The expansion has continued at a solid pace, driven by private domestic demand that has been little restrained thus far by energy price or interest rate increases. Household and business spending has been supported by ongoing wealth gains and favourable financial conditions. By contrast, net exports have subtracted considerably from growth, and the external account has again deteriorated. With resource slack diminishing and unit labour cost growth picking up, core inflation has moved higher. Growth is expected to slow towards potential during the next few quarters, and inflation to edge up. Although some of the monetary stimulus has been removed, further tightening is needed to contain emerging inflationary pressures, not least because long-term interest rates have remained surprisingly low. Government finances have improved little, as faster revenue growth has been partly offset by higher spending. Projected deficits thus remain large, underlining the need to adjust tax and spending levels to rein in the debt accumulation and prepare for impending demographic pressures. This might also lessen the record external imbalance.
Economic growth resumed at the beginning of 2005 after a pause in the latter half of 2004. The expansion is led by domestic demand, which is underpinned by strong corporate profits and a reversal of the declining trend in employment and wages. Despite a deceleration of export growth, the economy is projected to expand at a rate of between 1½ and 2% in 2005 and 2006, reducing the unemployment rate to 4% and helping to bring an end to deflation as measured by the core consumer price index. The Bank of Japan’s policy of quantitative easing should continue until inflation is sufficiently high so as to make the risk of renewed deflation negligible. Achieving the medium-term fiscal targets, which aim at a primary budget surplus in the early 2010s, is essential to slow the upward trend in public debt and maintain confidence in fiscal sustainability. Further progress in strengthening the banking sector is needed to help sustain economic growth, accompanied by a broad structural reform programme to improve competition, open new areas to the private sector and privatise Japan Post.
The recovery has lost momentum since mid-2004, but it should resume in 2006. Growth is projected
to drop from just below 2% in 2004 to 1¼ per cent in 2005 before recovering to around 2% in 2006,
with final domestic demand firming. The output gap will remain negative and the unemployment
rate high at over 8½ per cent. Once the impact of the oil price hike peters out, headline inflation
should fall to 1¼ per cent. Another hike in oil prices or a further appreciation of the euro could sap
the recovery further.
With inflation declining and a large output gap prevailing in 2006, there is room to ease monetary
policy, even though liquidity will have to be withdrawn again once the recovery is firming towards
the end of the projection period. The euro area lacks resilience against adverse shocks amid slow
trend growth -- less than 2%per annum. Both are shaped by structural factors. Structural policies
should aim at completing the European internal market, boosting labour market performance and
encouraging innovation. Fiscal policy should be rooted in long-term sustainability goals.
Growth remains weak and heavily dependent on foreign demand, but both non-residential investment and -- somewhat later -- household consumption are projected to pick up in the course of 2005, leading to GDP growth of 1¾ per cent in 2006, sufficient to allow the output gap to begin to narrow. The general government deficit is projected to be 3½ per cent this year and to remain above 3% in 2006. For economic performance to be raised in a durable way, reforms have to be continued and deepened within a coherent framework. Fiscal consolidation needs to be linked to more fundamental reform, requiring, inter alia, untangling responsibilities across different levels of government and continued reform of the social security system. Subsidies and tax expenditures should be reduced so as to create room for further cuts in statutory income tax rates.
Economic growth is likely to be uneven during the first half of 2005. A recovery is set to establish itself later in the year with growth averaging 2-2½ per cent through to the end of 2006. Domestic demand will be less strong in 2005 than in 2004 but export growth should respond to increasing foreign demand, picking up quite strongly later this year. Employment growth will be modest, permitting only a small fall in unemployment. Underlying inflation may increase slightly, though headline inflation is set to decline. While the budget deficit may ease, it is likely to stay stuck at 3% of GDP. Quarterly data for GDP growth has been particularly volatile since mid-2004; the slowdown in the first quarter of 2005 was partly due to lower public spending. On the other hand, the recent announcement of a supplementary increase in public sector wages, relatively small in itself, is symptomatic of a need for continuing efforts to control public spending if the deficit is to be reduced by more than foreseen in these projections.
