The Portuguese economy emerged from recession in 2004, driven by exports and private domestic demand. Real GDP growth is expected to pick up further and reach 2¾ per cent in 2006. By any measure, the economy would still not be operating at its potential at the end of the projection period. As a result the inflation differential vis-à-vis the euro area should remain small. Fiscal consolidation remains a challenge for policymakers. Reliance on large one-off measures to keep the deficit below 3 per cent of GDP has become the norm since 2002. These should be replaced by strict controls on spending and the implementation of already-approved reforms should be accelerated. A radical reform of the pension system is also needed to ensure the long-term sustainability of public finances. ...