Euro zone economic growth will halve in 2008 from 2007 and inflation will be much higher because of financial turmoil, soaring commodity prices and housing market shocks, the European Commission said today.
Updating its economic forecasts, the European Union executive slashed its prediction for gross domestic product growth for the 15 nations using the euro to 1.3 per cent from the 1.7 per cent predicted in April, as the OECD did on September 2nd.
In 2007, euro zone gross domestic product (GDP) grew 2.6 per cent.
The Commission cautioned that its new forecast for the euro zone could still prove too strong, and its figures showed the bloc's biggest economy, Germany, in recession, with GDP shrinking 0.2 per cent in the July-September period after contracting 0.5 per cent in the previous three months.
Spain, whose housing bubble has burst, will also go into recession in the second half of the year, as will Britain, the Commission forecast.
Both France and Italy, whose economies shrank 0.3 per cent in the second quarter, would only stagnate in the third.
"The main downside risks identified in the spring forecast have materialised, with the financial turmoil deepening, commodity prices soaring and the shocks to several housing markets spreading more widely," the Commission said.
The Commission raised its inflation estimate for this year to 3.6 per cent from 3.1 per cent previously. That is almost twice the European Central Bank's target of keeping inflation below, but close to, 2 per cent.
"This represents an upward revision, although inflation could be at a turning point as the impact of past increases in energy and food prices gradually fades in the coming months," the Commission said.
It said risks to the growth outlook remained more on the downside, and if they materialised, growth could be 1.1 per cent this year rather than 1.3 per cent.
"Risks to the inflation outlook (remain) more on the upside as the euro area might witness some second-round effects on inflation in the rest of the year, although there is no evidence of any widespread effects so far," the Commission said, referring to the risk of a wage-price spiral.
The Commission forecasts on growth for 2008 are in the lower end of the ECB's forecast range while on inflation they are in the upper end of the ECB projection range. The Commission said there had so far been only limited evidence of high oil and food prices driving up wage demands and prices in other sectors.
"However, the risk of such effects cannot be excluded, especially if (low) inflationary expectations were to become less well anchored," the Commission said.
"Moreover, the oil market remains tight, despite the current easing of prices, and any renewed oil price hikes will worsen the inflation prospects in the EU," it said.
Secondary inflation is what the ECB is keen to prevent and the bank raised interest rates in July by 25 basis points to 4.25 per cent despite signs of slowing growth to drive home its point.