Output has grown at a solid pace, underpinned by robust productivity growth, buoyant house prices, and fiscal and monetary stimulus. The continuation of several of these factors, together with the economy’s inherent momentum, suggests that the recovery will maintain a relatively smooth trajectory -- despite damaging hurricanes and large increases in oil prices. There has been little sign so far of increases in energy prices feeding into the general level of wages or non-energy consumer prices. Nevertheless, a moderate acceleration in core prices is expected during the next few quarters.

As the last signs of slack in the economy disappear, the large monetary stimulus delivered in recent years is no longer desirable and is being removed. Short-term interest rates are approaching a neutral position and will need to turn restrictive should increases in energy prices start being built into underlying inflation. The federal government’s financial position has improved, thanks to an unexpected increase in revenues. But much of this windfall is being spent on large hurricane and military-related expenditures. This highlights the importance of fiscal discipline in the face of longer-term spending pressures and the risks posed by the large external deficit.

The economy recovered from a pause in the latter half of 2004 with strong growth in the first half of 2005 despite a number of headwinds. The expansion is led by private domestic demand, underpinned by strong corporate profits and a reversal of the declining trend in employment and wages. A number of indicators suggest that the economy has finally completed the post-bubble adjustment, allowing output to grow at a rate of around 2% in 2006-07.

The Bank of Japan’s policy of quantitative easing should continue until inflation is high enough to make the risk of renewed deflation negligible. The government should accelerate the pace of fiscal consolidation given the faster than expected GDP growth. A broad structural reform programme is needed to boost potential growth in the context of rapid population ageing. While the enactment of the Japan Post privatisation bills is a welcome step, effective and rapid implementation of the bills is needed to realise the economic benefits of this reform.

Activity appears to be picking up after a lull in early 2005. The moderate recovery is expected to continue over the next two years. Business investment should rise as foreign and domestic demand improve, and household consumption should grow in line with disposable incomes. But the recovery is not expected to absorb all the economic slack by the end of 2007. Headline inflation should drop below 2% next year when the impact of the oil price hike wanes.

With the recovery expected to be moderate and any oil-price induced second round effects on wage inflation being uncertain, monetary policy should remain on hold for some more time, with tightening starting in earnest later next year. To ensure the long-term sustainability of public finances, fiscal consolidation needs to get underway as soon as it can safely do so without jeopardising the recovery. Further structural reforms are needed to improve the euro area’s medium-term economic performance and its resilience to shocks.

Based on strong export growth, output is projected to improve. While weak consumption and construction investment are still weighing on activity, equipment investment has strengthened. As the upswing broadens, GDP is projected to grow slightly above potential, 1¾ per cent (working day adjusted) in both 2006 and 2007. The general government deficit is likely to total 3.9% of GDP in 2005, and remain high in 2006, but then fall to 2.6% in 2007, largely on account of an increase in the value added tax rate.

For economic performance to be raised in a durable way, the new government has to go further in reforming labour and product markets within a coherent framework. Fiscal consolidation needs to be linked to more fundamental spending reform, requiring, inter alia, the untangling of responsibilities across different levels of government, more determined reductions in both subsidies and tax expenditures and continued reform of the social security system.

The recovery that appears to have gained hold in the second half of the year should continue into 2006. Domestic demand is expected to pick up slightly and exports should recover. Modest employment gains will permit only a small drop in unemployment. Inflation is likely to fall back somewhat as the “second-round” effects of higher energy prices appear to be small. The general government deficit is likely to remain above 3% of GDP.

While the shortfall on the target for reducing the budget deficit may be largely due to low growth, firm measures to reduce it significantly over the next few years remain necessary. Moves to simplify parts of the tax system are welcome; introducing more tax breaks for certain activities unfortunately offsets this, adding to the system’s complexity. Social unrest calls for policies to improve prospects for the excluded. Fundamental labour market reforms, including liberalising regulations that restrict job opportunities for the low-skilled, should be a key component.

The recession ended in the spring of 2005. Domestic demand has been stimulated by labour deepening, disinflation, fiscal ease and supportive monetary conditions. Exports have benefited from euro depreciation and recovery elsewhere in the euro area, but imports are also rising markedly. The pass through of higher oil prices will limit the strength of the recovery in 2006, but as these effects dissipate household consumption should support an acceleration of GDP in 2007.

