MercoPress. South Atlantic News Agency

Euro zone growth forecasted to shrink by 0.5% this year, says Dragui

ECB president: things would have been much worse without the massive support to the banking system

The European Central Bank downed its Euro zone growth forecast after holding interest rates at record lows on Thursday, and said things would have been much worse without its dramatic action to pump a trillion Euros into the banking system.

The ECB staff forecasts showed the economy could shrink by 0.5% this year and at best grow by a meagre 0.3%, a slight downgrade of its previous estimate.

“Available survey indicators confirm signs of a stabilisation in the Euro area economy. However, the economic outlook is still subject to downside risks,” ECB President Mario Draghi told a news conference, after the central bank left interest rates at 1.0%.

Meanwhile, a recent 20% rise in oil prices is rekindling inflation to some extent. It is now forecast to be higher, at between 2.1 and 2.7% this year, above the ECB target of close to but below 2%.

“Owing to rises in energy prices and indirect taxes, inflation rates are now likely to stay above 2% in 2012, with upside risks prevailing,” Draghi said.

Draghi was in no doubt that the ECB twin three-year funding operations, which pumped over one trillion Euros into the Euro zone banking system, had saved the currency bloc from a serious crisis.

Borrowing costs for debt strugglers such as Italy and Spain have tumbled as a result and Draghi said markets, including the inter-bank lending market, had reopened and “real money” investors were returning to Euro assets.

“All in all, we see that great progress has been achieved” he said. “Simply compare what the situation was in November last year and what it is today.”

Nonetheless, he put the onus back on governments to fight the Euro zone crisis from now on, demanding “further progress towards restoring sound fiscal positions and implementing the structural reform agenda”.

The Euro zone economy has stabilised over recent months, in part thanks to the ECB back-to-back rate cuts in November and December and the twin funding operations, which brought calm to Euro zone debt markets.