The International Monetary Fund has slashed its economic growth forecast for Europe today, warning that its financial markets were exposed to the troubled US housing sector and credit conditions were tightening.
"Exposure to the US subprime mortgage market - directly or through conduits and structured investment vehicles - has already strained banks' capital in a number of countries and forced them to expand their balance sheets," the IMF wrote in its World Economic Outlook.
"As a result, credit conditions are tightening and risk spreads are rising, with negative repercussions fordomestic demand," it said.
Ireland is also under threat from a sharper than expected fall in house prices as anxious lenders pull funding, according to the body’s World Economic Outlook report.
"Several countries, including Ireland, the United Kingdom, and Spain, have experienced their own housing booms, and these are starting to turn.
"The slowdown in mortgage lending could accelerate the so-far gradual adjustment of housing prices in a number of countries with elevated valuations," the IMF said.
The body also warned global growth would lose speed following the financial crisis and expects the US to enter a "mild recession" this year as the trauma in the world's largest economy is felt worldwide.
"Emerging and developing economies will not be insulated from a serious downturn in the advanced economies," the report added.
The IMF said it now expects the euro-zone economy to grow by a modest 1.4 per cent this year, down from a January forecast for 1.6 per cent and an October projection of 2.1 per cent growth.
For 2009, it expects growth of just 1.2 percent. In 2007, the euro area grew 2.6 per cent.
In Britain, 2008 growth is expected to hit 1.6 per cent, down from an October forecast of 2.3 per cent. That compares with 2007 growth of 3.1 per cent. The IMF forecast only a "moderate recovery" for 2009.
When reports surfaced last week that the IMF had taken a sharp knife to its forecast, some European leaders complained the IMF was being overly pessimistic.
They argued the region's economy was weathering the US distress well, with little sign of serious problems in the real economy.
Inflation remains uncomfortably high in the euro zone, but the IMF said it expected pricing pressure to moderate in 2009.
That suggests the European Central Bank "can afford some easing of the policy stance" after keeping interest rates on hold since June 2007, the IMF said.
"Similarly, while high inflation remains a concern in the United Kingdom, the deterioration in the outlook for activity should alleviate inflation pressures and provide room for further monetary policy easing," the IMF said.