EDITORIAL

9 June 2005 - Monthly Bulletin

At its meeting on 2 June 2005, the Governing Council of the ECB decided to leave the minimum bid rate on the main refinancing operations of the Eurosystem unchanged at 2.0%. The interest rates on the marginal lending facility and the deposit facility were also left unchanged at 3.0% and 1.0% respectively.

Overall, on the basis of its regular economic and monetary analyses, the Governing Council expects euro area underlying inflationary pressures to remain contained in the medium term. Accordingly, it decided to leave the key ECB interest rates unchanged. The exceptionally low level of interest rates across the entire maturity spectrum continues to provide considerable support to economic growth in the euro area, which currently shows only moderate dynamics. At the same time, the Governing Council will remain vigilant with regard to upside risks to price stability.

As regards the economic analysis underlying the Governing Council’s assessment, real GDP grew by 0.5% quarter on quarter in the first quarter of 2005, according to first estimates, compared with 0.2% in the previous quarter. However, figures for real GDP growth over the last two quarters partly reflect statistical effects related to working-day adjustments to the data. This has led to some understatement of growth dynamics in the last quarter of 2004 and to some overstatement in the first quarter of 2005. Most recent indicators for economic activity remain, on balance, on the downside.

The moderation in economic activity observed since mid-2004 is partly related to the rise in oil prices. Looking ahead, there is scope for positive fundamental factors to again shape the outlook, assuming that the effects from adverse developments gradually diminish. Notably, global economic activity is expected to remain strong, despite some moderation from the record levels observed last year. This continues to support euro area exports and should also have a positive impact on investment. Investment is expected to benefit from robust earnings, improvements in business efficiency and the very favourable financing conditions. At the same time, consumption growth is expected to develop in line with real disposable income growth.

This assessment is broadly consistent with the June 2005 Eurosystem staff projections. Euro area real GDP is projected to grow at rates of between 1.1% and 1.7% in 2005, and between 1.5% and 2.5% in 2006. Recent forecasts from international and private sector organisations give similar indications. In comparison with the March 2005 ECB staff projections, the ranges projected for real GDP growth in 2005 and 2006 have been adjusted slightly downwards.

All in all, in the judgement of the Governing Council real economic growth should gradually improve over the period ahead. At the same time, recent data have heightened the uncertainties surrounding the short-term evolution of domestic demand, and persistently high oil prices and global imbalances may pose downside risks to the projections for economic growth.

Turning to price developments in the euro area, according to Eurostat’s flash estimate annual HICP inflation was 2.0% in May, compared with 2.1% in April. Over the coming months, annual HICP inflation rates are expected to remain broadly around current levels. On the one hand, energy prices are exerting upward pressure on HICP inflation. On the other hand, underlying inflationary pressure has been rather contained and, on average, wage increases have remained moderate over recent quarters.

In the June 2005 Eurosystem staff projections, average annual HICP inflation is seen to lie between 1.8% and 2.2% in 2005, and between 0.9% and 2.1% in 2006. Compared with the ECB staff projections published in March 2005, the inflation projections for 2005 have been revised slightly upwards and for 2006 slightly downwards. In 2006, this largely reflects the expected statistical effect of a planned health care reform in one euro area country, the Netherlands, which is estimated to imply a one-off reduction of 0.2 percentage point in the euro area inflation rate for 2006. This effect should be excluded from the assessment of the medium-term outlook for price stability.

Taking into account the assumptions underlying the projections, upside risks to the inflation projections prevail. These risks relate notably to future oil price developments, indirect taxes and administered prices. Furthermore, ongoing vigilance is required in order to ensure that past price increases do not lead to second-round effects in wage and price-setting throughout the economy. In this respect, continued responsibility on the part of social partners is very important.

The monetary analysis provides further insight into the risks to price stability over the medium to longer term. Over the past few months, money and credit have continued to grow robustly in the euro area. These developments mainly reflect the stimulative effect of the low level of interest rates in the euro area. The monetary dynamics are driven by the strong growth of the most liquid components of broad money contained in the narrow aggregate M1. At the same time, the euro area private sector’s demand for MFI loans, in particular for house purchase, has remained strong.

The assessment of ample liquidity in the euro area is confirmed by all indicators. In the light of, among other things, the increasingly liquid nature of monetary expansion, the accumulated stock of the broad monetary aggregate M3 may entail upside risks to price stability over the medium to longer term.

To sum up, the economic analysis suggests that underlying domestic inflationary pressures remain contained in the medium term. At the same time, it is necessary to underline the conditionality of this assessment and the related upside risks to price stability. Cross-checking with the monetary analysis supports the case for ongoing vigilance.

As regards fiscal policies, developments in the euro area remain of concern. While a few countries are succeeding in maintaining sound budgetary positions, in several countries it is essential that fiscal consolidation is given the highest priority in view of the budgetary situation. Moreover, the revised rules and procedures for the Stability and Growth Pact, expected to take effect soon, need to be implemented in a strict manner to ensure credibility and to promote a timely return to sound budgetary positions.

With respect to structural reforms, the “Integrated Guidelines” for 2005-08, covering both the new Broad Economic Policy Guidelines and the new Employment Guidelines, are soon to be adopted. These guidelines for economic and employment policies will, in turn, serve as the basis for action at the EU level and for Member States to draw up national reform programmes by the autumn of this year. The new governance structure of the Lisbon agenda should provide fresh impetus to structural reforms in Europe. These reforms are vital for Europe’s ability to respond to the challenges arising from an ongoing deepening in the global division of labour, the fast process of technological change and the ageing of the population. A determined approach in addressing these challenges and successful communication that convinces the public of the benefits of the reforms hold the key to both improving the economic outlook in the short run and sustaining the prosperity of European citizens in the longer term.