Recession to hit Germany, UK and Spain

Any remaining hopes of Europe avoiding a sharp economic downturn were finally dashed on Wednesday after the European Commission forecast recessions this year in Germany, the UK and Spain – with France and Italy faring little better.

The steep downward revisions in growth forecasts by the European Union's executive arm showed it had thrown in the towel and accepted that tumbling business and consumer confidence was hitting economic activity – even though the European economy had been "generally sound" prior to the outbreak of financial turmoil.

Joaquin Almunia, economics and monetary affairs commissioner, described the environment as "difficult and uncertain". As well as financial turmoil and a near doubling of oil prices over the past year, significant housing market corrections in some countries were taking their toll, he said.

The Commission expected the economy of the 27-country European Union to expand by just 1.4 per cent this year, and the 15-country eurozone by 1.3 per cent. That compared with the 2 per cent and 1.7 per cent in its last forecasts, released in April.

Quarterly projections showed the German economy contracting by 0.2 per cent in the three months to September, taking it into technical recession – two quarters of contraction – after a fall of 0.5 per cent in the second quarter. The UK and Spain were expected to see contractions in both the third and fourth quarters. But France and Italy, which both contracted in the second quarter, were expected to see flat growth in the current quarter.

Jean-Claude Trichet, European Central Bank president, struck a more upbeat tone, telling the European Parliament that the "current episode of weak economic growth is expected to be followed by a gradual recovery".

But he reinforced expectations that ECB interest rates would remain firmly on hold by warning of a pick-up in eurozone unit labour costs that "has to be countered".

The ECB, which increased its main rate to 4.25 per cent in July, is particularly worried about wage indexation, especially in Spain, which it fears increases the risk of current high inflation rates becoming entrenched. The Commission forecast eurozone inflation would average 3.6 per cent this year – compared with an ECB target of an annual rate "below but close" to 2 per cent.

At the same time, Mr Trichet complained about the "cartel" among oil producers. "Stabilisation of prices might be a good thing but stabilisation at a very abnormally high level is not a good thing," he said.

The ECB president warned that financial markets would not return to conditions that had previous been considered normal, with three-month interest rates likely to remain elevated. At the same time, the economic outlook would depend increasingly on the fate of the financial system. "The financial market correction could be gradually changing its nature and scope and evolve into a more traditional credit-cycle downturn," he said.

In similar comments – which also echoed the fears of policymakers in the US – the Commission cautioned that, "a deceleration in real economic activity could amplify problems in the financial sector by decreasing the capacity of companies and households to service their debt-repayment obligations." In turn, that could trigger a further tightening in bank lending standards.

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