European Central Bank Slashes Growth Forecast, Says Financial Conditions Easing

The European Central Bank cut its growth forecast for the currency zone early Thursday as the economic bloc struggles to escape a recession that has gripped the continent for six quarters.

The ECB also noted in its Monthly Report that countries still have work to do to reign in budgets and cut deficits, which will weigh on growth.

Revised Forecasts

The ECB lowered its growth forecasts for both 2013 and 2014 this morning, predicting a deeper recession for 2013 before a return to growth in 2014. The ECB now forecasts the eurozone economy to contract 0.6 percent in 2013 compared to its prior forecast of a 0.4 percent contraction. For 2014, the ECB now forecasts that the economy will grow 0.9 percent, down slightly from the prior forecast of 1.0 percent growth.

"With regard to the economic analysis, following a six-quarter economic contraction in the euro area, recent confidence indicators based on survey data have shown some further improvement from low levels and tentatively confirm the expectation of a stabilisation in economic activity at low levels," said the ECB. "At the same time, labour market conditions remain weak."

"Looking ahead to the remainder of the year and to 2014, euro area export growth should benefit from a gradual recovery in global demand, while domestic demand should be supported by the accommodative monetary policy stance as well as the recent gains in real income owing to generally lower inflation. Furthermore, the overall improvements in financial markets seen since last summer appear to be gradually working their way through to the real economy, as should the progress made in fiscal consolidation. This being said, the remaining necessary balance sheet adjustments in the public and private sectors will continue to weigh on economic activity. Overall, euro area economic activity should stabilise and recover at a slow pace."

The ECB also lowered its inflation forecast and now sees inflation at 1.5 percent for both 2013 and 2014 vs. the prior forecasts of 1.7 percent and 1.6 percent respectively.

The euro rallied on the lower inflation forecast as traders forecast less erosive power of inflation on the purchasing power of the currency. The EUR/USD rose 0.27 percent to 1.3377 after touching a high 1.3380.

Downside Risks

"The risks surrounding the economic outlook for the euro area continue to be on the downside. Recent developments in global money and financial market conditions and related uncertainties may have the potential to negatively affect economic conditions," they continued. "Other downside risks include the possibility of weaker than expected domestic and global demand and slow or insufficient implementation of structural reforms in euro area countries."

The ECB noted as well that it expects inflation to temporarily fall over the next few months as energy prices stabilize at high levels. They also said that continued efforts to reign in budgets will weigh on growth, a key factor in lowering the forecasts.

Shares Higher

European shares rose despite the lower growth forecasts as the lower inflation expectations could open the door to a longer period of easing than previously expected given the ECB's anti-inflation stance. Peripheral shares rose the most, those grappling with the largest financial crises and fiscal adjustments, with Spain's Ibex Index rising 1.13 percent and Italy's FTSE MIB Index rising 1.4 percent.