EU Commission cuts euro zone growth forecast, sees muted inflation

By Jan Strupczewski

BRUSSELS (Reuters) - The euro zone economy is likely to grow slower than earlier expected this year and next, the European Commission forecast on Thursday, because of global trade conflicts, geopolitical tensions and Brexit.

The Commission cut its growth forecast for the 19 countries that share the euro to 1.1% this year from 1.2% it expected in July, and to 1.2% in 2020 and 2021 from 1.4%.

"Economic growth has continued, job creation has been robust and domestic demand strong. However, we could be facing troubled waters ahead: a period of high uncertainty related to trade conflicts, rising geopolitical tensions, persistent weakness in the manufacturing sector and Brexit," Commission Vice President for the euro Valdis Dombrovskis said.

"I urge all EU countries with high levels of public debt to pursue prudent fiscal policies and put their debt levels on a downward path. On the other hand, those Member States that have fiscal space should use it now," he said.

The Commission forecast the euro zone's aggregate budget deficit would rise from an historic low of 0.5% of GDP in 2018 to 0.8% this year, 0.9% in 2020 and 1.0% in 2021, unless policies change.

But pressure for higher fiscal stimulus is mainly on Germany and the Netherlands, referred to as countries that have fiscal space, because both have been running large budget surpluses for years and both of which have low public debt.

Germany is to have a budget surplus of 1.2% of GDP this year and 0.6% in 2020, while the Netherlands is to have a surplus of 1.5% this year and 0.5% next year.

Despite the slower GDP growth, the euro zone's aggregate public debt-to-GDP ratio is to continue declining for the fifth year in a row to 86.4% this year, 85.1% in 2020 and 84.1%

in 2021.

The Commission sees euro zone inflation, which the European Central Bank wants to keep below, but close to 2 percent over the medium term, at 1.2% this year and next, rising to 1.3% in 2021 -- still well below the ECB's target.

"Inflation ... slowed so far this year due to the fall in energy prices and because firms have largely chosen to absorb the cost of higher wages in their margins rather than pass them on to customers," the Commission said.

"Inflationary pressures are expected to remain muted over the next two years," it said.

(Reporting By Jan Strupczewski)