IMF expects EU economy to contract by 0.2% this year

The IMF forecasts growth to reach 3.5% this year and a more robust 4.1% next year.

However, conditions in the eurozone will remain challenging with the economy expected to contract by 0.2% before posting a modest growth rate of 1% next year, according to the Fund’s latest World Economic Outlook.

Effective policy responses have reduced the acute risks facing the eurozone, Japan and the US.

“If crisis risks do not materialise and financial conditions continue to improve, global growth could even be stronger than forecast. But downside risks remain significant, including prolonged stagnation in the euro area and excessive short-term fiscal tightening in the United States.”

In a press briefing following the release of the WEO, IMF chief economist Olivier Blanchard said moves towards a banking union and closer fiscal integration in the eurozone were important steps towards fixing the debt and financial crises that had affected the region.

Good progress had been made on both of these fronts, he noted. But for banking union to succeed it needed three components: a single supervisory mechanism; a common resolution regime; and a deposit insurance scheme. Moreover, there had to be a fiscal backstop underpinning banking union, said Mr Blanchard. If these steps are introduced in full, there is no need for debt mutualisation.

The IMF’s chief economist declined to comment on British prime minister David Cameron’s pledge to hold a referendum on the country’s EU membership. Neither would he comment specifically on the elections in Italy and Germany this year. “[eurozone integration] is a complex process and because of this governments have different constraints. What we have learned is that two steps forward and one step back ends up delivery, but it is a messy process.”

The US faced significant challenges over the medium term because of an aging population and medicare commitments. A fiscal consolidation of 5% over that timeframe was needed, which was “do-able,” he said.

Stock markets may be “getting ahead of themselves” and it is difficult to transmit this enthusiasm to the real economy because the banking system is broken. “But financial markets are seeing something optimistic in the real economy.”

Significant financial market reforms remain, but the threat of currency wars has been overblown, concluded Mr Blanchard.