Euro Area Policies: Staff Report for the 2007 Article IV Consultation with Member Countries Supplementary Information

The Euro Area Policies’ 2007 Article IV Consultation reports that the economy is poised for a sustained upswing because of cyclical considerations and policies, which have had a forward-looking cast. The area’s external position and the real effective exchange rate of the euro are within range of medium-term equilibrium. Stabilizing inflation below 2 percent might well require a further gradual tightening of monetary policy. Increased contestability and integration in the financial sector is also key to improving performance.

Abstract

The Euro Area Policies’ 2007 Article IV Consultation reports that the economy is poised for a sustained upswing because of cyclical considerations and policies, which have had a forward-looking cast. The area’s external position and the real effective exchange rate of the euro are within range of medium-term equilibrium. Stabilizing inflation below 2 percent might well require a further gradual tightening of monetary policy. Increased contestability and integration in the financial sector is also key to improving performance.

1. This supplement provides an update of economic and policy developments since the release of the staff report (7/10/07). The thrust of the staff appraisal remains unchanged.

2. Recent data indicate that economic activity remains buoyant (Table 1). Growth in 2007:Q1 was revised up modestly, to 2.8 percent on a quarterly annualized basis (3.1 percent over 2006:Q1). Industrial production data for May and purchasing managers’ indices for manufacturing and services in June point to robust growth ahead.

Table 1.

Euro Area: Main Economic Indicators

(in percent change)

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Sources: IMF, World Economic Outlook; Eurostat, ECB Monthly Bulletin.

Contribution to growth, in percentage points.

Includes intra-euro area trade.

In percent.

In percent of GDP.

Based on normalized unit labor costs.

Based on ECB data, which exclude intra-euro area flows.

Data for goods.

Calculated as the sum of individual countries’ balances.

3. Exports continue to show strong momentum. The latest foreign trade data suggest that euro-area (nominal) goods exports stood 9 percent and imports 5 percent above last-year’s levels during January-May 2007. Over the same period, the trade balance swung from a deficit of euro 20 billion (0.2 percent of GDP) to a surplus of euro 4 billion. The staff’s March 2007 assessment suggested that the euro’s real effective exchange rate was still broadly in line with fundamentals; since then the currency has appreciated by about 2 percent in real effective terms.

4. Headline and core inflation stayed at 1.9 percent in June. Capacity utilization continues to increase. Unemployment fell to 7.0 percent in May, the lowest level since the beginning of harmonized records. Labor cost indicators, however, suggest still contained wage increases. Inflation expectations have essentially moved sideways.

5. The ECB left interest rates unchanged at its July 5 meeting. Market participants expect further interest rate hikes in September and December, to 4½ percent by end year.

6. Pressures to slow fiscal adjustment are mounting. Since the staff report was finalized, key countries have loosened fiscal targets or tabled proposals to do so.

Euro Area Policies: 2007 Article IV Consultation: Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Member Countries
Author: International Monetary Fund