How the European economy is raising fresh global growth fears

The Bank of England and the European Commission both offered downbeat outlooks on Thursday, reaffirming growing fears about the health of Europe's economy.

Although, the BOE left interest rates unchanged, as expected, it cut its forecast for 2019 gross domestic product to 1.2% versus its previous estimate of 1.7%, with its current level representing the weakest growth since 2009 when a crisis sparked by complex mortgage bonds cast a pall over the global financial system.

"Naturally, the uncertainty over Brexit means considerable uncertainty over the U.K. macro outlook, and therefore monetary policy," said Bill Diviney, senior economist at ABN Amro.

Read: Brexit Brief: Labour throws Theresa May a lifeline (with a catch)

Both the BOE and Diviney still see a soft Brexit — where Britain leaves the European Union with a trade agreement in place — as the most likely scenario, but the U.K. economy seems destined to slow, notwithstanding any expectations of a trade resolution. The British pound GBPUSD, +0.0154% as well as the FTSE 100 Index UKX, -1.11%  didn't initially absorb the news in stride. While sterling recovered after falling to a session low, the U.K. stock benchmark booked its worst decline so far this year, down 1.1%.

And it doesn't look rosy on either side of the English Channel.

On Thursday, the European Commission cut its forecast for 2019 eurozone growth to 1.3% in 2019, compared with the 1.9% expected in November. Underlining its forecast was weaker-than-expected industrial and manufacturing data for the eurozone's biggest economy Germany.

"We think there are a number of important take-aways," said Diviney. "First of all, despite the large downgrade in economic growth forecasts, they probably do not go far enough, and further revisions are likely."

The euro EURUSD, +0.0000%  found itself in negative territory for most of Thursday, and the pan-European Stoxx 600 Index SXXP, -1.49%  notched a 1.5% decline, representing its worst one-day drop in six weeks, according to FactSet data.

Also read: The euro is 20 years old — here's a look back at its tumultuous history

The Commission was still expecting 0.3% quarter-on-quarter growth between January and March 2019, which isn't consistent with projections from a number of other business indicators, Diviney said.

ABN Amro only expects 1.1% eurozone GDP growth, or possibly less. The European Central Bank's outlook was still at 1.7%, clearly in need of a cut.

"This will also have knock-on effects to [the ECB's] view on inflation," Diviney said. "The European Commission did not publish forecasts to core inflation, but it suggested in the written text that core inflation would not embark on an upward trend until 2020."

These headwinds could lead the ECB to refrain from lifting interest rates—as has been anticipated for the second half of 2019 — and possibly introduce a fresh round of stimulus for eurozone banks, known as targeted longer-term refinancing operations, or TLTROs.

Finally, "the downgrade to Italy's growth forecast points to worse public finance outcomes, which will trigger renewed tensions with European authorities," said Diviney. According to the European Commission report, Italy's GDP will only grow 0.2% in 2019.

Italy is the eurozone's third-largest economy but the health of its finances have been a worry to investors for a while, particularly as Italian officials proposed a budget that breached EU budget guidelines late last year, proposing a 2.4% deficit. Rome and Brussels reached a budget agreement in December. ABN Amro expects Italy's budget deficit to be closer to 3% in 2019.

Market participants also look at Italy's high debt burden and a decision by the ECB to stop buying Italian bonds as part of its quantitative-easing program with caution, as this could lead to funding shortfalls if conditions worsen.

Taken together, sluggish growth in the U.K. and eurozone may remind European investors that nagging problems persists beyond trade deals and China's own slowdown.

That doesn't bode well for 2019's global growth story.

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Anneken Tappe

Anneken Tappe is a markets reporter for MarketWatch. She is based in New York.

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