Economic outlook for the Euro area in 2005 and 2006

Abstract

• The upswing of the world economy continues over the forecasting period, but at a lower rate. The recent oil price hike has dampened economic activity. Fiscal stimuli in the US have diminished, and China has already begun to take measures to cool down its economy from overheating. Growth rates of world trade are expected to decline slightly to about 7 percent, after 8.5 percent in 2004. • A rise of interest rates by the Federal Reserve and more cautious household spending behaviour will stabilize the current account deficit in the US, and the euro will not further appreciate against the US dollar. One euro will cost 1.28 dollars in 2005, depreciating to 1.20 dollars in 2006, in line with purchasing power parity. • The recovery in the euro area lags behind the world business cycle, and the forecasts have been revised downwards. GDP growth is expected to be at around 1.7 in 2005, and will accelerate to 1.9 in 2006. Due to the appreciation of the euro and the slowing upswing of the world economy, the contribution of net exports to GDP growth is 0, and growth will be mainly driven by the evolution of consumption and investment. • 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 payas- you-go pension and health insurance systems. Although financial conditions are favourable investment activities will not accelerate markedly. This hampers growth and employment prospects in the euro area in the long run. • Inflation forecasts represent a downward revision of the annual rates of the headline inflation in the euro area for what is left of 2004 and the first two quarters of 2005. About the ECB monetary policy, there is no room for a looser monetary policy for the time being and a tighter monetary policy can be expected over the forecasting horizon. • Compared to other forecasts, the EFN outlook is more cautious, possibly due to our pure econometric-model-based approach. Moreover, positive effects arising from recent structural reforms in some member countries are not taken into account, as they will only accrue slowly in the coming years.