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and a large output gap prevailing in 2006, there is room to ease monetary policy, even though liquidity will have to be withdrawn again once the recovery is firming towards the end of the projection period.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.