UPDATE 2-EU sees 2010, 2011 recovery, sets fiscal clock ticking

* EU revises up 2010 growth forecast, sees 2011 acceleration

* Forecasts mean 2011 at the latest is time to cut deficits

* Euro zone inflation seen well below ECB target in '10, '11

* EU reiterates 400 bln euro 2009/10 euro loan loss estimate

BRUSSELS, Nov 3 - Economic growth in the European Union will accelerate over the next two years, the European Commission said on Tuesday, setting the stage for the bloc's 27 member states to cut budget deficits from 2011 at the latest.

EU governments, keen to reassure investors and consumers that they would not let debt spiral out of control, have committed to reducing budget gaps over the next two years if the economy can grow without the support of public money.

In its forecasts, the EU's executive arm made clear the worst economic downturn since World War Two was now over, even though the economy could go through another "soft patch" in the first half of 2010. The 2011 deadline should therefore hold.

"With this forecast I will recommend to Ecofin (EU finance) ministers next week to declare or confirm that 2011 is the year when the EU and euro area start in aggregate terms this fiscal exit strategy," Economic and Monetary Affairs Commissioner Joaquin Almunia told a news conference.

The Commission forecast that the EU economy would expand by 0.7 percent in 2010 and 1.6 percent in 2011 after a contraction of 4.1 percent this year.

In the 16-country euro zone, it expects growth of 0.7 percent next year and 1.5 percent in 2011, after a 4.0 percent fall in 2009. This is a strong upward revision from its May forecast for the euro zone to contract by 0.1 percent in 2010.

Almunia said the economy was coming out of recession thanks to government and central bank support measures and urged that all the announced steps should be still implemented. He also said banks had to be repaired to make the recovery sustainable.

In its forecasts, the Commission quoted an estimate by the Committee of European Bank Supervisors (CEBS) from Oct 1 which said that future potential losses due to writedowns on loans and securities for euro area banks for 2009 and 2010 were in the range of some 200 to 400 billion euros.

"Without further repairing of balance sheets of many banks, credit flows will not be at normal levels and without normal credit flows we will not have a sustained recovery in our economy," Almunia said.

The forecasts compared with the European Central Bank's last forecast on Sept. 3 for euro zone GDP changes of between -4.4 and -3.8 percent this year and -0.5 percent to +0.9 percent in 2010. The ECB meets to review policy on Thursday.

The Commission said the euro zone emerged from recession in the third quarter with quarterly growth of 0.5 percent, a rate likely to slow to 0.2 percent in the fourth quarter.

SOFT START

The first half of 2010 is likely to be a "soft patch" as temporary factors now boosting growth, like inventory rebuilding, peter out. This is likely to slow euro zone quarterly growth to 0.1 percent in the first two quarters of next year, the Commission said, before it returns to 0.5 percent quarterly growth in the second quarter of 2011.

The bloc's finance ministers agreed last month that a number of countries should start cutting deficits earlier than 2011 and most should cut by more than 0.5 percent of GDP a year.

The Commission said that unless policies changed, the euro zone budget deficit would reach 6.9 percent next year and 6.5 percent in 2011 from 6.4 percent seen this year.

This is more than twice the EU limit on budget deficits of 3 percent of GDP. Of the 27-nation bloc only Bulgaria will not breach that limit next year, and Sweden will move below the threshold in 2011, the forecasts showed.

Euro zone debt is likely to soar to 84.0 percent of GDP in 2010 from 78.2 percent this year and to 88.2 percent in 2011.

Finance ministers will discuss the implications of the forecasts next week and the Commission will propose deadlines for bringing down budget deficits in some countries. Ministers are wary of withdrawing state support to the economy too early.

The Commission forecast unemployment in the euro zone would reach 10.7 percent of the workforce in 2010 and 10.9 percent in 2011, up from 9.5 percent seen this year.

After tumbling an expected 17.9 percent this year, euro zone investment is forecast to shrink next year by 1.3 percent and start growing by 4.1 percent in 2011.

Despite the expected recovery in 2010 and 2011, inflation should stay well below the ECB target of just under 2 percent, underlining market expectations the bank will not raise interest rates from record lows of 1 percent until late 2010.