By DAVID McHUGH, Associated Press
FRANKFURT, Germany — Europe is searching for something to get growth going again and pull the eurozone's heavily indebted countries out of their troubles — but with little luck.
Unemployment and manufacturing indicators suggest the 17 countries that use the euro are headed for a recession. Adding to these worrying signs is the realization that many of the traditional tools to give growth a shove — government spending, tax cuts and lower central bank interest rates — are off the table.
The absence of growth will be a big concern for European Central Bank President Mario Draghi and the bank's governing council when they meet Wednesday to decide the eurozone's benchmark interest rate. No change in the rate — which is at a record low of 1 percent — is expected this time around.
A recent round of economic indicators will be prominent in the governing council's minds when it meets. On Monday, the Markit index of industrial activity for the eurozone strongly suggested that the region's economy is still contracting after shrinking 0.3 percent in the last three months of 2011. Two straight quarters of falling output are a common definition of recession. Meanwhile, unemployment across the 17-country group crept up to a record 10.8 percent, official figures also released on Monday showed. And national jobless rates paint an even more disturbing picture — especially among the countries hit worst by the debt crisis: Spain at 23.6 percent unemployed, Greece 21.0 percent, Ireland 14.7 percent.
The European Union's executive commission estimates that the eurozone economy will shrink by 0.3 percent this year, while Greece faces shrinkage of 4.4 percent in the fifth year of a deep recession. Italy faces a 1.3 percent drop in output according to commission forecasts while Spain will fall 1.0 percent.
Short-term answers are scarce. The debt crisis hitting the eurozone means governments can no longer spend their way out of a downturn— in fact, they are doing the opposite and embarking on rounds of austerity cuts.
On top of this, the ECB is restrained from cutting interest rates by the eurozone's stubbornly high inflation rate, which has been pushed up by oil prices and some taxes to an annualized 2.6 percent. The ECB is concentrating on getting price increases down to under 2 percent. Lowering interest rates tends to push inflation up.
The region could even face the prospect of so-called "stagflation" — a period of no or very little economic growth accompanied by inflation — according to Carsten Brzeski, an economist at ING.
"The fact that the recovery of the eurozone economy would be slow and bumpy was already clear," Brzeski wrote in a note to investors.
"Now, high energy prices have even increased the risk of stagflation in the eurozone, a worst-case scenario which should cause concern at the Eurotower in coming months" — a reference to the ECB's Frankfurt skyscraper headquarters.
Brzeski adds that the stubborn inflation rate meant that "further rate cuts should be off the table".
Another weapon in the ECB's arsenal has also been put beyond use. The €1 trillion program of "all-you-can-eat" loans to banks in December and February did manage to take some heat off the debt crisis that was crippling governments including Spain and Italy. Some banks used the cheap money to snap up government debt that paid a higher interest rate. The program has helped lower costs at which governments borrow on the financial markets and stopped the economic malaise from becoming much deeper.
But the ECB loans are seen as a stopgap at best. The bank is currently in a holding pattern before it can start further, similar, measures as it waits to see whether that money finds its way through to loans to businesses and the wider economy.
The problem remains: Countries that don't slash spending risk being unable to borrow money from bond investors because the borrowing costs set by those investors — the so-called yields — are too high. Once they are of cut off from the bond market by prohibitively high yields, a bailout is the only alternative to default. Greece, Ireland and Portugal have already been forced to seek help from the other eurozone member countries and the International Monetary Fund.
Spanish and Italian yields were hitting dangerously high levels around 7 percent late last year before the ECB stepped in with its cheap loans. The countries' yields dropped to more manageable levels, but are beginning to creep up again. Spanish 10-year bond yields edged up to 5.42 percent on Tuesday, from under 5 percent a month ago. Italy's 10-year bonds yielded 5.15 percent, also up from under 5 percent last month.
The solution to the debt crisis, eurozone officials, the ECB and economists all say, is structural reforms to make indebted countries more business-friendly by slashing regulation and eliminating costly restrictive labor practices.
As the European economy gets bigger, the relative size of its debt pile shrinks, and higher tax revenues and stronger finances reassure bond investors — so they will loan money at affordable rates.
But those changes to labor markets take time to win approval in parliaments — often against resistance from labor and business special interests. Then they may take years to show results in terms of higher growth.
"The kind of structural reforms that we are talking about will take five, six, seven years to really have a full impact," said Guntram Wolff, deputy director of the Bruegel research institute in Brussels.
For short-term growth, aside from the ECB loans, "we really don't have a story there," Wolff warns.
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