Economic outlook for the Euro area in 2005 and 2006

Abstract

· The upswing of the world economy continues over the forecasting period, driven by high growth dynamics in the US and in most emerging markets economies. High commoditiy prices, however, in particular for crude oil, continue to dampen world economic growth. · Rising interest rates and more cautious household spending behaviour will stab ilize the current account deficit in the US at the end of 2005. As a consequence, the chances are good that the dollar will appreciate a bit against the euro. Our forecast is an exchange rate of 1,30 dollars per euro for 2005 and 1,25 for 2006. · Despite quite favourable financial conditions, business investment will rise only modestly. This expansion, however, will contribute significantly to overall growth of the euro area economy in 2005 and 2006, because consumption will increase even less. Consumers in the euro area appear to be cautious in view of the budget problems in many member states, as well as of sustainability problems affecting the pay-as-you-go pension and health insurance systems, and the weak performance of national labour markets. · This outlook is a bit more cautious than the one published by the EFN in December, because output growth in the final quarter was disappointing and oil prices are again on record levels. Moreover, the economic sentiment indicators point to a reduction of economic growth in 2005. Given this scenario, we consider very probable that the European Central Bank will keep its reference interest rate at 2.0% at least until the last quarter of 2005. · In spite of the pressure of the international oil prices on the domestic inflation for the euro area, our forecasts for 2005 have been revised downwards to 1.7% due to a significant improvement in goods core inflation. The latter is due to a deterioration of the economic expectations, as measured by the economic sentiment indicators, and to the appreciation of the euro. For 2006 we expect an inflation rate of about 1.9%.