BRUSSELS — The 17-nation eurozone economy will suffer a modest recession this year despite recent signs of stabilization, particularly in financial markets, the European Union's executive branch said Thursday.
In its latest projections, the European Commission forecast a 0.3 percent contraction in the eurozone economy, with Greece leading the way downward with a massive 4.4 percent decline.
That would be the fifth straight year of recession in Greece, which earlier this week clinched its second massive bailout package in less than two years.
In its last forecast in November, the Commission predicted a 0.5 percent expansion across the eurozone economy following last year's 1.4 percent growth. The difference this time is that it now expects the economies of Belgium, Spain, Italy, Cyprus, the Netherlands and Slovenia to contract in 2012, not just Greece and Portugal.
The overall decline is limited by resilient activity in Germany and France, the eurozone's two-largest economies. Growth in Germany is penciled in at 0.6 percent while France is forecast to grow by 0.4 percent.
"Although growth has stalled, we are seeing signs of stabilisation in the European economy," said Olli Rehn, European Commissioner for Economic and Monetary Affairs. "Economic sentiment is still at low levels, but stress in financial markets is easing."
He said the forecast was based on the assumption that uncertainty created by the debt crisis "will gradually fade away."
Sony Kapoor, managing director of economic think-tank Re-Define, urged Europe not to get complacent over its handling of the debt crisis.
"The sharply deteriorating economic forecasts underscore why despite the lull arising from a quietening of the acute phase of the crisis, EU policy makers must not be allowed to procrastinate and become complacent, a pattern that has characterized EU decision-making from the start of the crisis," Kapoor said.
Last November, financial markets were struck by fears that Europe's debt crisis would not be confined to the relatively small economies of Greece, Ireland and Portugal. Worries grew that Spain and Italy could get swamped by their debt loads, too. Both countries now have new governments to enact sweeping austerity measures.
The more benign atmosphere in financial markets has also been helped by the European Central Bank's offering of super-cheap long-term loans to banks and the decision of the 17 euro countries to tie their economies closer together.
Though austerity measures are the main pillar in Europe's strategy to fight the debt crisis, they are clearly hurting the economy in the short-term — Spain and Italy are expected to sink into recession this year as their governments cut debt aggressively.
Italy, which is the eurozone's third-largest economy and has a debt mountain of around €1.9 trillion ($2.5 trillion), is predicted to contract by 1.3 percent this year, in contrast to the 0.3 percent growth predicted in November.
And Spain is expected to contract 1 percent in 2012, against the 0.7 percent growth predicted in the fall. The Commission warned that if the Spanish government enacts further budget cuts in an effort to meet its 2012 targets, its economy will likely shrink even more.
Rehn dodged questions on whether the Commission would be willing to give Spain more time to cuts its deficits considering the country's worsened economic situation. Under current commitments to the EU, Spain has to cut its deficit to 4.4 percent of GDP for 2012. But the new government, facing another recession, has hinted it wants the EU to lower the target a bit.
The Spanish government has yet to release official figures but says the deficit for 2011 will come in at around 8 percent of GDP, rather than 6 percent as forecast by the Socialist administration it ousted in November elections.
Of the three bailed-out countries, only Ireland offered some glimpse of hope. While Greece and Portugal were expected to remain in deep recessions, Ireland's economy was forecast to grow 0.5 percent this year, on top of 2011's 0.9 percent growth.
Rehn said many of the measures being taken across Europe are "essential" for financial stability and to establish conditions for more sustainable growth and job creation.
"With decisive action, we can turn the corner and move from stabilisation to boosting growth and jobs," Rehn said.
Rehn also reiterated a previous call on the euro countries to boost the currency union's bailout funds so prevent a further spread of the crisis.
"The past one and a half years have shown that this call was more than justified," Rehn said.
Under current plans, the lending capacity of the eurozone's bailout funds is capped at €500 billion ($662 billion), of which more than €150 billion ($198 billion) have already been promised to Greece, Ireland and Portugal.
Eurozone leaders will have to decide next week whether they will keep the money remaining in the interim bailout fund, the €440 billion ($582 billion) European Financial Stability Facility, available once the permanent €500 billion European Stability Mechanism comes into force in July.
Germany has so far rejected this proposal, though the Commission believes that a bigger firewall could protect vulnerable economies like Italy and Spain.
The wider 27-nation EU, which includes non-euro countries, is expected to post flat growth this year. Britain is forecast to eke out growth of 0.6 percent, while Poland is expected to post a 2.5 percent expansion, the highest rate across the EU.
Pylas contributed from London