BRUSSELS (Reuters) - Any new shocks could halt the euro zone's economic recovery, spoil improving market sentiment and eventually tip the region into deflation, the International Monetary Fund warned on Monday.
The euro zone economy has been growing for a year, but its expansion remains too weak to compensate for the preceding two years of recession across the 18 countries that share the euro. Nor can it yet make inroads into record-high unemployment.
"With limited policy space in the near term, further negative shocks - either domestic or external - could sour financial market sentiment, halt the recovery, and push the economy into lower inflation and even deflation," the Fund wrote in a regular report.
News last week of irregularities at a web of family-held holding companies behind Portugal's largest listed bank, Banco Espirito Santo (BES.LS), pushed up borrowing costs for some euro zone countries and revived memories of the region's debt crisis.
The IMF said the euro zone's recovery remained too weak after the efforts of member governments to reform, the European Central Bank's action to spur growth and a clean-up of the financial sector.
A report on Monday showed euro zone industrial production dropped in May, underscoring the fragility of recovery. The IMF urged the euro zone to support economic demand, complete a reform of the banking sector known as banking union and advance structural reforms.
"With the economic recovery taking hold and financial markets rallying, additional progress on reforms may be prone to reform fatigue - both at the national and euro area level," the Fund said.
REBOUND TOO FRAIL, INFLATION TOO LOW
Real economic activity in the bloc has yet to reach pre-crisis levels and inflation remains worryingly low, the IMF warned. It cautioned governments not to cut spending further if growth stumbles.
"The broadly neutral overall fiscal stance is appropriate but any negative growth surprises should not trigger additional consolidation efforts as this would be self-defeating," the Washington-based body said.
The strength of the 9.6 trillion-euro economy's recovery in the first quarter was disappointing, hurt by poor performance in Italy, the Netherlands and France.
Recent weak data from Germany, the region's growth engine, further cloud the outlook. IMF said higher inflation and a weaker euro, currently seen by the IMF as broadly in equilibrium, would help buoy the economy.
Euro zone's consumer price inflation has been stuck below 1 percent since October, and the ECB has repeatedly made clear that it was ready to act if consumer prices stayed too low for too long or tipped into deflation.
"They remain low even in the core. Energy and food price developments, euro appreciation, and structural reforms have contributed to disinflationary pressures but cannot fully explain them," the Fund said Some analysts said recent economic bumps were unlikely to be more than noise.
"We expect a re-acceleration in economic activity in late Q2 (strong rebound in June), but the pace of improvement on a quarterly average basis is likely to have been a bit weaker than originally expected, and below that indicated by the business surveys," UniCredit wrote in its updated 2014/2015 euro zone outlook.
The euro zone's GDP growth flash estimate for the second quarter is due on Aug. 14. In a separate report, the IMF's analysts said that should the ECB deploy quantitative easing - in effect, printing money through a sustained expansion of a central bank's balance sheet - it must ensure all euro zone countries benefit rather than just big members.
"If inflation remains too low the ECB should consider a substantial balance sheet expansion, including through asset purchases," the Fund said.
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The euro zone economy has been growing for a year, but its expansion remains too weak to compensate for the preceding two years of recession across the 18 countries that share the euro. Nor can it yet make inroads into record-high unemployment.
"With limited policy space in the near term, further negative shocks - either domestic or external - could sour financial market sentiment, halt the recovery, and push the economy into lower inflation and even deflation," the Fund wrote in a regular report.
News last week of irregularities at a web of family-held holding companies behind Portugal's largest listed bank, Banco Espirito Santo (BES.LS), pushed up borrowing costs for some euro zone countries and revived memories of the region's debt crisis.
The IMF said the euro zone's recovery remained too weak after the efforts of member governments to reform, the European Central Bank's action to spur growth and a clean-up of the financial sector.
A report on Monday showed euro zone industrial production dropped in May, underscoring the fragility of recovery. The IMF urged the euro zone to support economic demand, complete a reform of the banking sector known as banking union and advance structural reforms.
"With the economic recovery taking hold and financial markets rallying, additional progress on reforms may be prone to reform fatigue - both at the national and euro area level," the Fund said.
REBOUND TOO FRAIL, INFLATION TOO LOW
Real economic activity in the bloc has yet to reach pre-crisis levels and inflation remains worryingly low, the IMF warned. It cautioned governments not to cut spending further if growth stumbles.
"The broadly neutral overall fiscal stance is appropriate but any negative growth surprises should not trigger additional consolidation efforts as this would be self-defeating," the Washington-based body said.
The strength of the 9.6 trillion-euro economy's recovery in the first quarter was disappointing, hurt by poor performance in Italy, the Netherlands and France.
Recent weak data from Germany, the region's growth engine, further cloud the outlook. IMF said higher inflation and a weaker euro, currently seen by the IMF as broadly in equilibrium, would help buoy the economy.
Euro zone's consumer price inflation has been stuck below 1 percent since October, and the ECB has repeatedly made clear that it was ready to act if consumer prices stayed too low for too long or tipped into deflation.
"They remain low even in the core. Energy and food price developments, euro appreciation, and structural reforms have contributed to disinflationary pressures but cannot fully explain them," the Fund said Some analysts said recent economic bumps were unlikely to be more than noise.
"We expect a re-acceleration in economic activity in late Q2 (strong rebound in June), but the pace of improvement on a quarterly average basis is likely to have been a bit weaker than originally expected, and below that indicated by the business surveys," UniCredit wrote in its updated 2014/2015 euro zone outlook.
The euro zone's GDP growth flash estimate for the second quarter is due on Aug. 14. In a separate report, the IMF's analysts said that should the ECB deploy quantitative easing - in effect, printing money through a sustained expansion of a central bank's balance sheet - it must ensure all euro zone countries benefit rather than just big members.
"If inflation remains too low the ECB should consider a substantial balance sheet expansion, including through asset purchases," the Fund said.
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