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Brussels, 6 September 2006

European economic growth speeds up in 2006 boosted by buoyant investment and consumption

Economic growth is speeding up this year to 2.7% in the European Union and 2.5% in the euro area, driven mainly by domestic demand, particularly investment. This is the strongest growth since 2000. In this positive climate, the number of jobs created by the economy is also growing and the unemployment rate dropped to 8% in the EU and 7.8% in the euro area in July. While consumer prices are pushed up by higher energy costs, underlying inflation remains contained thanks to improved labour productivity and international competition. Overall, inflation is expected to be 2.3% in 2006 in both EU and euro area after 2.2% last year.

Economic growth this year is set to be the best we have had since 2000. Let’s use these good times to press ahead with further structural reforms and budgetary consolidation. Only this way will we be able to increase the growth potential where it is low and manage the necessary safety margin for when the going gets rough”, said Joaquín Almunia, the Economic and Monetary Affairs Commissioner.

Economic growth in 2006 is set to reach 2.7% in the EU and 2.5% in the euro area, up from 1.7% and 1.4% in 2005. This is a strong upward revision of the Commission's spring 2006 economic forecast (2.3% and 2.1% respectively). The revision is justified mainly by the acceleration of growth in the first quarter to 0.8% followed by 0.9% in the second quarter, in both the EU and euro area.

Consumer price inflation in 2006 is seen at 2.3% for both EU and euro area versus a forecast in the spring of 2.1% and 2.2%, respectively, and a result in 2005 of 2.2%. This is based on the assumption that oil prices will remain around $73 per barrel, in accordance with market expectations, and that the exchange rate of the euro against the US dollar will remain around its current level.

These are the second interim forecasts of the Commission’s Economic and Monetary Affairs Directorate General. As in February, the exercise provides updates for the five largest economies of the EU. This time also Poland was included, being the biggest of the 10 countries that joined the EU in 2004. Together they account for 77% of the EU’s GDP.

Domestic demand is the main driver

The European economy is set to continue to grow above potential throughout the year despite an increase in oil prices of 80% since the start of 2005.

Global growth, revised upwards by around ½ percentage point this year, continues to support the outlook. But, it is domestic demand that is the main driver of the recovery in the EU. Recent data confirmed strong private investment, with an increase of 2% quarter-on-quarter in the second quarter.

The strong pick-up in EU growth goes hand in hand with narrowing growth differences among the larger economies. Although the survey data suggest an easing in the second half, the larger Member States are all expected to grow at or above potential. In the case of Germany, the growth profile is influenced by the increase in the standard VAT rate by 3 percentage points in January 2007, but the overall effect of these measures is assessed to be broadly neutral over a time horizon of two years.

Looking further ahead, the updated economic growth outlook may result in an upward revision also for 2007. But the impact of a higher carry-over into 2007 will have to be carefully assessed. The next fully-fledged Commission economic forecasts are due early November.

Steady underlying inflation

On the inflation front, consumer prices continue to be pushed up by energy costs, but core inflation (excluding energy prices and unprocessed food) remains subdued pointing to limited second-round effects so far. Inflation expectations also remain relatively contained thanks to the pick-up in labour productivity and intense international price competition. However, increased price pressure at producer level has started to become a source of concern. Overall, inflation is expected to reach 2.3% in both the EU and the euro area this year (+0.2 and 0.1 pp compared to the spring forecast).

Positive outlook in both labour market and public finances

Reflecting the economic activity, employment growth has also increased more strongly since the last quarter of 2005. In July, the jobless rate stood at 8% in the EU and 7.8% in the euro area versus 8.7% and 8.6%, respectively, a year earlier. In view of the pronounced pick-up in economic activity, labour productivity is set to rise at around 2% this year.

The information available also suggests that in most of the larger Member States, the budgetary outturn may turn out somewhat better than expected in 2006, thanks to the improved outlook and a higher tax content of growth.

Risk assessment

The risks to the forecasts seem to be slightly tilted to the upside for the second half of this year. Provided that the current favourable conditions are maintained, the present strong growth momentum may be sustained implying higher quarterly growth rates than expected. Moreover, the improved labour market situation may impact on private sector spending more strongly than assumed. Looking into next year, however, the risks are rather on the downside. In particular, further oil price hikes cannot be ruled out. In addition, a disorderly unwinding of global imbalances continues to be a threat to the world growth outlook, particularly if the US housing market slows down more markedly.

More detailed report available on:
Table 1: Real GDP growth
[ Figures and graphics available in PDF and WORD PROCESSED ]
Notes: (a) Data for 2006/1 and 2006/2 are estimates released by Eurostat. Where possible the quarterly
growth rates are working-day and seasonally-adjusted, whereas the annual projections are unadjusted.

Table 2: Consumer price inflation

[ Figures and graphics available in PDF and WORD PROCESSED ]

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