Economic Assessment of the Euro Area: Forecasts and Policy Analysis Spring 2007

Economic Assessment of the Euro Area: Forecasts and Policy Analysis Spring 2007

Embargo: 00:01 a.m. Friday 30 March 2007

The EUROFRAME – European Forecasting Network comprises ten of the most respected economic forecasting and research institutes in Europe, including the ESRI. On behalf of the European Commission, it produces bi-annual reports on the Euro Area covering economic forecasts, regular policy monitoring and special policy topics.

Today sees the launch of the network’s report for Spring 2007. Among the findings contained in the report are the following:

• GDP growth in the Euro Area was 2.8 percent in 2006. This was higher than had been anticipated for much of 2006 and is well above the growth rates of recent years.

• For 2007, the network expects GDP growth in the Euro Area of 2.5 percent. For 2008, we expect the growth rate to be 2.2 percent.

• The reasons for the marginal slowdown between 2006 and 2007/08 include the following:

• The growth rate in the US is expected to fall from 3.3 percent in 2006 to 2.4 percent in 2007 and to 2.3 percent in 2008;
• An appreciation of the euro relative to the dollar is expected, in response to diverging interest rate paths and the large and on-going current account deficit in the US;
• The ECB is expected to raise its key interest rate again in 2007, although only one further increase is expected;
• Restrictive budget policies are expected to remain in place in many Euro Area countries as governments continue to deal with fiscal deficits.

• Inflation in the Euro Area is expected to fall to 1.8 percent in 2007, partly in response to lower energy prices and despite the increase in VAT in Germany. In 2008, inflation is forecast to rise slightly to 2 per cent.

• The improvement in the economic environment in the Euro Area has been reflected in the labour market and this is expected to continue. The rate of unemployment is expected to fall to 7.2 percent in 2007 and to 6.8 percent in 2008. The improving labour market is expected to contribute to an increase in consumption, with growth rates of 2.1 percent and 2.3 percent expected in 2007 and 2008 respectively.

The report contains an analysis of possible adjustment in the US to its current account deficit and the likely consequences for the Euro Area. The analysis shows that an adjustment that is domestic to the US (such as a house price fall) has a much smaller impact that an internationally-based adjustment, such as a dollar depreciation.

From Ireland’s perspective, the important features of the forecasts include the following:

• The continued increases in ECB interest rates will lead to further increases in mortgage re-payments. However, the forecast of the group suggests that the end to interest rate increases is in sight with only one further rate rise of 25 basis points anticipated.

• The US is likely to slow down in 2007 relative to 2006. Although the impact on the Euro Area as a whole may be limited, the impact on Ireland will be stronger given our relatively stronger trade links.