The sustainability of the recovery depends on reversing highly unfavourable trends in international competitiveness and public debt. In particular, real wage growth needs to be better aligned with productivity, while public spending must be restrained sufficiently to lower the tax wedge and restore the primary surplus. Service sectors should be opened to competition to boost productivity.

Growth has slowed sharply, largely due to weaker consumption related to the ending of the house price boom. But strengthening investment and exports should lift growth from below 2% this year to 2½ per cent in 2006 and 2¾ per cent in 2007.

The government deficit exceeded 3% of GDP in 2004. If fiscal developments disappoint relative to the 2005 Budget projections, beyond what can be explained by weaker-than-expected growth, then the Government will need to take further measures to achieve a decisive reduction in the deficit. With inflation having surprised on the upside and the prospect of a gradual return towards trend growth early next year, there is currently no compelling case for a further cut in interest rates. To raise potential growth a priority is to roll out nationally the reform of the disability scheme, while taking measures over the longer term to improve workforce skills.

Despite the marked appreciation of the Canadian dollar, the economy has been extremely resilient and is operating near full capacity. Economic activity is expected to grow at rates close to potential in the next two years, with the foreseen slowdown in domestic demand being offset by improving global market prospects. The surge in energy prices is boosting headline inflation temporarily this year above the upper end of the monetary policy target range.

With inflationary pressures emerging, the Bank of Canada started increasing its policy rate in September and will need to continue to bring interest rates to around their neutral level. Given the buoyant macroeconomic outlook, any additional fiscal stimulus should be avoided. By contrast, more attention should be given to preparing the economy to cope with the rising long-term spending pressures coming from the ageing population.

Economic activity strengthened in the first half of 2005, primarily driven by business investment. With non-residential investment expected to remain buoyant, the ending of the housing boom to be orderly and gradual, and the drag from net exports diminishing, output is likely to accelerate in 2006 and 2007. This should help to sustain the good labour market performance. Inflation may edge up somewhat in response to surging energy prices.

To preserve price stability, monetary policy needs to remain on guard to prevent higher energy prices from feeding into core inflation. The stabilisation task should be facilitated by the projected steady fiscal surpluses over coming years. Rapid implementation of the planned industrial relations reform would also help as it would promote productivity gains and restrain unit labour cost growth.

Growth of GDP is expected to fall to 1.8% in 2005, as the impact of increased oil prices and the slowdown of demand in major export markets more than offset the positive stimulus from deficit-financed tax reductions. With growth gathering pace slowly, reaching 2¼ per cent in 2007, unemployment will remain high by historic standards. The impact of oil prices on inflation will fade by 2007.

The government deficit is projected to decline only modestly by 2007. However, further substantial reductions in government spending will be necessary to lower the relatively high level of government debt in relation to GDP significantly, and make more room for future increases in ageing-related spending.

Developments in oil prices and in export markets have weighed on Belgium’s activity but, with these factors becoming more favourable, growth is projected to pick up progressively, reaching 2.3% in 2007. Employment growth is, however, unlikely to be strong enough to reduce the unemployment rate much from the current 8.4%. Headline inflation should fall back almost to the underlying rate of 1.6% by 2007.

Further fiscal consolidation measures, focusing on expenditure restraint, should be implemented to build on progress made in moving public finances towards a sustainable path. Reforms to lower benefit dependence and increase employment rates, especially for older and younger workers, are vital as they reduce the amount of consolidation required for the sustainability of public finances.

Growth is expected to be 4¾ per cent in 2005, with an exceptionally large contribution from net exports. For 2006 and 2007 the trade component will fall while domestic demand is expected to strengthen and GDP growth is projected to be 4½ per cent. This will bring inflationary pressure and a slight tightening of monetary policy.

Though growth performance has strengthened since the early years of the decade, better progress in improving the business environment and labour-market efficiency would help reduce downside risks. In fiscal policy, even though there are good prospects of fulfilling the Maastricht criteria, further reform to the financing and provision of public services is needed to reduce the risk of unsustainable public finances in the longer term.

GDP is projected to grow almost 3% a year before abating somewhat in 2007. Recent house price increases are likely to sustain consumption growth into 2006. Starting with a slight negative output gap, economy-wide wage and price inflation is expected to gather pace towards 2007, with the construction sector already now beginning to show signs of overheating.

