Euro-area outlook is unsettled, but potential for renewed grow remains
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Page 226
Economic recovery in the 12-country euro area appears to be off to a soft start, according to an IMF staff statement issued on July 12 after the organization's regular consultation with euro-area officials. The weaker-thanexpected growth rates are due in part to a plunging stock market and an appreciation of the euro, which is expected to restrain domestic demand in the short term. Overall, these recent developments suggest that, unless the global recovery gathers strength, growth in the euro area in 2002 will falter despite the gradual upturn of economic activity that began in the first quarter of this year.
Barring significantly more pronounced shocks than those seen so far, however, the IMF staff reports that the region's prospect "would seem to remain one of an upswing back to potential growth." For one thing, the appreciation of the euro should have a positive impact on consumer confidence and spending in the long run and thus help jump-start domestic demand.
The inflation outlook in the euro area presents more of a concern. Although the recent acceleration in inflation is attributable in part to the one-off effects of weather, energy, and the euro changeover, it also coincided with wage pressures, increases in inflationary expectations, and supportive monetary conditions. In this environment, inflation was expected to recede slowly to just below 2 percent in 2003.
The staff noted that the appreciation of the euro relieves price pressures and that faltering growth makes it less likely that inflation will be problematic.As a result, the pressure on monetary policy has eased, and the ECB has gained some breathing room to determine what to do with interest rates.
As for the IMF's concern that the ECB's price stability objective may be too low, the staff noted recent statements byPage 227 ECB officials recognizing that vigilance would be necessary in the event that inflation fell to excessively low levels and that a small positive rate of inflation "say, between 1 and 2 percent," would significantly reduce the risks of getting trapped in a deflationary spiral.
On the fiscal front, the main issue in the euro area is for the three largest economies-Germany, France, and Italy-to meet their commitments to achieve a budget close to balance or in surplus by 2004 and "thereby impart badly needed credibility to the Stability and Growth...
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