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Italy and France to lag Germany in euro zone recovery

Vice-President of the European Commission Olli Rehn speaks during the event hosted in honour of the Euro introduction in Latvia in Riga Janu
Vice-President of the European Commission Olli Rehn speaks during the event hosted in honour of the Euro introduction in Latvia in Riga Janu

By John O'Donnell and Robin Emmott

BRUSSELS (Reuters) - Germany is set to accelerate away from France and Italy in 2014 as the fragmented euro zone economy gradually recovers from its worst crisis, the European Commission said on Tuesday.

In a departure from the gloom of recent years, Brussels slightly increased its growth prediction for the bloc's 9-trillion-euro economy to 1.2 percent in 2014 from an earlier 1.1 percent.

It was powered chiefly by an expected 1.8 percent jump in the euro zone's biggest economy Germany.

The statistics also made clear the scale of the challenge facing Italy and its new prime minister, Matteo Renzi, in turning around the bloc's third-largest economy. The Commission predicts meager growth of 0.6 percent this year.

No.2 economy France is expected to grow 1 percent in 2014.

For the bloc as a whole in 2015, the commission raised its forecast slightly to 1.8 percent.

"Recovery is gaining ground," said Olli Rehn, the EU commissioner in charge of economic policy. "The worst of the crisis may now be behind us," he said, cautioning, however, that the recovery was "still modest".

The improving growth outlook will relieve the European Central Bank, but policymakers there will also have to grapple with forecasts showing persistently low inflation and no significant drop in the region's record unemployment rate.

Meanwhile, the economic output figures outline how Europe still lags the United States. The U.S. economy is expected to grow by around 3 percent in 2014, buoyed by a massive money printing program that the ECB has been unable to emulate.

The figures draw a clear dividing line in the euro zone between southern countries such as Greece, struggling economically and arguing for more freedom to spend, and Germany, buoyed by strong exports and determined to enforce thrift.

Paul De Grauwe, an economist with the London School of Economics, blamed Germany for hampering the ECB and said the time had come for the central bank to act following its creation of a special emergency program to buy state bonds through outright monetary transactions, known as OMT.

"They need to take some risks," he said. "The ECB has been bold once when they announced OMT but since that it has done nothing.

"The Germans are afraid of their own shadow. The U.S. has been willing to go further in stimulating the economy. As a result, growth has accelerated," he said.

ECB President Mario Draghi has less freedom, however. Under its statutes, the bank is banned from buying bonds directly from governments, although it can find ways to buy them from banks, for example, on the open market or accept them as security in return for finance.

Some in the market expect the ECB's next move could be to offer a further round of cheap, long-term loans to banks.

Complicating the picture further for the ECB, the Commission sees consumer price inflation at well below the central bank's target of just below 2 percent. Inflation is likely to be 1 percent in 2014 and 1.3 percent next year.

MISSED GOALS

Whatever the modest improvement in economic outlook, unemployment will barely budge from record highs of 12 percent in 2015, according to the EU executive.

Here again, there is a stark contrast between Germany, with unemployment of just over 5 percent, and Spain, where one in four is unemployed.

"We know how difficult the situation remains in many member states, especially with unemployment and youth unemployment so high," European Commission President Jose Manuel Barroso told the European Parliament.

The problem of modest economic growth and high unemployment is compounded by the debts of Europe's top economies.

While Berlin will not spend more than it taxes, reaching a balanced budget this year and next, Madrid will see its budget deficit rise in 2015 to 6.5 percent of economic output, unless it deepens some of the toughest spending cuts in a generation.

That raises doubts about Prime Minister Mariano Rajoy's promises to cut income taxes as of next year, when a general election will be held. Spain is far from meeting the EU ceiling on deficits of 3 percent.

In the Commission's outlook, France too will miss a goal to reduce its deficit below 3 percent despite being given two extra years to meet this target. The Commission predicted a shortfall of 4.0 percent this year and 3.9 percent in 2015.

President Francois Hollande's government is hoping that the recovery will help it cut the public deficit, although the national audit office has said this is optimistic.

Economists doubt the wisdom of restricting spending at a time of weak growth. "There has been this narrative in Germany that in times of crisis you need to spend less," said De Grauwe. "But we should not be spending less."

(Additional reporting by Leigh Thomas in Paris; Editing by Jeremy Gaunt, John Stonestreet)

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