budget deficit of Italy, the EU country hardest hit by the coronavirus, will surge the most to 11.1% of GDP this year from 1.6% last year, but will fall back to 5.6% in 2021, the Commission forecast.

Spain’s deficit will be 10.1% this year, up from 2.8% in 2019. France will be close behind with a deficit of 9.9% this year. The Commission expects it to fall to 4.0% next year.

Italy’s public debt will also record the biggest increase this year, to 158.9% of GDP from 134.8% in 2019. It is seen falling to 153.6% in 2021, he Commission said.

Reporting by Jan Strupczewski; editing by Philip Blenkinsop, Larry King