The euro area is in a recession, driven by faltering confidence, which is projected to persist into the early part of 2013. Growth is projected to pick up only slowly during 2013 and into 2014. On-going fiscal consolidation will hold back activity, but private demand will pick up as confidence and the functioning of the financial sector improve. Continued high unemployment and a large margin of excess capacity will depress inflationary pressures. The main risk is a lack of sufficient progress by policy makers in resolving the crisis.
Stronger bank balance sheets and a full banking union would reduce the adverse feedback loop between sovereigns and the banking system. Vulnerable economies should enter the ECB’s Outright Monetary Transaction (OMT) programme if needed. To support demand, the ECB should reduce interest rates further and issue forward guidance on maintaining the accommodative policy stance for a long period. In the event of severe turmoil, further non-standard measures should be taken. Euro area member countries should implement fiscal consolidation measures as planned, but if activity weakens more than expected in their fiscal programmes they should allow the automatic stabilisers to work. To avoid loss of credibility for individual countries acting alone, this should be announced in co-ordination. Structural reforms are essential in both debtor and creditor economies to boost growth and rebalance their economies. The EU Single Market should be given greater priority.