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 reduction.