Economic outlook for the Euro area in 2006 and 2007

Abstract

• At the end of 2005, the upswing of the world economy continues due to strong investment activity. The chances are good that the investment upswing will continue during the forecasting horizon, because the rapid integration of emerging market economies makes capital comparatively scarcer and investment more attractive. • Growth of production in the euro area has accelerated during 2005 and, since summer, production has expanded at a faster pace than the long run trend. This is mostly due to higher investment, stimulated by low real interest rates, upbeat stock markets, and higher profits related to the limited increase in unit labour costs, lower than the inflation rate since summer 2004. • The favourable conditions for investment will by and large continue, as will the upswing of investment activity. Private consumption will remain stable, while government consumption and net exports will slightly increase, mostly due to, respectively, the less stringent interpretation of the Maastricht criteria and the appreciation of the dollar. Overall, production will expand by 2.1 % in 2006 and by 2.0 % in 2007; this is, in both years, roughly equal to the potential growth rate of the euro area. • Inflation is expected to remain over 2% for the next six months, but there is a 60% probability that it will fall below 2% by the end of 2006, related to better medium term perspectives for energy prices. Core inflation should also remain below 2%. Overall, there appear to be no major economic justifications for a tightening of the ECB monetary policy, but the ECB might nonetheless increase the key interest rates in 2006 by up to half a percentage point.