After recovering throughout most of 2004, the economy fell into recession early in 2005. High unit labour cost growth, coupled with euro appreciation and strengthening global competition in Italy’s areas of specialisation, have entailed large losses of market shares. Domestic demand, once sustained by strong employment growth and low real interest rates, has been slowing. Activity is projected to strengthen towards end-2005, reflecting a renewed upturn in world trade, improving labour productivity, and tax cuts. Structural reforms are needed to address the underlying causes of poor competitiveness. Wage bargaining should be adapted to better reflect productivity developments. Sheltered sectors should be made subject to more effective competition to reduce downstream costs and inflation pressures. Debt reduction should be quickened to make room for lower taxes and higher human and physical capital investments.
Despite a marked slowdown in household spending due to the cooling housing market, output
growth has remained close to trend rates since mid-2004 and into the first quarter of 2005.
Nevertheless, inflationary pressures are emerging, suggesting that the economy is operating close
to, or slightly above, capacity. Going forward, growth is likely to moderate further as export
demand from Europe weakens in the near term and as the saving ratio continues to rise. Despite the recent pick-up in inflation, weakening growth prospects suggest that monetary
tightening will not be required to maintain inflation close to the target. The government deficit
was 3% of GDP in the fiscal year ending in the first quarter of 2005 but, in the absence of a
spontaneous rise in taxes, a slowdown in spending will be required to achieve a further decisive
The marked appreciation of the Canadian dollar has continued to restrain activity. The economy may now be operating slightly below potential, although most economic fundamentals have remained sound. Activity is expected to accelerate somewhat in the second half of 2005, once the effects of currency movements have been worked through, before slowing next year. The recent surge in oil prices is boosting headline inflation temporarily this year. Uncertainties about the impact of the currency appreciation on activity have warranted a pause in monetary policy tightening, but further increases in interest rates will be needed from the second half of 2005 onwards. Regardless of how the current political uncertainties are resolved, fiscal policy needs to remain prudent, with the surplus allocated to paying down public debt while demographics remain favourable.
Economic growth slowed in the second half of 2004, reflecting the ongoing drag from net exports, and a rundown in inventories. With domestic demand weakening as households restructure their finances towards lower dissavings, GDP growth should remain subdued this year but pick up thereafter, helped by an acceleration in exports. The slowing economy, combined with firmer monetary conditions, is expected to keep inflation within the Reserve Bank’s 2 to 3% target band. To create room for continued strong growth, the government should accelerate structural reforms to reduce the risks of capacity constraints proliferating. Reforms should focus on making wage bargaining more flexible, creating stronger incentives to labour market participation, removing disincentives to hiring, improving training and education, and promoting productivity growth by further strengthening competitive pressures in the economy.
Growth of GDP is expected to be about 2% in 2005, much the same as in 2004, with the positive stimulus from deficit-financed tax reductions offset by slower growth of export markets on a year-over-year basis. With growth picking up to 2¼ per cent in 2006, unemployment may begin to fall, notwithstanding strong labour supply growth, while the impact of higher oil prices on inflation is likely to fade. Although legislated pension harmonisation marks progress towards long-term sustainability of government finances, further reductions in general government outlays will be necessary to offset the impact of tax reductions on the deficit and make progress in moving it back to balance.
Economic growth is projected to slow to 1.3% in 2005 but to rise to 2.4% in 2006 as domestic demand and exports strengthen. Despite a pick up in employment growth in 2006, the unemployment rate should only ease back to around 8%. Headline inflation is likely to fall to 1.6% as the effects of higher energy prices pass, converging with the underlying rate. Additional consolidation measures will be required to keep the budget in balance. In view of the economic costs of the already high tax burden, these should focus on expenditure restraint. Subsidies for early retirement should be progressively phased out to increase the employment rate for older workers.
Output growth of 4% in 2004 surpassed expectations and is projected to be marginally higher than that in 2005 and 2006. Growth in the export sector is expected to fall off somewhat but will nevertheless remain robust while household consumption spending is likely to pick-up. Though inflation is currently low, pressures are expected to build and are projected to be met with some tightening of the monetary stance in 2006. Though the prospects for reaching the Maastricht criteria for euro entry are good, faster progress is needed in structural reforms to make fiscal consolidation sustainable in the longer term. More rapid progress is also needed in making improvements to the business environment.
