Economic recovery in the European Union (EU) will remain fragile this year as a debt crisis looms large, the European Commission warned in a report on Thursday.

According to the report, both the whole EU and the 16-nation euro zone were forecast to see a sluggish growth of 0.7 percent in 2010, after shrinking 4.1 percent and 4.0 percent respectively in 2009.

After hard hit by the financial crisis, the EU economy is now recovering from the deepest and longest recession in its history. Real gross domestic product (GDP) started to grow again in the third quarter of 2009, thanks to the exceptional crisis measures put in place in the EU.

However, growth eased in the fourth quarter, as the impact of some temporary factors, such as the car-scrapping scheme in Germany that ended in September, started to fade.

"The exceptional crisis measures put in place in the EU and its major trading partners played a key role in turning the economy around, with inventory adjustment shaping the short-run dynamics," the commission said.

While the EU economy is gradually recovering, it is still facing headwinds.

"Uncertainty surrounding these projections remains rife, as recent developments in financial markets illustrate well," the commission said.

The Greek debt crisis and worsening public finances in several other eurozone countries posed one of the biggest challenges to the European economic recovery, which contributed to recent volatility in the financial markets and sent down the euro.

"The mood deteriorated quite significantly in some segments of financial markets at the start of 2010 following growing concerns about the fiscal situation in developed economies, particularly in some euro-area countries," the commission said.

German Chancellor Angela Merkel admitted on Thursday that the euro is now in a difficult situation for the first time since its launch.

"The euro is now, for the first time since its introduction, in a difficult situation, but it will come through," Merkel was quoted as saying by the German daily Frankfurter Allgemeine Zeitung.

Despite the recent Greek debt crisis, the commission kept its forecast unchanged from a previous one released in November.

Meanwhile, the inflation projections also remained largely the same at 1.4 percent and 1.1 percent in the EU and the euro zone respectively.

"According to the current update, the economic outlook for the EU remained broadly unchanged," the commission said.

EU Commissioner for Economic and Monetary Affairs Olli Rehn urged member states to bring their house in order so as to ensure a sustainable recovery

"We need to work on two fronts: the economic recovery and the consolidation of our public finances," he told reporters when presenting the forecast.

"The recovery of the EU economy is materializing but it is still fragile," he added.

On the upside, the commission said the EU economy was to be supported by a stronger global recovery, but it remained to be seen to what extent this would help this year.

Global economic activity proved more robust in the second half of 2009 than previously expected, especially in emerging Asia. Regarding the near term, global indicators are encouraging, partly reflecting the inventory cycle in manufacturing.

Improved sentiment indicators for the EU also pointed to an expansion of activity going forward, but hard data, especially industrial production and retail sales, have been less encouraging recently.

"With many of the main driving forces being still temporary in the EU and globally, the robustness of the recovery is yet to be tested," the commission said, adding the risks to the EU growth outlook for 2010 appeared broadly balanced.

In sharp contrast to the sluggish growth in the EU, the rest of the world was expected to see an economic growth of 4.5 percent this year, led by "markedly more robust recovery in the emerging economies, especially in Asia."

Rehn said the EU is concerned about being left behind emerging economies.

"We should certainly be concerned about this, and I think it is a further factor which underlines the necessity of modernizing our economies in line with enhanced productivity and higher levels of employment," he said. "This will require more investment in innovation and education, it will mean a focus on a resource- efficient economy and it will mean a focus on higher productivity. "

The commission was scheduled to present a proposal next week for the EU's growth strategy in the next decade, known as Europe 2020, which would put sustainable growth and job creation at its focus.