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IP/07/197

Brussels, 16 February 2007

Economic growth in the European Union continues at a brisk pace

Economic growth in the European Union is set to stay at a brisk pace in 2007 with growth seen at 2.7% in the EU and 2.4% in the euro area in the European Commission's interim forecast. This is +0.3 percentage point above the autumn forecast for both areas. 2006 was a remarkable year, with growth driven by domestic demand thanks to an improved labour market situation (3 million jobs created of which 2 million in the euro area). This allowed the EU economy to weather energy prices that reached record levels in the summer, tighter monetary conditions and a slowdown in the United States. Such developments bode well for 2007. On the inflation front, while higher energy costs pushed up consumer prices to 2.2% last year in both the EU and the euro area, inflation is expected to decline to 1.8% in 2007 in the euro area (2.0% in the EU) on the back of lower oil prices and a relatively limited impact of the German VAT hike.

The European economy has done remarkably well in 2006 and is set to continue to grow briskly in 2007. This is not only due to the favourable cyclical conditions. It also reflects an increased resilience of the European economy and shows that the economic reforms already carried out were worth the effort. The result is that the EU is creating more jobs and the structural unemployment has fallen to its lowest level in more than a decade. We must avoid repeating the mistakes of the past and make use of these good economic times to pursue on the road of sound public finances and structural reforms, which is the only way capable of delivering a greater and more sustainable economic growth," said Joaquín Almunia, Economic and Monetary Affairs Commissioner.

Economic growth reached 2.7% in the euro area and 2.9% in the EU in 2006, up from 1.4% and 1.7% respectively in 2005. This was the highest growth in both areas since 2000. Higher oil prices kept consumer price inflation at 2.2% in 2006 for both the euro area and the EU, unchanged from 2005. But core inflation (excluding energy an unprocessed food prices) remained steady at around 1.5%.

Looking ahead, GDP growth is set to continue at a relatively brisk pace, though moderating to 2.4% in the euro area and 2.7% in the EU. This is still 0.3 percentage points higher than projected in the Commission services' autumn 2006 forecast. And inflation is seen lower at 1.8% in the euro area and 2.0% in the EU.

This is the third interim forecast of the Commission’s Economic and Monetary Affairs Directorate General. It updates the economic outlook for France, Germany, Italy, Poland, Spain, United Kingdom and, for the first time, the Netherlands. Together, these seven countries account for more than 80% of the EU’s GDP.

Growth to stay above potential

The European economies performed better than expected in 2006 despite the high oil prices, tighter monetary conditions and a slowdown of the US economy. Survey data indicate that the EU economy will continue to grow above potential.

Global growth, revised upwards to 5½% for this year, continues to support the outlook. But it is domestic demand, i.e. private consumption and investment, which will be the main drivers of the recovery. In particular, the better-than-expected inflation outlook and favourable labour market developments will boost real disposable income, thereby supporting private consumption further.

The pick-up in growth goes hand-in-hand with narrowing growth differences across the largest economies. In the case of Germany, the growth profile is also influenced by the 3 percentage point increase in the standard VAT rate in January 2007.

Inflation is easing, but upside risks

Inflation is expected to drop in 2007 on the back of lower oil prices and a more muted impact of the German VAT increase than initially feared. Based on the futures market, the average price for Brent crude is estimated at $59.9 per barrel in 2007, $6½ less than in the autumn.

A pick-up in labour productivity and intense international price competition should also contribute to keep inflation in the euro area below the 2% threshold of the European Central Bank. However, some price pressures at producer level and higher-than-expected wage settlements could constitute a risk to this benign inflation outlook later in the year.

Positive outlook in both labour market and public finances

Reflecting the buoyant economic activity, employment growth has picked up remarkably since the last quarter of 2005, with 3 million new jobs in the EU, of which 2 million in the euro area. In December 2006, the jobless rate stood at 7.5% in the euro area (an annual average of 7.8%), the lowest level in more than a decade. This is equal to the estimated natural rate of unemployment, which has seen an encouraging decline in recent years, suggesting that structural reforms are paying off.

The information available also indicates that public finances turned out better than expected in several Member States in 2006, a positive development that should, at least in part, be carried over to 2007.

Risk assessment

The risks to the forecast seem to be broadly balanced. In particular, the turnaround in the labour market could lead to a virtuous circle of rising labour incomes, improved confidence and higher consumer spending. On the other hand, and despite the leeway created by the recent rebound in productivity growth, an acceleration of wages unrelated to expected increases in productivity could choke off the expansion by inducing a faster-than-expected monetary policy tightening. Uncertainty also remains high regarding the impact of the VAT increase in Germany, where the strong performance in the second half of 2006 could be followed by weaker growth in the first half of 2007. On the external side, while the risk of a hard landing for the US economy seems to have diminished, the issue of global imbalances and the associated risk of their disorderly unwinding remains a concern.

More detailed report available on: http://ec.europa.eu/economy_finance/publications/european_economy/forecasts_en.htm
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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