Monetary conditions, reinforced by new loan types on the mortgage market, are providing stimulus for the economy and this is likely to continue with short-term interest rates remaining stable in line with those of the European Central Bank. In this context, the sizeable extra revenues from North Sea oil exploration must be used to reduce public debt, with fiscal policy helping to contain aggregate demand. Measures to raise labour supply should also be considered.

Growth is expected to recover from 1¼ per cent in 2005 to average 3% over the next two years, in part reflecting a bounce back from the effects of a labour dispute in the paper industry. Net exports rather than consumption will become increasingly important for driving growth.

Job creation is likely to be less than half that required to hit the government’s employment target, while ageing will lead to a declining labour force and pressures to raise social security contributions. This underlines the importance of measures to reduce early retirement and motivate job search as well as to contain public spending pressures so that the overall tax burden can be reduced.

The economy has slowed during 2005, mainly as the result of a post-Olympic slump in investment activity, though it continued to outpace the euro area average. Output growth is set to weaken further going into 2006, before rebounding to 3½ per cent in 2007 as domestic demand strengthens. Inflation should decelerate to around 3¼ per cent over the next two years, but a large inflation differential vis-à-vis the euro area average will remain. The current account deficit is expected to stay high.

Sustained fiscal consolidation requires a better control of primary spending and decisive reforms in key areas of social spending and public administration. Reducing tax evasion and tax avoidance is likewise critical. Plans for improving the operation of public enterprises are welcome. Further progress in the structural reform agenda would provide a sounder environment for long-term growth.

Output growth of close to 4¼ per cent is expected in 2005, rising to 4½ per cent in 2006 before edging down a little in 2007. While some reduction in the contribution from the external sector is likely, domestic demand is expected to pick up. Inflation is set to fall sharply in the near term, reflecting reductions in indirect taxes but will rise again in 2007, though it will remain on track to meet medium-term targets.

Ensuring fiscal sustainability must be a priority. For 2006 the government aims for a substantial cut in the headline budget deficit but one-off factors, notably plans to take expenditure on motorway construction off budget, suggest that the underlying deficit will increase by about one percentage point of GDP. A fiscal strategy that backs realistic targets with stronger spending discipline is needed to recover credibility and avoid an increase in the risk premium.

The economy continues to show signs of overheating, as the large-scale aluminium-related investment projects are in full swing and household demand is booming. The external deficit is soaring and inflation exceeds the authorities’ upper tolerance limit. The major challenge for policymakers is to ensure an orderly unwinding of the present imbalances and to prevent their recurrence in the future.

Further interest-rate increases are probably required to put inflation on a downward track toward the official target. Avoiding a premature loosening of the fiscal stance would reduce upward pressure on interest rates and help avoid excessive exchange-rate fluctuations, thereby facilitating the stabilisation task of monetary policy.

Output is projected to grow at a steady 5% rate over the entire projection period. Robust household income gains and government spending will be the engines of growth. Net exports are projected to taper off as rising unit labour costs hold back exports. With strong activity exerting inflationary pressures, core inflation is projected to creep up over the projection period.

More intense competition is needed to provide a countervailing force to inflationary pressures in the short-term and boost growth prospects in the long term. The proposal to repeal the Groceries Order (a regulation hampering competition in retail trade) is welcome in this regard, and deregulatory efforts should be broadened to other sheltered sectors starting with the professions and network industries. A tighter fiscal stance would help to contain inflationary pressures and provide a buffer against adverse shocks from the housing market or the exchange rate.

Private consumption is now recovering from the protracted adjustment following the collapse of the household credit bubble in 2002 and exports have begun to pick up. These factors are projected to boost economic growth from 4% in 2005 to around 5% in 2006-07. Underlying inflation is expected to increase to the mid-point of the central bank’s 2½ to 3½ per cent target zone in the context of stronger growth and higher energy prices.

Monetary policy should focus on the medium-term inflation target, accompanied by a flexible exchange rate policy. Concerns about rising housing prices in some parts of the country should be addressed through tax measures and policies to increase supply. Further reforms are needed to address the structural causes of weak domestic demand, notably household debt delinquency.

