The euro zone economy is heading into its second recession in just three years and the wider European Union will stagnate, the EU's executive said today, warning that the currency area has yet to break its cycle of debt.

The European Commission forecast that economic output in the 17 nations sharing the euro will contract 0.3 per cent this year, reversing an earlier forecast of 0.5 per cent growth in 2012.

The wider, 27-nation European Union, which generates a fifth of global output, will not manage any growth this year.

Ireland's economy will grow by 0.5 per cent this year, the forecasts predicted, with private consumption falling and export growth slowing as the weaker outlook for the euro area affects trade.

Employment is also expected to fall further, as the public service and financial sector contract, although this will be partly mitigated by people moving out of the work force and further net outward migration.

Inflation is set to rise slightly to 1.6 per cent for the year, as the effect of the increase in VAT and other price increases come into effect.

"Risks to the growth outlook remain tilted to the downside. If downside risks to the euro area materialise, it could have an impact on demand for Irish exports," the forecast said.

"The continuing need for household balance sheet repair could weigh on consumption more heavily than projected. The low interest rate environment may, on the other hand, assist the household sector in this regard without impacting unduly on already-low domestic demand."

Battered Greece will enter its fifth year of economic contraction and Spain and Italy, which saw their financing costs pushed up to near unaffordable levels last year, will shrink by around 1 per cent, it forecast.

With the euro zone's sovereign debt crisis moving from a chronic to an acute phase, the EU's top economic official warned that there would be little clemency for heavily-indebted countries who must meet strict budget targets even as their economies stall.

There seemed to be some leniency when it came to Spain, however.

"Member states facing close market scrutiny should be ready to meet budgetary targets," said economic and monetary affairs commissioner Olli Rehn defending his strategy of tough love for countries that live beyond their means.

But he suggested Spain's 2 012 deficit target of 4.4 per cent may be allowed to rise once all available data was gathered by the EU's statistics agency Eurostat.

"The full information of budgetary figures will be available in the March notification, which will be then validated and (published) by Eurostat in April. On that basis, we work with the Spanish authorities and decisions will be taken once we have a full picture," Mr Rehn said.

Economists are increasingly questioning the EU's strategy for southern Europe as austerity reaches such extremes that some indebted town halls are unable to pay staff, social services shutter and joblessness reaches record levels.

But the commission said budget cuts were the way to regain investor confidence. "Negative feedback loops between weak sovereign debtors, fragile financial markets, and a slowing real economy do not yet appear to have been broken.

The euro zone was last in recession in 2009, dubbed the Great Recession worldwide, when the economy contracted 4.3 per cent during the deepest global slump since the 1930s.

A poisonous mix of high public debt, evaporating investor and business confidence and rising unemployment killed off the two-year recovery from the global financial crisis. Despite signs of stabilisation this year, economists polled by Reuters only expect growth to return in 2013.

Inflation for the euro zone this year should come to nearer to what the European Central Bank judges about the right level for stable prices and a healthy economy: 2.1 per cent, the Commission forecast.

The growth forecast for the euro zone is a shade more optimistic than the International Monetary Fund's view that output in the currency area will dip 0.5 per cent this year. But both agree the region will manage only a modest recovery in the final months of 2012.

Additional reporting: Reuters