Eurozone outlook still subdued

An interesting piece put out last week by the three leading European economic institutes signaled that the 16-nation economy will remain in a recession through the end of the year, but the steepest declines in economic activity are over.

The report said that GDP dropped 2.5% quarter-over-quarter (q/q) in 1Q, after a fall of 1.8% in 4Q 2008. Economic prospects remain subdued, but the contraction of activity is likely to be less sharp in the coming quarters. Real GDP is forecast to shrink by 0.6% q/q in 2Q and by 0.4%, respectively, in 3Q and 4Q.

The fall in industrial production is likely to continue but at a progressively slowing pace: recent business surveys indicate an improvement in production sentiment but the "economic environment remains unsupportive."

With inflation well below the European Central Bank's target of "close to but below 2%," and the key lending rate still stubbornly stuck at 1.0%, central bankers in Europe still have room to cut as worries remain about how the major bank's will weather the recession next year. Another words, the ECB could be more supportive.

Inflation, which is its sole focus based on its mandate, is expected to rise to 1.0% by the end of the year, up from -0.1% currently. Yes, there is plenty of room to relax policy even more.