Modest economic growth in 2005 reflected a continuing weakness in export performance. The second-half recovery continued into 2006 and is likely to be maintained. Inflation should remain around 2% or lower, though some pick-up in the underlying rate is expected. The outlook for employment remains poor, even though the unemployment rate should decline slowly. The general government budget deficit shrank substantially in 2005, partly reflecting a special one-off factor. Going forward, the challenge is to step up the pace of underlying fiscal adjustment and restore public finance sustainability in the face of the pressures stemming from population ageing. Labour market reform made progress last year with the introduction of a new contract for small firms but stalled more recently on opposition to the proposed new contract for workers under 26. Over the longer run, minimising the uncertainty surrounding separation costs for employers and moving towards a single labour contract would help reduce the social exclusion and insecurity associated with labour market segmentation.