The European Commission Thursday said Spain's economy is likely to contract around 1% this year, a much gloomier forecast than the last one released late in 2011, opening the door for a slowdown in the pace of frantic budget cuts in the euro zone's fourth-largest economy.
Last November, the commission had already trimmed its Spanish growth forecast to 0.7% this year from a previous 0.8%, and said it still expected the country to reach targets calling for a drop in government budget deficit to 6% of gross domestic product in 2011 and 4.4% in 2012, from 9.2% in 2010.
However, an accelerated slump in Spain--where the central bank anticipates a 1.5% economic contraction this year--and a warning by the country's new conservative government that the budget deficit for 2011 will be around 8% largely due to overruns by regional authorities has dramatically worsened Spain's economic prospects--as the commission acknowledged Thursday.
"Now it's certified that we are in recession," said Spain's Budget minister Cristobal Montoro. "Our budget policy will have to be tailored for that."
In an interim forecast ahead of more detailed numbers to be released later this year, the commission said its estimate for a 1% contraction doesn't take into consideration additional fiscal cuts yet to be adopted by the country's government, as it doesn't plan to release a budget until late March.
Just before that happens, Spain is expected to present its own economic growth and general budget deficit estimates for the year. The commission didn't provide any budget deficit estimates.
Spanish officials have recently hinted they will try to revise the targets for budget deficit this year and next--currently Spain is targeting 3%-of-GDP deficit in 2013--saying the current economic environment and last year's deficit overrun make them unfeasible.
"Taking into account additional fiscal measures in the forthcoming budget may significantly change the picture both for real GDP growth and for its individual components," the commission said, noting that the economy may approach a zero-growth rate only by the last quarter of the year.
Even before the new budget, Spain's forecast is well below the commission's forecast for 0.3% contraction on average in the euro zone, and the fourth-worst of any individual country, behind Greece, Portugal and Italy. Compared with the previous commission estimates, Spain is the country with the most deteriorated growth picture, slightly ahead of Greece.
On the bright side, the commission said Spain's poor economic activity should lead to a drop in inflation from around 3% in 2011 to 1.3%, below the euro zone's 2.1% average. This should lead to "some improvement in Spain's price competitiveness," the commission said.
-By David Roman, Dow Jones Newswires, +34 91 395 8127;