Bank of Portugal more downbeat on economy

The Bank of Portugal on Tuesday painted a dismal picture for the domestic economy this year as a result of the government's efforts to rein in the budget deficit.

With early elections likely in the wake of Prime Minister José Sócrates resignation last week following parliament's rejection of his Socialist administration's last batch of austerity measures, the central bank estimated GDP would contract by 1.4 percent this year before returning to growth of 0.3 percent in 2012.

The figures included in its spring report on the economy are worse then those in its winter bulletin when it forecast output would shrink 1.3 percent in 2011 and grow 0.6 percent next year.

The bank said deficit-cutting already in place and the need for more of the same on this front would cause domestic demand to contract 3.6 percent this year and 1.0 percent in 2012, with government spending dropping by 6.6 percent and 1.0 percent respectively.

Household spending is expected to shrink by 1.9 and 1.0 percent in the next two years. Forecast inflation of 3.6 percent this year is likely to reduce spending power as will hikes in taxes and lower wages.

The only bright note is an improved performance by the foreign sector, with net trade ? exports minus imports ? expected to contribute 2.5 percentage points to GDP this year and 1.4 points in 2012. Imports are forecast to contract 1.6 percent this year because of weak domestic demand, while the bank sees exports growing by 6.0 percent, accelerating to 6.5 percent in 2012.

"The Portuguese economy is not expected to follow the cycle of recovery in economic activity at the European level over the next few years, but will benefit from it in terms of external demand," the bank said.

The Stability and Growth Program (SPG) presented by the Sócrates government and voted down by parliament predicted GDP would shrink by 0.9 percent this year, compared with a forecast of growth of 0.2 percent in the 2011 state budget.

The Socialists and the country's other main political groups, the Social Democrats and the People's Party have pledged to continue to trim the shortfall in the government's books.

The SPG presented by the Socialists, which included a special levy on pensions of over 1,500 euros a month as well as other tax hikes and spending cuts aimed to lower the deficit from around 7 percent of GDP last year to 4.6 percent this year before bringing it down to the limit allowed by the European Union of 3 percent the following year and to 2 percent in 2013.