WASHINGTON (MNI) – Eurozone economic growth will be anemic at best
in the second half of this year and the downside risks are ominous if
the sovereign debt crisis is not contained, the International Monetary
Fund warned Tuesday.

“Should the periphery’s debt crisis continue to propagate to core
euro area economies, there could be significant disruption to global
financial stability,” the Fund said in its World Economic Outlook.

The ECB will have to continue to provide unlimited liquidity, buy
bonds in the secondary market — at least until the EU’s own rescue fund
is operational — and stand ready to cut interest rates “if downside
risks to growth and inflation persist,” it said.

The IMF’s projection for annual Eurozone GDP growth of 0.25% in the
second half suggests that economic activity would be practically flat
before picking up by 1.1% next year (revised down from +1.7%). Forecasts
for the larger economies were slashed by between 0.5 and 1.0 point to
range from 0.3% in Italy to 1.3% in Germany and 1.4% in France.

“The ongoing financial turbulence will be a drag on activity
through lower confidence and financing, even as the negative effects of
temporary factors such as high commodity prices and supply disruptions
from the Japanese earthquake diminish,” the IMF said.

Since the bailout countries must stick “steadfastly” to adjustment
programs, their output will likely remain “below capacity for some
time,” the report said.

Moreover, “risks to growth are mainly to the downside,” the IMF
said. An “overarching concern” is whether investment will hold up while
higher sovereign and banking spreads “are eventually transmitted to
corporate funding costs.”

Assuming receding commodity prices, Eurozone HICP inflation is
expected to slow to 1.5% next year, which could give the ECB leeway to
lend further support to a fragile recovery.

The IMF’s fiscal policy advice is largely in line with the current
strategy of Eurozone leaders, namely to implement as rapidly as possible
their July accord to expand the mandate of the EFSF rescue fund and to
accelerate fiscal consolidation in countries threatened by a spread of
the debt crisis.

The Fund suggested further reforms of social programs to create
more budget leeway and urged France and Spain to spell out “measures
that will be used to attain their medium-term fiscal targets.” Without
calling for stimulus measures, it suggested that Germany “allow
automatic stabilizers to work fully to deal with growth surprises” and
to delay some planned adjustments “if activity were to undershoot
current expectations.”

The report watered down earlier comments by IMF Managing Director
Christine Lagarde on the need for recapitalization of European banks —
comments that triggered protests from EMU leaders and central bankers.
Still, it urged that immediate efforts to “fill the gaps” revealed by
the latest stress tests “be more ambitious than supervisors deemed
necessary.”

“The objective should be to lift bank equity beyond the Basel III
minimums and well ahead of the Basel III timetable, while allowing
flexibility in the use of macroprudential tools to address
country-specific financial and systemic risks,” the report said.

“The overriding policy challenge, beyond containing the crisis, is
to push forward with European integration,” the IMF said. “Countries
must stand ready to sacrifice some policy autonomy for the common
European good.”

“Good progress has been made in putting in place a framework for
sharing sovereign risk,” but any support must be tied to sustained
budget adjustments, it stressed. “More integrated and flexible labor,
product, and services markets would facilitate adjustment in response to
shocks.”

“This is particularly important for the financial sector, which
urgently needs a truly integrated financial stability framework,
featuring a single rules book, integrated supervision, and burden
sharing,” the IMF added.

External demand for the Eurozone is likely to weaken further as the
global economy loses steam, and risks here are also to the downside, the
IMF said, citing “negative spillovers from a slower U.S. growth path or
collapse in market confidence in U.S. fiscal policy.”

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