Growth picked up again in 2004, as households raised their spending and strong external demand pulled up exports. The expansion should continue, with accelerating exports gradually taking over as the main driver of growth. Inflationary pressures are likely to be modest as the output gap is projected to stay just below zero, but they may be less benign if households spend even more out of their income and wealth gains. Tax cuts in 2004 and other measures to strengthen households’ disposable incomes continue to boost prospects for this year, while the planned resumption of Special Pension contributions will take back some of the stimulus next year. Monetary policy settings may provide further underpinning of growth in the near term, while a gradual tightening is projected in 2006, as Danish interest rates follow those of the European Central Bank. With growth likely to be above potential, the government should now return its focus to its medium-term targets for the fiscal balance and employment.
Following strong growth during 2004, output is now slightly above potential. With tax cuts worth nearly 1% of GDP being phased in during 2005-06, and strengthening export demand, economic growth should be about 2¼ per cent in 2005 and 3% in 2006. Wage and price inflation will remain moderate because of the recent incomes policy agreement, but with a positive output gap inflationary pressures could rise when the agreement ends in 2007. To curb inflationary pressures and ensure that employment expands swiftly, reforms to reduce early retirement and motivate active job search are needed. Rising municipal deficits must be brought under control through greater service efficiency and spending restraint to avoid excessive fiscal stimulus.
The economy remained strong in 2004, fuelled by robust domestic demand. Nevertheless, the general government deficit rose to 6% of GDP. The ending of the Olympic Games related spending, together with a substantial fiscal tightening, is expected to curtail demand in 2005 especially, so that GDP growth may slow to about 3% in 2005-06, though remaining higher than the euro area average. Inflation is also likely to stay above the euro-area average, reducing competitiveness, but even so the current account deficit will gradually decline as the growth differential vis-à-vis the euro area narrows somewhat and service exports remain strong. The underlying very fragile state of the public finances, revealed by the fiscal audit of public sector accounts going back to 1997, highlights the imperative to implement the recently announced consolidation programme. Cuts in primary spending are required, and recent proposals to modify the tax system should not be allowed to hinder consolidation. Greater labour market flexibility, and strengthened competition in product markets, could help boost both employment and competitiveness, and narrow the inflation gap with the euro area partners.
Activity expanded briskly in early 2004 but then slowed in the second half of the year. Growth is expected to pick up again from mid-2005, driven by accelerating export demand and investment activity. Inflation has fallen sharply since mid-2004 and is expected to fall further. Although the macroeconomic policy mix has improved recently, significant further progress is required to meet the 2010 target date for euro adoption. While falling inflation expectations leave scope for further monetary easing, this needs to be assisted by a strong commitment to fiscal consolidation, including bolder steps on structural spending measures.
The economy is overheating, prompting aggressive monetary tightening to steer inflation back to the official target. With huge external deficits and debt levels, waning capital inflows as the large-scale investment projects gear down could lead to a reversal of the substantial currency appreciation in recent years, the first signs of which may already be seen. This could entail a protracted period of high interest rates and possibly a full-blown recession, as happened following the previous overheating period in 2002. Further interest-rate increases will probably be needed to forestall a wage/price spiral. Now that tax cuts have been passed, the government should aim at budget surpluses higher than those currently planned to ensure a better policy mix. This should involve additional spending restraint and reductions in tax expenditures favouring the booming housing sector.
Growth is projected to continue steadily at a rate of close to 5%. Domestic demand should expand rapidly as strong income growth continues and government spending provides additional impetus. Despite strong wage growth, inflation is projected to remain relatively muted, edging up to 2¾ per cent in 2006. At the same time, increasing unit labour costs weigh on competitiveness. Strong wage pressures in some sheltered sectors, where regulations limit the scope for competition, could revive inflation. Further liberalisation in network industries, in retail distribution and in professional services would improve resource allocation and help curb the risk of renewed price and wage inflation.
Buoyant exports, driven in large part by China, have led the expansion, while domestic demand has remained weak since the end of the household credit bubble. A gradual recovery in private consumption is projected to sustain economic growth in the 4 to 5% range in 2005 and 2006, despite some moderation in export growth. Further reforms are needed to address the structural causes of weak domestic demand, notably debt delinquency and problems that discourage business investment. Monetary policy should maintain its expansionary stance until domestic demand recovers, while the appreciation of the won should be allowed to continue, in line with the country’s flexible exchange rate policy. The recently announced "Comprehensive Investment Plan" which is intended to boost demand, should aim at promoting economic efficiency.
