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In the past three years the world economy has been hit by an unusual series of negative shocks - the bursting of the bubble in the information and communication technology sector, accounting scandals, epidemics, terrorist attacks and geopolitical stress. While it is not surprising that the euro area went into a downturn following the 1995-2000 upswing, it is striking that growth has been recovering much more hesitantly than in many other OECD countries. Domestic demand has remained particularly weak, which is to some extent due to subdued consumer confidence, but has started to recover recently. Looking forward, the OECD projects a shallow recovery in 2004, which should gather steam in 2005 with growth of 2½ per cent. In these projections, the output gap would remain large and start to close only slowly in 2005. Helped also by the strong exchange rate, inflation is expected by the OECD to decline to 1½ per cent in 2005. However, there are upside risks to the inflation projections mainly due to high oil prices and uncertainties concerning further increases in indirect taxes and administered prices.
In the May 2003 review of its policy strategy, the European Central Bank (ECB) reiterated its definition of price stability, but clarified that in the pursuit of price stability it aims to maintain inflation rates close to but below 2 per cent over the medium term in line with its past conduct of policy. At this juncture, policy determined interest rates are likely to remain on hold as long as the medium term inflation outlook remains favourable. If evidence of weakening of economic activity surfaces, moderating inflationary pressures, the ECB should stand ready to reduce its interest rates. At the same time, the ECB should continue to be vigilant to upside risks.
Inflation performance since the advent of the euro
Per cent rate of change
1. Harmonised index of consumer prices (HICP). Percentage change over same period of previous year.
2. Core HICP is the overall index excluding energy, food, alcohol and tobacco.
3. Change over 6 months earlier (s.a.a.r.).
4. Break even inflation rate between the nominal yield of French government bonds and the real yield of French index linked bonds. Up to March 2002, government bonds linked to the French consumer price index with a maturity up to 2009; from March 2002, government bonds linked to the euro area HICP with a maturity up to 2012.
Source: European Commission/Eurostat and Agence France Trésor.
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