By Nick Mann | 22 May 2012

The eurozone crisis has worsened since the turn of the year and urgent action is needed to prevent it damaging the fragile global economic recovery, the Organisation for Economic Co-operation and Development said today.

In its latest Economic outlook, the OECD forecasts the eurozone economy will shrink by 0.1% this year, compared with growth of 1.6% for the OECD nations as a whole and 2.4% for the US.

The crisis in the single currency remains the ‘most important source of risk to the global economy’, the OECD said. The eurozone faces threats of weak or even declining confidence, volatile financial markets and a potentially significant drag on growth from fiscal consolidation.

Recent events have increased these risks, with election results in eurozone countries signalling an increase in ‘reform fatigue’ and suggesting tolerance for fiscal adjustment has reached a limit.

‘With the expectation of a euro area with no growth in 2012, but with recession in a number of countries in 2012 and 2013, a combination of enduring financial fragility, rising unemployment and social pain may spark political contagion and adverse market reaction,’ it said. ‘Dramatic developments in individual countries would accelerate the process.’

The OECD called on European Union leaders meeting in Brussels tomorrow to introduce ‘comprehensive structural reforms’ in areas such as education, innovation, competition and  green growth.

These structural measures must proceed ‘hand-in-hand’ with fiscal consolidation, where a ‘careful balance’ is needed between spending cuts and revenue increases. ‘Much can be gained in efficiency of public spending and through a composition of taxation that is least harmful to growth,’ the OECD said.

‘Importantly, the reform agenda must be targeted at supporting employment through both labour and product market reforms. Last but not least, resources should be devoted to support the weakest segments of the population and mitigate the pressure of consolidation.’

Further enhancement of the eurozone firewall would help to prevent the financial crisis in those countries if European Stability Mechanism funds could be used to directly support banks’ recapitalisation needs, the OECD said. EU countries should also provide resources for the European Investment Bank to fund infrastructure projects.