Economic outlook for the Euro area in 2007 and 2008

Abstract

• In the second half of 2006 the expansion of world output has slowed down, mainly due to the end of the upswing in the US. World trade, however, continued its brisk pace, driven by the high growth dynamics of most emerging markets economies. In 2007, as production in the industrialized countries will be more or less close to capacity, the world economy will approach a growth path that is close to potential. • In the coming year, the investment boom in the euro area will have passed its peak. The driving force of growth will be household demand instead of investment: prudence as a motive for saving will become less urgent when labour markets improve further. In addition, the upswing will finally entail a higher wage growth. • A main risk of this forecast is that the slow down of the US economy might be more severe, and that the indirect spillover effects might be more important than it is assumed here: financial transatlantic ties have become more relevant in recent years. Thus, a weaker dollar means capital losses for many European investors who have invested in the US. In addition, sluggish demand in North America might weaken the ability of multinational firms to invest anywhere, in the US or in Europe. • The forecasts for headline and core inflation in the euro area for 2006 are around 2.2% and 1.5%, respectively. Considering the impact on euro area inflation of the three percentage point VAT increase in Germany, and assuming that 80-85% of the increase will be transferred to consumer prices, the forecast headline inflation rate for 2007 are around 1.9%, and the probability of meeting the inflation target established by the ECB for 2007 is over 50%. For 2008, we expect the annual growth of the headline price index to be more stable, around an average rate of 1.8%.