Euro area: Below potential
The euro area economy has slipped into recession this year, with tighter financial conditions, negative wealth effects, weaker housing market activity and greater uncertainty all reducing domestic demand. Growth is expected to remain below potential until the middle of 2010, before picking-up as the effects of monetary policy easing and the dissipation of stress in global financial markets emerge. Lower commodity prices and the emergence of a sizable negative output gap as production slows below potential will dampen inflationary pressures, with headline inflation projected to fall to around 1.5% during 2009.
With inflationary pressures already easing, there is scope for additional monetary stimulus, which should be prompt to minimise the downside risks to activity. The loss of tax revenues from financial and housing markets and the costs of emergency actions to alleviate financial turmoil will add to budgetary pressures. Any additional discretionary fiscal measures should be well-targeted and, reflecting the need for medium-term fiscal consolidation, temporary. Growth prospects would be enhanced by implementing measures to strengthen the regulatory and supervisory frameworks in European financial markets.