Europe risks botching its big plans to rescue the economy

London(CNN Business) Europe's ability to recover from the worst economic shock it has seen since the Great Depression is being jeopardized by the reopening of old political and legal wounds that could threaten trillions of euros in stimulus money.

The European Union economy will shrink by a record 7.5% this year, the European Commission warned Wednesday, and the drop could be even more precipitous across the 19 countries that use the euro.

It's a much steeper decline than the region suffered following the 2008 global financial crisis, and a more pessimistic outlook than forecast by the International Monetary Fund just three weeks ago.

Consumer prices are expected to fall significantly, while spending on coronavirus relief measures will push the deficits of European governments from just 0.6% of GDP in 2019 to around 8.5% this year. The Commission predicts that EU unemployment will increase from 6.7% in 2019 to 9% this year.

"Europe is experiencing an economic shock without precedent since the Great Depression. Both the depth of the recession and the strength of recovery will be uneven, conditioned by the speed at which lockdowns can be lifted, the importance of services like tourism in each economy and by each country's financial resources," EU economy commissioner Paolo Gentiloni said in a statement.

The pain could be even worse than forecast, according to EU officials, who warned that "a more severe and longer lasting pandemic than currently envisaged could cause a far larger fall in GDP than assumed."

What's needed, they said, is a "strong and timely common recovery strategy" at the EU level to avoid "severe distortions" within the huge trading bloc.

Yet the cavalry may not arrive in time, or when it does it may be badly hobbled. Despite broad agreement among EU member states on the need for urgent relief, old divisions are likely to delay the implementation of major recovery efforts. And a landmark legal decision earlier this week in Germany could hamper the ability of the European Central Bank to use one of its main stimulus tools.

Spend! But how and when?

EU leaders have signed off on immediate rescue measures worth at least €500 billion ($538 billion) drawn up by finance ministers. That package includes wage subsidies aimed at preventing mass layoffs, as well as loans to businesses.

But deep divisions among member nations have prevented EU officials from making quick progress on a bigger recovery fund that the European Commission hopes could raise at least €1 trillion ($1.1 trillion) to rebuild regional economies ravaged by the pandemic.

Charles Michel, president of the European Council of EU national leaders, had called for the package to be operational by June 1. But the Commission failed this week to finalize its proposal on measures to be included in the fund, meaning at least another week of delay. EU leaders are not scheduled to meet again until June 18.

Differences remain over how the fund should operate, in particular whether it should provide loans or grants to the hardest-hit countries such as Italy and Spain. Grants, or direct money transfers, would imply a degree of debt sharing that states such as the Netherlands, Austria and Germany have long resisted.

German judges and the ECB

Germany may have just thrown another spanner in the works.

Its highest court handed down a decision on Tuesday that could prevent the Bundesbank from purchasing bonds as part of the European Central Bank's flagship stimulus program, which predates the coronavirus crisis. The ECB now has three months to justify the program.

While the ruling doesn't directly affect the ECB's plan to purchase €750 billion ($810 billion) in government bonds and other assets in response to the pandemic, it may hamstring its ability to further expand such measures, which have helped knit together economies that use the euro. Economists are worried about the longer term implications.

"If the ECB were to restrain its asset purchases as a result of the limits which the German court has emphasized, or if a forced exit of the Bundesbank from such asset purchases in three months were to cause financial turmoil, as it may, the result could be a longer and deeper recession in Germany and the eurozone as a whole," said Berenberg chief economist Holger Schmieding.

The ECB responded to Germany's constitutional court in a brief statement on Tuesday, noting that the European Court of Justice had already confirmed that its stimulus efforts are legal. The two authorities are now on a collision course.

"Two of Europe's top courts arguing about the legality of bond-buying in the middle of a pandemic inject uncertainty into a market that doesn't need it and does nothing to boost confidence," said Societe Generale strategist Kit Juckes.

The ruling could also spur further legal challenges to programs undertaken by the central bank, including its pandemic-related bond buying. That in turn would place even more pressure on the fractious EU member states to agree a showstopping package of fiscal measures.

"The ECB cannot be the only game in town forever. Governments have to step up," said analysts at BofA Global Research.

-— Mark Thompson contributed reporting.