Outlook for euro zone strugglers darkens further

The fortunes of the euro zone's most vulnerable economies have darkened markedly since June, according to a Reuters poll of economists that showed Spain will apply for an EU bailout within months.

Forecasters polled this week slashed their 2013 economic outlook for Greece, Portugal and Spain, and said they will all fail to achieve budget deficit targets agreed with the European Commission.

Among the struggling euro zone peripheral economies, only Ireland looks on course for a return to modest growth any time soon.

While the survey pointed to a reduced likelihood Greece will exit the euro zone soon, it also underlined why Spain is the new focal point of the bloc's sovereign debt crisis.

Its economic woes - with spiralling unemployment topping the list - have further to run.

"As Spain is stuck in a deep recession, markets will continue to have doubts on the medium-term solvency of Spain," said Gernot Griebling, head of bond research at LBBW in Stuttgart.

"As a consequence Spanish (government bond) yields and the corresponding spreads over Bunds will stay high or even climb further."

Spanish Prime Minister Mariano Rajoy last week inched closer to asking for an European Union bailout for his country, where government borrowing costs have failed to recede much from near-unsustainable levels.

Economists said there was a median 68 percent chance of a full sovereign bailout, involving the EU's official rescue funds, before the end of the year. June's poll showed 35 out of 59 economists thought that was "likely" or "very likely".

ECB President Mario Draghi last week signalled it was preparing to buy Spanish and Italian bonds, but only after EU bailout funds were triggered and countries had asked for help.

The poll suggested Spain's economy will contract 1.6 percent this year and then 1.1 percent in 2013 - the latter forecast representing a sharp downgrade from the 0.7 percent decline in June's survey.

The unemployment rate, which at 24.6 percent in the second quarter hit its highest level since the Franco dictatorship ended in the mid-1970s, has further to climb.

The poll showed it ending this year at 25 percent, and next year at 25.6 percent.

The euro zone's No.3 economy will also fall further behind on its budget deficit targets, even in light of euro zone ministers last week granting Madrid an extra year until 2014 to reach its goals.

While it will come close to meeting this year's budget deficit target of 6.3 percent of gross domestic product, the shortfall will only shrink to 5.0 percent in 2013, short of the 4.5 percent target, the poll showed.

Dismissing the drachma

There was a strong consensus that Greece will remain in the euro zone over the next 12 months, with 45 out of 64 economists in agreement - a stronger majority than the 35 of 64 in June's poll.

"We would expect the euro zone to strive to keep Greece in the euro as long as it proceeds with reforms. However, there is a tail risk of an uncontrolled exit, in the case official funding is cut," said Marcus Sonntag, economist at Merrill Lynch.

Still, the poll showed Greece faces vast challenges in escaping its depression, as analysts downgraded their GDP outlook for the fifth time in a row.

The economy will shrink around 6.6 percent this year and then 2.0 percent next year, much worse than June's poll which pencilled in declines of 5.8 percent and 1.3 percent, respectively.

"The stabilisation of economic sentiment from its current weak fragile state will require a more constructive stance from EU partners, especially regarding the targeted speed of fiscal adjustment," said Nicholas Magginas, economist at the National Bank of Greece.

Indeed, economists see slow progress on Greece's budget deficit. It will shrink from last year's 9.3 percent to 8.0 percent this year, compared with its target of 7.3 percent, and just 6.8 percent in 2013.

That would put Athens well off-track from its aim of getting the deficit below 3 percent by the end of 2014 from 9.3 percent in 2011.

Portugal too suffered a cut to its outlook for next year. After shrinking 3.0 percent this year, the Portuguese economy is expected to decline around 1.0 percent in 2013, compared with a 0.6 percent contraction in the last poll.

Similarly, it looks unlikely to meet its target of cutting its budget deficit to 3.0 percent in 2013, with the poll instead showing it at 3.7 percent by the end of next year.

Ireland at least looks on track to return to modest economic growth, starting with 0.3 percent this year and quickening to 1.5 percent next year.

That would put it more in line with the outlook for Europe's bigger and more resilient economies.

And unlike its peripheral peers, Ireland looks likely to beat its deficit target of 8.6 percent this year, with the poll suggesting it will come in at 8.3 percent of GDP.

The findings backed up a separate poll of economists on Wednesday, which showed Ireland will benefit from stronger exports.

Source: Reuters