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Citi Says Euro Crisis to Escalate; Cuts Global Forecast

The crisis in the euro zone will escalate in 2012, economists at Citi said on Tuesday, sending the countries that share the euro into recession next year and resulting in no more than “modest but sustained growth in the U.S. and still relatively strong – albeit slowing – growth in Asia."

In its sixth consecutive monthly downgrade, Citi cut its 2012 global growth forecast and now expects global growth to slow from 4.2 percent in 2010 and about 3.0 percent in 2011 to 2.5 percent in 2012.

For 2013, it expects “a modest reacceleration in global growth”, to 3.1 percent.

“The hangover from the pre-recession credit boom will continue to cast a deep shadow across industrial country growth in 2012 and beyond," Citi said in a note.

It pointed out that global growth would be led by Asia.

“Our base case is that the EMU (European Monetary Union) sovereign crisis will escalate, provoking a sufficiently strong policy response from the ECB and creditor governments to prevent EMU disintegration and a string of disorderly sovereign debt defaults,” Citi said.

It expects sovereign yield spreads vs Bunds to remain high in many euro zone countries.

“We do not, however, expect the euro area to break up in 2012 or the following years, nor do we expect the disorderly default of an EA (euro area) sovereign,” Citi said.

Italian and Spanish sovereigns are “probably fundamentally solvent, in the sense that, with politically feasible amounts of additional fiscal austerity and structural reforms, these sovereigns can achieve sustainable debt burdens provided they retain access to funding at rates that reflect this fundamental solvency,” Citi said.

Citi’s economists said the euro area was probably already falling back into recession.

“We now expect real GDP to fall by 1.2 percent in 2012, whereas last month we forecast a 0.3 percent decline and four months ago we forecast expansion of 1.2 percent,” they said.

The UK was likely to be near recession.

Citi noted “sizeable risks” in its outlook however and put the chance of one or more countries leaving monetary union in 2012 and 2013 at 25-30 percent.

“If this happens it would probably be a Greek exit, but there is also a small chance that Germany balks at the costs of sustaining EMU and walks out probably together with other core countries,” Citi said.

The bank also noted that bank deleveraging amid economic weakness (which is likely in Europe) can cause a large drop in economic activity, significantly worse than its base case.