GDP growth is projected to slow to 3.3% in 2005 owing to weaker exports but to recover to 4% in 2006 as both exports and domestic demand strengthen. Harmonised consumer price inflation in 2005 should be pushed up towards 3% because of the high weight of oil products but then it is expected to ease to less than 2% in 2006. Unemployment will come down a little, but most of the employment increase continues to come from abroad. The growth recovery should be used to initiate structural reforms to put fiscal balances on a sustainable path, notably by reducing replacement rates in the very generous first pillar pension scheme.
Growth quickened after mid-2004, underpinned principally by robust domestic demand, and prospects are expected to remain bright despite a projected slowdown of foreign demand. After a sharp rise, headline inflation turned down again in early 2005 and core inflation eased. Faced with rising inflation expectations, the successive moves over 2003-05 to tighten the monetary policy stance have been appropriate. On the fiscal front, the 2004 budget target was easily met, thanks to higher-than-projected oil revenues. The supportive revenue environment is expected to allow further consolidation of public finances. But a revenue-enhancing tax reform remains essential to reduce the vulnerability of public finances to oil price changes.
Economic growth turned negative at the end of 2004 and in the first quarter of 2005, interrupting the short and weak recovery that was underway. This slowdown reflected deteriorating net exports following the appreciation of the euro and depressed domestic demand in the first quarter of 2005. Following weakness in recent months, exports are projected to strengthen during 2005, leading to a more broadly based recovery and lifting growth to 1.7% in 2006. Employment, however, may only recover gradually, with the unemployment rate continuing to rise in 2005 but falling to 6.1% in 2006. Core inflation is expected to edge down further. The government should complement the reforms stimulating labour supply with measures to reduce poverty traps in order to enhance employment prospects for low-skilled workers.
Economic growth has been running ahead of potential, with labour shortages and inflationary pressures mounting. Higher interest rates will damp domestic demand through the coming year, although this will be offset by the income effects of the "working for families" package. Increased business investment will help ease capacity constraints and pave the way for higher productivity growth and increasing real wages. Demand also continues to be boosted by a vigorous expansion in government consumption. With the pace of activity now slowing, the recent monetary tightening should be sufficient to limit inflation, given the appreciation of the exchange rate. But additional fiscal stimulus beyond that already planned could put the projected soft landing at risk and would need to be offset by higher interest rates in order to bring the economy back onto a sustainable growth path.
After a soft landing in 2003, growth of Mainland GDP bounced back, reaching 3½ per cent in 2004. Domestic demand gained momentum in the second half, fuelled by historically low real interest rates, favourable terms of trade and rising domestic confidence. Mainland growth is projected to accelerate in 2005 to 3¾ per cent, while slowing to a more sustainable 3% pace in 2006. Fiscal credibility needs to be reinforced via stricter adherence to the fiscal guidelines, and a less expansionary macro policy stance is necessary to support long term sustainability objectives. In this respect, the spring debate about reforming pensions and labour market incentives will be crucial.
Economic expansion continued in 2004 despite some slowing in the second half of the year. Activity should remain robust in 2005, although it is expected to decelerate as exports weaken following the appreciation of the zloty. An investment-led recovery is well under way and should gain strength in 2005 as a consequence of accession in the European Union. This will also help to raise employment. Despite robust growth in 2004, the budget deficit deteriorated substantially. With the expected moderation of GDP growth, public expenditure targets will need to be reinforced if medium-term fiscal sustainability is to be attained. Budgetary slippages could make the task of the central bank more difficult and could also trigger drastic consolidation measures, given the constitutional provisions to limit the level of debt.
The Portuguese economy fell back into recession in the second half of 2004. while activity is expected to recover gradually in the course of 2005, and gain momentum in 2006, the negative output gap could remain among the largest in the OECD over the projection period. Against this background and with the unemployment rate still high, inflation should fall slightly below the euro area average. If the new government stands by its decision not to rely on one-off measures to curb the fiscal deficit, the 3% of GDP deficit limit would be overshot by a large margin in 2005 and 2006. This underlines the urgent need for consolidation measures, in the form of fundamental reforms rather than temporary fixes.
