The eurozone economy is starting to show some tentative signs of improvement but remains in a deep recession, the European Commission said in a report on Monday.

Thanks to substantial banking support measures implemented by the 16 euro-adopted European Union (EU) countries, most eurozone financial markets are showing encouraging signs of stabilization although conditions remain fragile, according to the commission's quarterly report on the euro area.

The measures, mainly in the form of recapitalization, debt guarantees and asset reliefs, have had a positive impact on banks' capital and access to wholesale funding. Developments in price indicators of financial distress suggest that the functioning of interbank markets has improved significantly.

As a further sign of the improvement, spreads on money and bond markets have narrowed on the back of improved economic sentiment and weaker risk aversion. Financing conditions in the euro area have also improved as the cost of bank loans, equity capital and market debt have all declined.

However, money and credit growth have slowed further in recent months, mainly reflecting very weak economic activity but also some supply constraints.

The eurozone economy shrank by 2.5 percent in the first quarter of this year, the fourth quarterly decline in a row, according to the EU's statistics office Eurostat. The drop was driven mostly by an inventory adjustment and a continued sharp fall in investment.

On the positive side, the fall in private consumption was contained by the deceleration of consumer price inflation and comparatively supportive developments in nominal disposable income, while world trade growth has also shown signs of improvement.

Annual inflation in the euro zone has fallen to zero for the first time in May, due to subdued world oil prices and a recession-hit economy, according to Eurostat.

The positive tone was reflected in recent surveys which have begun to show a pick-up in confidence in most eurozone countries.

Also on Monday, the commission said in separate reports that eurozone economic confidence continued to improve in June for the third month in a row, while the business climate indicator for the eurozone also continued to recover from historical lows.

Meanwhile, the fiscal stimulus measures by eurozone governments are significantly supporting economic activity in the area, but pressure on public finances is increasing.

From its low in 2007, the euro zone average debt ratio is projected to increase by 18 percentage points to reach 84 percent of gross domestic product in 2010 and will rise further in the years beyond because of high government deficits.

The commission said this projection raises sustainability concerns and calls for robust exit strategies, coupled with an expected increase in age-related expenditure and an adverse impact on potential output.

"The priority is now clearly to concentrate the efforts in resolving quickly the crisis and to swiftly return to sound public finances," it said.

The report, however, warned that the economic and financial crisis is likely to result in a lower growth potential in the years ahead due to lower employment and productivity levels as research and development and capital investment are likely to decrease or stagnate.

Historical evidence shows that financial crises tend to have a deeper and more lasting impact than recessions caused by other factors and can be followed by lower productivity growth. A return to pre-crisis potential growth is also likely to be much slower.

The commission said this calls for timely and appropriate policy responses to create new jobs, for example, in low-carbon industries, and by upgrading skills through apprenticeships and the fight of early-school leaving.

(Xinhua News Agency June 30, 2009)