Bailout turmoil weighing on growth, warns EU

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The European Union warned Monday that the turmoil over eurozone debt is now a threat to growth, which will slow next year, as markets gave a cool response to a weekend rescue for Ireland.

With analysts tipping first Portugal and ultimately Spain to need potentially breaking-point emergency rescues, the European Commission said they will not hit their crucial public deficit targets for next year.

The Commission said growth in the 16-nation eurozone economy will slow to 1.5 percent next year from 1.7 percent this year but then pick up to 1.8 percent in 2012.

It also adjusted radically downwards Ireland's growth forecast, to 0.9 percent next year, from three percent.

Markets raised borrowing costs for all three countries caught in the eye of Europe's debt storm, even moving on Italy as the euro fell to a nine-week low against the dollar as the risk of crisis contagion increases.

"The government in Lisbon will find it difficult to resist the likely mounting pressure from European partners to trigger (a) euro rescue," Deutsche Bank said in a note to investors.

"Unless the fiscally-strained euro area countries can convince markets that they will be on a sustainable fiscal path by 2013 -- which looks unlikely to us -- peripheral bond markets are likely to remain under strain, in particular Portugal," was the view from Citi European Economics.

At MF Global in Tokyo, Nicholas Smith said: "The one to really watch is Spain."

"The financial-market situation remains a concern, with further tensions possible, as highlighted by the reappearance of stress in sovereign-bond markets lately," the European Union's executive said in updated economic forecasts for 2010-2012.

Economic and Monetary Affairs Commissioner Olli Rehn warned that "the turbulence in sovereign debt markets (highlights) the need for robust policy action" -- the morning after Ireland became the second joint EU-International Monetary Fund eurozone bailout of the year.

Along with the Irish bailout, plans to encourage money markets to continue lending to countries in difficulty drew a similarly lukewarm reaction, with bond buyers facing the prospect that they could face lower returns if government debt has to be restructured at some point.

The decisions taken by EU ministers are "not a silver bullet," according to Milan-based UniCredit analyst Marco Valli, for whom an elevated "risk of debt restructuring ... not only on debt issued after mid-2013" runs counter to EU intentions.

Greece's repayment schedule will now be extended in line with Ireland's.

The Commission appeared more aggressive over the deficit reduction plans in Portugal and Spain, with Portugal's deficit hitting 4.9 percent of annual output in 2011, against the 4.6 percent Lisbon expects, and Madrid on 6.4 percent rather than six percent.

Each remain well above the three-percent of GDP prescribed by the EU.

The Commission also trimmed its forecast for Spain's economic growth next year to 0.7 percent from 0.8 percent. That is barely half the 1.3 percent growth Madrid hopes to record after a contraction of 0.2 percent according to the Commission's latest forecast.

Slower growth makes managing deficits much more difficult, with governments tempted to spend more to buoy their economy even as revenues fall.

The bright spot on the EU's forecast horizon was a projection showing that the unemployment rate should gradually fall to about nine percent by 2012, having hit a record one-in-10 during the aftermath of the world's deepest recession since the 1930s.

Even there, though, Spain's rate will only fall to 19.2 percent in 2012 from around 20 percent currently.

© 2010 AFP

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