11/10/2011 04:41 EST | Updated 01/09/2012 05:12 EST

EU slashes eurozone growth forecast to 0.5 pct, warns of possible recession

BRUSSELS - The European Union warned Thursday that the 17-country eurozone could slip into "a deep and prolonged recession" next year as the debt crisis shows alarming signs of spinning out of control.

The EU's economic watchdog, the European Commission, said its central forecast is that the eurozone will grow by only a paltry 0.5 per cent in 2012. That's way down on the 1.8 per cent prediction it made in the spring.

"This forecast is in fact the last wake-up call," the EU's Monetary Affairs Olli Rehn warned. "Growth has stalled in Europe, and there is a risk of a new recession."

The warning is the first acknowledgment of the possibility of a double-dip recession in Europe, a development that could hit the global economy hard. The Commission said "a deep and prolonged recession complemented by continued market turmoil cannot be excluded," given the uncertainty over whether countries will implement spending cuts and reforms.

The sharp cut in the forecast comes as the eurozone's debt crisis has spread to Italy, the single currency bloc's third-largest economy. The interest rate on Italy's 10-year bonds has reached the same 7 per cent level that eventually forced Greece, Portugal and Ireland to request multibillion euro bailouts.

Speculation Premier Silvio Berlusconi will be replaced by leading economist and former Commissioner Mario Monti once he officially resigns has helped calm the market mood somewhat Thursday, but interest rates remain much higher than just a week ago.

And although Greece named Lucas Papademos, former vice-president of the European Central Bank, as interim prime minister, there are still doubts whether the country sustain its massive debt in the long run.

The Commission's half-yearly predictions also warned that unemployment in the EU would be stuck at 9.5 per cent for the foreseeable future. That's even higher than the 9 per cent rate in the U.S.

"While jobs are increasing in some member states, no real improvement is forecast in the unemployment situation in the EU as a whole," Rehn said.

The report also contained some worrying figures for some individual member states.

Italy is unlikely to fulfil its promise of balancing its budget by 2013 if recently promised austerity and reform measures aren't implemented. According to the forecast, which does not take into account the most recent promises, Italy will still run a deficit of 1.2 per cent, with debt close to 119 per cent of economic output. And growth is set to slow to 0.1 per cent next year, down from 1.3 per cent forecast this spring.

Berlusconi has come under so much pressure that he promised to resign as soon as the new budget has been passed. The Commission this weeks started a verification mission in Rome to check on Italy's efforts. The International Monetary Fund is due to follow soon.

Rehn said Italy's most important task in Italy was to restore political credibility and effective decision making.

He added that because of the relatively long average maturities of Italy's debt, the country could sustain the recent jump in borrowing costs for a short time.

Several other states that have so far not been caught up in the debt storm will soon risk sanctions under new EU spending rules if they don't implement additional measures to get their budgets control, Rehn warned.

"What we need now is unwavering implementation," Rehn said. "On my part, I will start using the new rules of economic governance from day one."

The countries that may face sanctions first are the eurozone nations of Belgium, Cyprus, and Malta, as well as Hungary and Poland, which do not use the euro.

Under the new rules, set to come into force in mid-December, sanctions for countries that break the caps on budget deficits and debt levels become more automatic, in an effort to prevent a worsening of the debt crisis.