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Euro zone growth 'to decelerate' after Brexit: IMF

The U.K.'s decision to leave the EU isexpected to weigh on euro zone growth, the International Monetary Fund (IMF)said on Friday, lowering its growth forecasts for the 19-country region.

The IMF said in its latest report on theeuro area that the U.K.'s vote to leave the European Union (EU) would hampergrowth prospects in the region, despite the single currency zone seeing astrengthening recovery recently which had been helped by lower oil prices andan accommodative monetary policy.

Euro area gross domestic product (GDP)growth is expected to decelerate from 1.6 percent this year to 1.4 percent in2017, the IMF said, "mainly due to the negative impact of the U.K.referendum outcome."

The IMF warned that inflation expectationsalso remain "very low" and below the European Central Bank'smedium-term price stability objective or around 2 percent. The IMF said thatheadline inflation is expected to increase from 0.2 percent this year to 1.1percent next year, however, helped by gradually rising energy prices.

Still, "downside risks havegrown," it said, laying out a litany of risks both within Europe andbeyond.

"Externally, a further global slowdowncould spill over and derail the domestic demand-led recovery. Domestically, therisks are largely political," the IMF noted.

"Further spillovers from the U.K.post-referendum situation, the refugee surge, or a heightening of securityconcerns could contribute to greater uncertainty, hurting growth and hinderingprogress on policies and reforms. Other risks include banking and financialsector weaknesses in some countries. Moreover, prolonged low growth andinflation themselves make the euro area increasingly vulnerable to shocks.Policy buffers to counter these risks are low," the IMF said.

'Mediocre' prospects

The medium-term prospects for the euro zonewere not much to cheer either, with the fund saying these were"mediocre" "with crisis legacies of high unemployment, elevatedpublic and private debt, and deep-rooted structural weaknesses weighing on theoutlook and productivity growth."

As a result, growth five years ahead isexpected to be about 1.5 percent, with headline inflation reaching only 1.7percent, the IMF said.

The fund said that "comprehensive andmore balanced policies taken collectively are needed to respond to these risks,helping to boost growth, rebuild buffers, and strengthen integration."

It added that structural reforms to improveproductivity and reduce macroeconomic imbalances, many of which have beenencouraged in the euro zone following financial bailouts, need to beincentivized.

"Given limited fiscal space at thenational level, an expansion of centralized fiscal support is needed, butshould be accompanied by a stronger governance framework to ensure that memberscomply with the fiscal and structural rules. These measures would complementthe current stance of monetary policy, providing a more balanced policymix."

The IMF's remarks come at a difficult timefor the European Commission that is trying to get euro zone members to stick tobudget deficit rules – which state that deficits must not exceed 3 percent ofGDP – while remaining wary of rising anti-EU sentiment and continuing economicpressures on countries still in recovery mode following the financial crisis.

Spain and Portugal have breached deficitrules despite being given some leeway to meet targets and on Thursday, theCommission determined that the countries had not taken "effectiveaction," as Commission Vice President Valdis Dombrovskis said in astatement, to bring their budget deficits within EU limits.

The Commission concluded that Portugal didnot correct its excessive deficit by the deadline of 2015 and that Spain is offtrack to correct it by the 2016 deadline. "For various reasons, thewindfalls from higher growth and lower interest rates were insufficiently usedto reduce deficits and debt," Dombrovskis said. The Commission said it hadbegun formal disciplinary procedures against both countries for their excessivedeficits, which may lead to fines being levied against them.

Against this challenging backdrop, the IMFurged "strong collective actions to boost growth and strengthen the union,and cautioned that the cyclical recovery should not lead to complacency.Policies should prioritize structural reforms, enhancing investment and fiscalgovernance, maintaining supportive monetary policies, completing the bankingunion, and repairing balance sheets. (IMF) Directors warned that withoutdecisive actions, the euro area will remain vulnerable to instability andrepeated crises of confidence."