The Greek economy is projected to shrink by 4.4 pct this year and to enter an era of deflation, the European Commission said on Thursday.

In its interim report on the EU’s economic outlook, the Commission said an economic recession in the country would be deeper from initial forecasts made in autumn 2011 (-2.8 pct) and added that the economy would also face the risks of a very low consumer and business confidence.

The Commission forecasts a decline in both external and domestic demand, as a result of a restructuring in the labor market and a cut in private sector wages. At the same time, exports will be less dynamic compared with the previous three years despite lower labor cost in Greece, while imports were also expected to decline further.

The EU’s executive said it expected Greece to suffer a deflation this year (-0.5 pct), as a result of an expected decline in available incomes and consumption. The Commission stressed that the labor market was entering a painful adjustment period and that unemployment would continue rising in 2012. Minimum wage will fall by 22 pct and labor costs will fall by 15 pct on average in the next three years. The Commission said that a government’s decision to cut minimum wages was expected to raise hurdles in domestic demand and have a negative impact on employment in the short-term. In the medium-term, however, the Commission expects that these structural reforms will create favourable conditions for employment.

The Commission forecasts that the Eurozone economy will shrink by 0.3 pct in 2012, while the EU’s economy will remain stagnant this year.