US downturn and trouble in financial markets will sharply reduce economic growth in Europe and push it below potential in mature Western European economies for some time, the International Monetary Fund said today.
In a report on Europe, the IMF maintained the main forecasts and policy prescriptions it made earlier this month in its World Economic Outlook, including that the European Central Bank and Bank of England can cut interest rates to shore up growth.
"Even though Europe faced the financial turbulence from a position of strong fundamentals, spillovers from the expected mild recession in the United States, the global reassessment of risks, and the strains in the financial system are sapping its economy's strength," the IMF report on Europe said.
It predicted a significant slowdown in Western Europe and a less marked deceleration in the central and eastern part of the continent, where it said the central banks of many countries , among them Russia, needed to tighten rates further.
"The baseline outlook is for a relatively soft landing, with projected growth rates for most of the region remaining close to IMF staff estimates of potential growth," the report said of the economies of central and eastern Europe.
"More specifically, growth is expected to slow from 6.9 per cent in 2007 to 5.5 per cent in 2008, and soften somewhat further in 2009. Headline inflation is expected to come down in the second half of 2008 as food and commodity prices moderate.
As for Western Europe, the IMF, whose stance many European governments have called overly pessimistic, said: "Growth in the advanced European economies is expected to decline by 1-1/4 percentage points to 1.5 per cent in 2008, well below potential growth, and to weaken further in 2009."
The report said the ECB had appropriately kept interest rates on hold through the end of March but should now stand ready to respond flexibly to changes in the economic climate. "The ECB can afford some easing of the policy stance," it said.
Michael Deppler, head of the European economics department at the Washington-based IMF, held a news conference to present the report in Frankfurt where he acknowledged inflation figures had got worse in recent weeks. He slightly qualified the IMF's recommendation on ECB monetary policy.
"We're not saying cut now, but in our view these shocks are transitory and once we go beyond these shocks to commodity prices and energy prices and their implications for headline rates, and we get through the German spring wage round, the room for easing will increasingly emerge," said Mr Deppler.
The IMF report saw room for the Bank of England to cut too.