Economic outlook for the Euro area in 2005 and 2006

Abstract

• At the end of August, hurricane Katrina closed down most of crude oil production and refining at the US-coast of the Gulf of Mexico, and hurricane Rita could create additional problems. If the capacity for production and refining oil is significantly reduced in the US beyond 2005, a downturn of US and world growth is quite probable. Spot and future prices for oil and gasoline, however, are about the same as those before Katrina. In our view the markets are correct; thus, in this forecast, the effects of the Katrina shock on the world economy are only temporary and modest. • Katrina happened when the world economy appeared to continue on its healthy growth path. Although world trade growth was sluggish in the first quarter, early indicators suggest that it has regained momentum from the second quarter onwards. • Despite the assumption of a significantly higher oil price for the rest of this year and 2006, our forecast has not altered much from our last update in June. Indeed, we predict euro area growth for 2006 being 0.2 percentage points higher than we did in June. • The major risk for the world economy in 2005 and the coming year comes from consumption of US households: Higher interest rates put an end to the house price boom. This could, in combination with the energy price hike, weaken private demand. While more cautious spending of the US consumer is welcome from a balance of payments perspective, an abrupt change could depress world demand on a noticeable scale. • Inflation in the euro area will increase till y-o-y rates around 2.7% in the first months of 2006. Then will decline till rates close 1.7% at the end of that year. • Most countries in the euro area are experiencing negative short term real interest rates, and only Finland and Germany register positive rates around one per cent.