The expansion in domestic demand that began in the first half of 2004 has gathered pace, and GDP growth is expected to remain in the 4¾ to 6% range over the projection horizon. However, employment growth has disappointed, and the unemployment rate is not expected to fall below 17% until late 2006. Fiscal policy outcomes have been good, but the plan to adopt the euro in January 2009 will remain credible only if strict adherence to planned expenditure cuts is achieved. Moreover, any sign of overheating or renewed exchange rate appreciation may require tighter fiscal policy.
Sustained by the persistent dynamism of domestic demand, activity should accelerate to over 3% by 2006. Net exports, however, are likely to remain a drag on activity. Inflation may moderate slightly after the pass-through of the oil price hike but should remain about one percentage point above the euro area average. Although the neutral fiscal stance is currently appropriate, a tighter fiscal policy would be desirable in the medium run to reduce domestic demand pressures and prepare for the fiscal consequences of population ageing. Further pension reforms also need to be considered. Continued efforts to improve productivity growth and a reform of the wage bargaining system would help to halt the deterioration in competitiveness.
Strong growth has resumed after a brief pause last autumn. The export sector is projected to remain robust, with business investment playing an increasing role. Household consumption will be supported by low interest rates, rising house prices and tax cuts. The continuing expansion should eventually deliver the long-awaited improvement in the job market. Inflation has been surprisingly low recently, but is likely to pick up as the impact of various temporary factors abates and spare capacity is used up. Fiscal policy has been pushed off track by the expansionary measures in the recent autumn’s budget. The government will need to tighten policy again in order to achieve its target for the budget surplus. Meanwhile, the central bank can afford to keep interest rates on hold for some time yet, but it will need to raise interest rates as the output gap shrinks.
Although activity increased by 1¾ per cent in 2004, the recovery remains fragile and dependent on developments in the euro area. The recovery should continue in 2005 at a more moderate rate of some 1¼ per cent and then gradually gather pace, with GDP growth reaching 2% in 2006 thanks to a more robust external environment. These developments will probably be accompanied by a decline in unemployment as of 2006, but without generating inflationary pressures. In the absence of inflationary pressures, the continuing easy stance of the Swiss National Bank’s monetary policy would seem appropriate to underpin the recovery. Continuing efforts are needed to contain public spending and so reign in its trend rise and pursue fiscal consolidation. Combined with the strengthening of competition, this policy will stimulate potential growth.
Dynamic household consumption and private investment backed by strong confidence raised GDP by nearly 9% in 2004, for a third consecutive year of high growth. Absent any shocks, expansion should remain robust in 2005 and 2006 at a more sustainable rate of around 6%. The strict macroeconomic policy mix and structural reforms should be fully enforced to ensure that growing capital inflows do not reverse suddenly in the future, and that the domestic economy makes efficient use of such financial resources.
Developments in Selected Non-member Economies
Asian growth stabilised in 2004 with a slight increase in China being offset by weakness elsewhere in the area. The increase in Chinese growth came despite tighter fiscal policy and strengthened controls over investment. The latter were only partially effective as high profitability continues to drive outlays in the ever more important private sector. The strength of exports, and the economy as a whole, was also related to the depreciation of the effective exchange rate that resulted from the extensive foreign exchange intervention to stabilise the Renminbi rate against the US dollar. This policy accentuated the increase in inflation. Going forward, domestic demand may slacken but rapid export growth will limit the slowdown and produce a marked increase in the current account surplus. Growth in South America is estimated to have been above 5% in 2004, the strongest in almost 20 years. The strength of the Brazilian recovery was beyond market expectations. Growth continues to be driven by buoyant consumer demand in the major economies in the region, pushed by the recovery in employment and wages, and investment. Export growth also remains robust, due to favourable commodity prices and strong demand from OECD markets, as well as from China. Imports have surged on the back of robust private consumption and investment. Exchange rates have appreciated in the major economies, contributing to the maintenance of low inflation. Growth is set to continue in 2005-06, albeit at a lower pace than in 2004. The area-wide external current account is expected to remain close to balance at the end of the projection period, underscoring the region’s renewed resilience to potential future external shocks. Russia and other commodity exporters among the Newly Independent States are expected to continue to benefit from very high prices for hydrocarbons and metals. However, Russian activity should slow, as the growth rates of both investment and export volumes have fallen and are unlikely to pick up again in the absence of steps to restore shaken business confidence. Nevertheless, Russia’s expansion is set to continue, as oil windfalls are increasingly used to finance expansionary fiscal policy and to fuel household consumption.
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