* Sees return to low EU growth 2010, high unemployment
* Need for rigorous bank testing to boost confidence
* Govts must exit expansionary policy before ECB
* Debt markets coming under pressure, yields rising
* Europe divided on crisis strategy
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By Andrew Hay
MADRID, June 29 (Reuters) - The European economy will return to very low growth and high unemployment in 2010 and needs reforms, rigorous bank testing and political coordination to recover, EU economic chief Joaquin Almunia said on Monday.
The weak outlook means governments must continue fiscal stimulus spending, or even expand it, as the European Central Bank maintains expansionary monetary policy, Almunia said.
"You can see that Europe will not have the growth potential it had before the crisis, and it is going to be very low, and if we don't have capacity to grow, we can't reabsorb the unemployed and we'll have a long situation of low growth and a bad job market situation," Almunia told Spain's Cinco Dias newspaper financial forum.
WEAK RECOVERY
The United States should return to economic growth later this year but the European Union will not exit recession until early 2010, Almunia said. Holding Europe back is Germany's dependence on global trade as well as the housing crisis in Spain and the UK, he said.
Financial markets in Europe may also fail to regain confidence because bank stress-testing in Europe had failed to shed light on the health of individual institutions, unlike in the United States, Almunia said.
"One of the risks we have is that as areas of the financial sector normalise, market players say we are still where we were before, where we should not be and we go back to the previous situation just like we were before," said Almunia.
He urged governments to implement fiscal stimulus and bank recapitalisation plans to restore economic demand and financial sector confidence.
"We have to keep applying stimulus, and even not rule out new stimulus, if necessary, to support demand," Almunia said.
But there are risks the ECB could be forced to remove accommodative policies if governments keep up stimulus spending indefinitely, he said.
DEBT YIELDS TO RISE
Euro zone inflation risks are anchored in the short and medium term, but oil and raw material prices are likely to rise once there is evidence of recovery, he said.
"It's better for everyone that the first to withdraw stimulus, when convenient, are those in charge of fiscal policy, and to leave expansionary monetary policy for some time," Almunia said. "The opposite of that, would be for monetary policy to move first because of a failure on the part of authorities to launch fiscal consolidation."
An inevitable cost of fiscal stimulus is a rise in public debt costs as governments hike borrowing.
"Debt markets are already being exposed to tremendous pressure, and it is going to increase in the future," he said. "Interest rates are going to increase, as are the budgetary costs of this."
Complicating crisis recovery are divisions on strategy, as France, Britain and Germany propose their own solutions.
He saw the need for education and labour reforms across the 27-member European Union, especially in countries like Spain where the collapse of consumer spending and housing booms have exposed economic structural weaknesses.
"If we don't move forward together we won't get back to where we were before, and Europe will fall behind next decade," he said.
(Reporting by Andrew Hay; Editing by Victoria Main)