European Commission Upbeat About 2010

The European Commission released new forecasts Tuesday that generally upgraded its outlook for the first time in two years. On Thursday, the ECB staff will provide updated forecasts, as well.

The EC now expects the euro zone economy to expand by 0.7% next year. Previously it thought the region's economy would contract by 0.1%. The IMF is less sanguine and forecasts a 0.3% expansion next year, half of what the EC envisions. The EC places this year's contraction at 4%, while the IMF sees it a tad deeper at -4.2%. The EC sees unemployment rising to 10.7% in 2010 and the 10.9% in 2011. Here too, the IMF is less confident and has forecast unemployment to rise toward 11.7% in 2011.

The EC forecasts inflation to rise from 0.3% this year to 1.1% next year, and 1.5% in 2011. The ECB had seen inflation at 0.4% this year and 1.2% next.

All euro zone members are expected to run budget deficits in excess of the 3% cap, with the deficit for the area averaging just shy of 7%. The EC wants countries to introduce fiscal consolidation measures in 2011.

Separately, some observers are highlighting the fact that there is a shift taking place in the sovereign credit default swap space where cost of insurance against an Irish default has fallen below Greece. The Irish government is talking about cutting spending next year by four billion euros and trying to keep the deficit below 12% of GDP. The EC does not expect that. Next year's Irish budget is expected to be unveiled on Dec 9. Meanwhile the new government in Greece is projecting this year's deficit to be twice what the outgoing government claimed and this has spurred concern from at least one rating agency.

In the past month, benchmark 10-year Greek bond yields have risen 15 basis points while the 10-year Irish bond yield has fallen 8 basis points. Nevertheless Irish 10-year yields are still about 7 basis points above Greece.

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