EU to stick to tough budget cuts, may consider small leeway

BRUSSELS/MADRID (Reuters) - A darkening economic horizon may persuade the EU to give countries such as Spain softer deficit targets but there will be no let-up in the overall austerity drive as the continent struggles to draw a line under its two-year debt crisis.

The European Commission will release its latest 2012 and 2013 forecasts for the 27-nation bloc on Thursday. Sources believe it will show a steep fall in activity and kick off a new debate among member states about revising agreed targets for this year and next.

One senior European official with direct knowledge of the matter told Reuters existing deficit goals would look increasingly unattainable and would likely be changed when the EU executive publishes another round of forecasts on May 11.

"The (European) Commission doesn't want to look ridiculous by insisting on unrealistic targets so it will have to make some adjustments," said the official.

According to three other senior sources, the Commission could allow member states to exceed by a few decimals their targets for 2012 but stick to the objective for 2013, the date agreed by most countries to bring back their deficits below the limit of 3 percent of the GDP permitted by EU rules.

Alternatively, it could decide to give member states an extra year, until 2014, to reach this limit after updating its November predictions of 0.5 percent growth this year and 1.5 percent next.

In recent weeks, several countries, including Italy and Spain have questioned openly - or quietly - the German-led austerity drive and called for a more balanced approach between tough spending cuts and measures to boost their stricken economies and fight unemployment.

EU leaders discussed the issue at a summit in January and on Monday Britain, the Netherlands, Italy, Spain and eight other countries said the euro zone should try to concentrate on reviving growth in a bloc that produces 16 percent of global economic output rather than slavishly cutting debt.

The focus is on Spain after the government, blaming its Socialist predecessor, announced in December that the budget deficit would reach 8 percent of GDP or more in 2011, way above previous forecasts.

While, in public at least, Madrid maintains for now that it will reduce the deficit to 4.4 percent this year, the growth outlook makes that highly unlikely.

One of the sources said Spain and others were hopeful the Commission would show "understanding" as many European economies are falling back into their second recession in three years but cautioned he expected only a "small or very small" revision.

Spanish newspaper El Pais reported on Wednesday that Prime Minister Mariano Rajoy would ask Brussels for Spain's target to be raised to above 5 percent of gross domestic product from 4.4 to avoid a negative impact on growth and unemployment.

Rajoy and his economy minister, Luis de Guindos, had talks last Tuesday with Jose Manuel Barroso, the president of the Commission, and Olli Rehn, the EU commissioner for Economic and Monetary Affairs, after Reuters reported the EU executive was likely to take action against Madrid for not doing enough to curb its high deficits.

Three senior EU officials told Reuters last week that a final decision had yet to be made, but the Commission believed the new government overstated the deficit figure for 2011 so the current year's data would look better.

NO APPETITE IN NORTH

The economies of both the 17-nation euro zone and the wider 27-nation EU shrank 0.3 percent in the last three months of the year. Despite signs of stabilisation, analysts in a Reuters poll predict the euro zone will shrink 0.4 percent in 2012, returning to weak growth only in 2013.

But with a 130-billion-euro (108 billion pound) rescue for debt-laden Greece just agreed and new problems looming in Portugal, the European Commission as well as countries with a sound fiscal position are adamant the top priority should remain to cut spending.

As has become the norm within the European Union, its northern members are disinclined to cut their partners any slack.

"Will there be a discussion on deficits at the Eurogroup (of finance ministers)? Maybe, but there is little or no appetite or sympathy at all for softening the targets," said one euro zone official with direct knowledge of the situation. "Ask the Belgians or the Nordics or Germany, for instance."

Under pressure from the European Commission, Belgium agreed in January to freeze 1.3 billion euros in spending on top of 11.3 billion euros of savings already announced. It is now not willing to be lenient with its euro zone peers.

Germany, Finland, the Netherlands or Luxembourg are also reluctant to loosen the targets because they believe fiscal consolidation is a pre-condition for a sustainable growth in the future and, like the Commission, insist the euro zone crisis remains one of confidence.

"Softening the targets wouldn't help," said the official, considering that it would also undermine the credibility of the tougher rules on deficit and debt surveillance that the EU has adopted since the crisis started in late 2009.

Under the new EU rulebook a country now needs to present its budget in advance to Brussels and can face automatic sanctions and fines if it breaches the limits of a deficit-to-GDP higher than 3 percent or a debt-to-GDP higher than 60 percent.

Last month, 25 member states out of 27 went further by agreeing a rule limiting their primary deficits to 0.5 percent of their GDP on the economic cycle.

"I can't see any softening happening," said a senior euro zone official echoing comments from two others. "Having said that, we're all looking for any possible pocket of growth within the ongoing process of consolidation."

(Editing by Sebastian Moffett/Mike Peacock)