Economic outlook for the Euro area in 2006 and 2007

Abstract

• In spring 2006 the worldwide upswing continues in all main economic regions. Monetary tightening in most industrial countries has little effect, since long-term interest rates are still low and stock market prices have continued to rise. • In the euro area demand had a weak spot at the end of last year. Investment, however, was still moderately dynamic. Confidence of financial markets and profit prospects of large firms have also improved during the winter. • The Euro area economy will only gain more momentum if private consumption will recover. Against this stand the long term motives for the relatively high saving rate of private households, in particular old-age provisions in economies with unfavourable demographics. However, slightly improving labour markets will give some dynamics to private consumption. This, in addition to brisk export and investment activity, will result in growth rates which, by standards of the euro area, amount to a healthy upswing. • Inflation is expected to remain above 2% in the first half of 2006, but there is a 50% probability that it will fall below 2% in the second half, as a result of better medium term perspectives for non-energy industrial goods. The core inflation forecast improves compared to forecasts of previous reports, with the average rate for 2006 at 1.5%. As to key interest rates, an increase to 2.75% can be expected from the ECB for the near future. This bias towards a more restrictive policy is based on the ECB´s concern that the boosting effect of credit expansion on inflation will be stronger than the moderating effects of other factors, such as the output gap.