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.