PARIS (MNI) – Economic weakness in Eurozone peripheral countries is
spreading to the core, cutting the growth outlook for the entire
single-currency bloc for at least this year and next, the International
Monetary Fund said Monday.

In its semi-annual World Economic Outlook report, the IMF said
policy initiatives from Brussels and the European Central Bank plan have
temporarily calmed market tensions, but fears of another flare-up are
having a broad dampening effect on growth.

“The recession in most of the periphery is increasingly spilling
into other economies in the region,” the IMF report said. “The
possibility that the euro area crisis will escalate remains a major
downside risk to growth and financial sector stability until the
underlying issues are resolved.”

The Eurozone economy will shrink by 0.4% this year, the IMF
projected, a slight downward revision from the -0.3% forecast it issued
in July. The 2013 growth outlook was slashed to 0.2% from 0.7%. Within
the euro area, only smaller countries like Austria and Finland will have
growth higher than 1% next year, the IMF said, while six countries –
led by giants like Italy and Spain – will continue to contract.

To address underlying issues, the IMF called for EU policy-makers
to press forward with plans to allow the European Stability Mechanism to
recapitalize banks directly. Pan-European programs to guarantee bank
deposits and shut down sick banks are also needed to stop the capital
flight draining from the periphery and into the core, the IMF said.

“Resolving the euro area crisis requires progress toward banking
and fiscal union in combination with short-term demand support and
crisis management at the euro area level,” the IMF said.

The ECB should keep its policy rate low, or even reduce it further,
while continuing to provide ample liquidity to banks, the IMF said. The
OMT bond-buying plan, once implemented, “should help ensure that low
policy rates transmit to borrowing costs in countries in the periphery”
that have agreed to the proper conditions, the IMF said.

The IMF also said that further budget cutting in the Eurozone
should be focused on reducing structural deficits rather than nominal
deficits that are affected by the variations in economic growth.

And in countries that have fiscal leeway and are not subject to
market pressures, budget mechanisms that automatically increase spending
to soften economic downturns should be “allowed to operate fully,” the
IMF said.

–Paris newsroom,+33142715540; jduffy@marketnews.com

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