Bottoming Out? ECB Forecasts Recession until Mid-2010

In its latest monthly report, the European Central Bank suggests the worst of the economic crisis may have passed in Europe. However, it still predicts that the deep recession will last until at least mid-2010.

Has the free fall in the German economy bottomed out? An increasing number of economic indicators suggest it has. Still, it may be months before an economic recovery takes place. A new forecast released by the European Central Bank in Frankfurt suggests the current recession plaguing the euro zone, the countries that use Europe's common currency, will be long and deep.

Bank skyline in Frankfurt: The German economy will remain cloudy until 2010.

Bank skyline in Frankfurt: The German economy will remain cloudy until 2010.

Foto: ddp

After a phase of stabilization during the rest of 2009, positive, quarter-on-quarter economic growth is first expected in mid-2010, the ECB stated in its monthly report for June, released in Frankfurt on Thursday.

The forecast for Germany is also gloomy. The country's Kiel Institute for the World Economy (IfW) on Thursday again radically lowered its economic prognosis for 2009. The institute believes the economy will contract by 6 percent rather than its previous estimate of 3.7 percent. The institute reported, however, that the German economy had come close to stabilizing in mid-year. During the coming year, IfW is less pessimistic -- it anticipates economic growth of 0.4 percent rather than its previous estimate of a contraction of 0.1 percent.

The expectation that growth will not return to the euro zone for months is distressing many experts. ECB financial stability expert Dejan Krusec fears that, in the worst-case scenario, another banking crisis could be precipitated. If a fast "V-shaped" rebound takes place, he said, banks will be strong enough to weather the storm, the Daily Telegraph quoted him as saying. "If this is 'U-shaped', the banks will have problems." He added: "The problem is not 2009. Euro-area banks are well enough capitalized to cover losses. The problem is 2010. We are concerned about the length of the recession." ECB is currently monitoring 25 banks it considers to be of strategic importance.

ECB officials said they felt the current key interest rate of 1 percent was nevertheless "appropriate." In addition to interest rate policy, the assessment also includes additional measures like the planned sale of covered bonds. Inflation in the euro area is also expected, in the medium term, to be dampened as a result of weak economic activity and remains consistent with the central bank's medium-term goal of an inflation rate of around 2 percent.

Grim Labor Market Forecasts

Although the economic downturn appears to have bottomed out, the delayed impact of the recession on the labor market is only now starting to take shape. Generally, it takes about six months before the effects of a paralyzed economy to hit the job market with full force.

Labor market forecasts for the next two years are grim. Wolgang Franz, head of Center for European Economic Research in Mannheim, warns that in the labor market "in contrast to the economy, we are still facing the worst." By year's end, he estimates, the number of jobless in Germany will surpass 4 million (up from about 3.46 million in May).

German Labor Minister Olaf Scholz, of the center-left Social Democrats, recently moved to extend to 24 months a government program that allows companies to reduce employees working hours, with Berlin picking up the tab for social insurance and part of the lost work. But Franz was also critical of short-time working programs, saying it would be better for structural transformation of the labor market if qualified workers were laid off rather than keeping them artificially employed by struggling compnies.

The ECB said Thursday that measures such as Germany's short-time working programs should be kept temporary. If an economic decline is short, then programs to support shorter working hours can be effective as an instrument for saving jobs, officials stated in the monthly report. The ECB has a negative view of using such measures over a longer time frame.

"If used extensively over a prolonged period of time, however, the financial support of such government measures reduces the incentives for firms and workers to reallocate," the report states. "In addition, over time, these measures generate major fiscal burdens without creating incentives for investment to foster recovery." It adds: "The reallocation of workers across firms and sectors is important in order to make it easier to exploit profitable investment opportunities that emerge with the onset of a recovery."

dsl -- with wire reports
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