EU Says Economy Faces Substantial Impact From Crisis

By Ben Sills and Stephanie Bodoni

Dec. 19 (Bloomberg) -- The European economy may suffer a “substantial” impact from the global financial crisis next year as bank losses stymie lending, the European Commission said.

“Downsizing of banks’ balance sheets should exert a significant drag on economic growth,” the Brussels-based commission, the European Union’s executive, said today in a report. “Together with the marked deterioration in the global economy, this paves the way for a sharp cyclical downturn in the euro area.”

The economy of the nations that use the euro is already heading deeper into recession during the current quarter after the collapse of Lehman Brothers Holdings Inc. triggered a rout in stock, bond and loan markets. Manufacturing and service industries contracted at the fastest pace in a decade in December and business confidence in Germany, the region’s largest economy, dropped to the lowest since 1982.

“Quick and decisive action is needed to prevent a downward spiral,” the commission said in the report, a quarterly assessment of the euro region’s economy. “To be effective, the European fiscal response to the crisis needs to be coordinated.”

Even so, European Central Bank President Jean-Claude Trichet this week signaled policy makers may pause in January after lowering its benchmark rate by 175 basis points since October. Trichet said Dec. 16 the central bank is more concerned in ensuring that cheaper credit reaches companies and consumers than cutting its benchmark rate further.

The credit crunch has “impaired the transmission mechanism of monetary policy to output and inflation,” the commission said.

European lenders have written off almost $300 billion of assets over the past 17 months as the fallout from the collapse of the U.S. housing market roiled global markets. EU leaders have pledged to deliver 200 billion euros ($280 billion) of fiscal stimulus in a bid to keep the economy going.

To contact the reporters on this story: Ben Sills in Madrid at bsills@bloomberg.net; Stephanie Bodoni in Brussels at sbodoni@bloomberg.net.