The euro zone will not return to growth until 2014, the European Commission said today.
The Commission reversed its prediction for an end to recession this year and blamed a lack of bank lending and record joblessness for delaying the recovery.
The euro zone economy, which generates nearly a fifth of global output, will shrink 0.3% in 2013, the Commission said.
This means the euro zone will remain in its second recession since 2009 for a year longer than originally thought.
The Commission, the EU executive, late last year forecast 0.1% growth in the euro zone's economy for 2012, but now says tight lending conditions for companies and households, job cuts and frozen investment have delayed an expected recovery.
The Commission sees the euro zone economy growing 1.4% in 2014, with a figure of -0.6% for 2012.
"The improved financial market situation contrasts with the absence of credit growth and the weakness of the near-term outlook for economic activity," said Marco Buti, the commission's director-general for economic and monetary affairs.
"The labour market is a serious concern," he said, in a preamble to the Commission's latest forecasts.
The European Central Bank's promise last year to do what it takes to defend its common currency has removed the risk of a break-up of the euro zone, and member countries' borrowing costs have come down from unsustainable levels.
But the damage from the 2008/2009 global financial crisis and the ensuing euro zone debt crisis has been greater than expected on the real economy, with global demand for euro zone exports one of the few saviours in terms of generating growth.
Joblessness in the euro zone is set to peak at 12.2%, or more than 19 million people, in 2013, the Commission said, and both private and public consumption will not make any contribution to improving output, instead dragging on the economy.
The outlook raises the prospect of further interest rate cuts by the ECB to jump-start the economy by reducing the cost of lending for companies and families, although with banks reluctant to lend, any impact may be muted.
Consumer inflation is forecast by the Commission to be 1.8% for 2013, and with such pressures contained the ECB may feel more comfortable cutting rates to below the current 0.75% level.
The Commission's overall view is a little more pessimistic than that of the International Monetary Fund, which sees a 0.2% euro zone contraction this year. The ECB previously cut its estimate of euro zone gross domestic product (GDP) for next year to between a fall of 0.9% and growth of just 0.3%.
"A weaker-than-expected final quarter of 2012 is set to shift the inception of the recovery towards mid-2013," the Commission said.
Euro zone budget gap to fall despite recession
Most euro zone countries will reduce their budget deficits this year but some, like Spain, will badly miss agreed targets, European Commission forecasts showed today.
France and Portugal will also miss their debt targets, the EU's executive said. All three countries have already indicated as much and will now hope for more leeway from Brussels.
The European Union executive said the euro zone economy would shrink 0.3% in 2013 after a 0.6% recession last year, but the aggregated budget deficit will fall to 2.8% of GDP from 3.5%.
The euro zone is consolidating its public finances to regain market trust after excessive government spending, property bubbles and lack of competitiveness triggered a sovereign debt crisis that sent the euro zone into recession.
Under EU budget rules, sharpened at the peak of the crisis in late 2011, euro zone countries can face fines if they fail to take action to meet deficit reduction targets set by EU finance ministers.
Progress has been uneven among the 17 countries sharing the euro. The main laggard was Spain, which badly missed the 6.3% of GDP deficit target for 2012 with a result of 10.2%. Even excluding money the government spent on recapitalising banks, the 2012 deficit is still well above target at 7% of GDP.
This year, Madrid will have a deficit of 6.7% rather than the 4.5% set for it by EU finance ministers. And unless policies change, Spain will have a gap of 7.2% in 2014 against the target of 2.8%, the Commission said.
Euro zone countries whose economies perform much worse than expected can count on an extension of deficit deadlines. But they need to show that while they missed the nominal deficit target because of recession, they have still cut the structural deficit, which strips out the effects of the economic cycle and one off effects.
The euro zone's second biggest economy France will also miss its nominal deficit targets - this year's shortfall will be 3.7% rather than the 3% agreed with the EU. But Paris almost hit its deficit target last year with a 4.6% gap against a goal of 4.5% and its growth was clearly weaker than expected with the economy stagnating last year and expected to barely grow this year.
Also, France cut its structural deficit by 1.2% in 2012 to 3.3% and will cut it again to 2% this year.
Portugal, which had to be bailed out by the euro zone and the International Monetary Fund in 2011, called for more time to reduce its deficit earlier this week. Commission forecasts showed Lisbon's headline budget deficit rose to 5% of GDP last year from 4.4% in 2011 and will only ease to 4.9% this year, unless policies change.
The EU executive will only decide on whether to grant governments more time for adjustment, or step up punitive action, when more detailed figures are available in May.
Italy's 2013 recession to be worse than expected
The European Commission today forecast that Italy's recession would be worse this year than previous estimates showed, underlining the scale of the challenge facing the government to be elected this weekend.
Italy's economy will shrink 1% in 2013, the EU's winter forecast said, double its November estimate of a 0.5% fall. This compares to a forecast of a 0.3% decline for the euro zone, showing Italy continues to lag its partners.
Austerity-weary Italians vote this weekend for the successors of a technocrat government led by economist Mario Monti, which introduced taxes and spending cuts to pull Italy from the brink of a Greek-style financial meltdown.
The commission's forecast is in line with Bank of Italy estimate that also sees a fall of 1% of GDP this year, but is more pessimistic that the government's forecast for a 0.2% decline in GDP this year.
The commission also hiked its unemployment forecasts for the country, predicting the unemployment rate would rise to 11.6% this year and 12% in 2014.