Output growth slowed sharply during the first half of the year, as high energy prices weighed on private consumption and weaker foreign markets on exports. The economy nonetheless retains considerable momentum, notably in the services sector, and should soon return to a faster pace. The increase in headline inflation has triggered an indexation of salaries, which could lead to second-round effects.

Fiscal automatic stabilisers have been allowed to operate freely during the slowdown and the public deficit has therefore exceeded 2% of GDP. The government should do more to rein in public spending, which has been growing at nearly two-digit rates.

Following a slowdown in the first half of 2005 due to weaker foreign demand, growth is expected to pick up after mid year, underpinned by the strengthening of export markets and increased public investment, fuelled by high oil revenues. Headline and core inflation rates have come down to the central bank's target and are expected to continue a gradual decline. Employment is growing at a relatively strong pace.

The central bank eased its stance in the second half of 2005. On the fiscal front, the deficit target of 0.2% of GDP in 2005 will be easily met, thanks to higher-than-projected oil revenues. The draft budget for 2006 targets only a moderate consolidation, as lower oil revenues are assumed. A revenue-enhancing tax reform is needed to address spending needs while reducing the vulnerability of public finances to oil price volatility.

The Dutch economy has gone through a long period of below-trend growth in the past five years. With improving cost competitiveness, stronger export market growth and repaired balance sheets, a recovery is now underway; it is projected to broaden in 2006-07. Headline inflation has increased due to rising energy prices, but core inflation is likely to remain moderate.

In view of the expected expansion, the government should allow automatic fiscal stabilisers to fully operate on the upside. Moreover, measures to further relax strict employment protection legislation (EPL) on regular contracts would increase resilience and reforms aimed at increasing working time over the lifespan would help to strengthen labour supply.

Activity is projected to slow and capacity constraints to ease, but some imbalances will persist. While rapidly expanding household incomes are likely to temper the effects of higher interest rates on consumer spending, rising wages and other input costs will squeeze business profitability further and curtail investment. Exports should recover as the effects of the exchange rate appreciation wear off and external markets improve. Inflationary pressures will remain important.

Significant monetary tightening has not yet produced a material slowdown in domestic demand growth, and risks of a sharp correction are increasing. The task of bringing the economy back onto a sustainable growth path would be made easier if the government delayed the planned easing in its fiscal stance, thereby allowing a more balanced policy mix for managing current macroeconomic challenges.

Since mid-2003, mainland Norway has experienced a robust cyclical upswing. After booming at nearly 4% in 2005 thanks to strong domestic demand, mainland real GDP growth is projected to slow towards potential in 2006 and ease further in 2007 in response to the withdrawal of monetary stimulus.

With oil revenues surging and pressures for higher public spending rising in 2006, it will become increasingly important to adhere to strict budgetary discipline so as to preserve the credibility of the fiscal rule, following up on declarations of the new government. Gathering inflationary pressures call for a return to a neutral monetary stance.

The first half of 2005 saw lower-than-expected economic growth as domestic demand weakened. With electoral uncertainty removed, the future should bring a gradual revival of private consumption and investment activity, while net exports may provide less support to growth. Slow but steady improvement in the labour market should help sustain consumer confidence.

Despite lower economic growth, budget revenues came out above expectations and the general government deficit will be lower than planned. However, reform of public expenditure is still needed in order to ensure medium-term fiscal sustainability. A firm commitment to such reform by the new government might allow earlier relaxation of monetary policy, which has been quite tight recently.

The Portuguese economy started to recover in the first half of 2005 driven by exports and private consumption. Real GDP growth is expected to gain momentum in 2006 and 2007 but is likely to lag the average growth in the euro area, with the economy still operating well below its potential.

Fiscal consolidation remains the key policy challenge. After a major slippage in 2005 due to strong social expenditure and the cancellation of all one-off measures, the deficit is expected to narrow somewhat over the projection period as a result of higher tax rates, spending freezes and more in-depth reforms on the expenditure side.

GDP growth is expected to continue in the 5½ to 6½ per cent range and employment growth is picking up. However, inflation risks are re-emerging and structural unemployment remains very high.

Both monetary and fiscal conditions will need to tighten over the projection horizon, in order to damp inflation risks, further reduce the fiscal deficit, and ensure that the plan to adopt the euro in January 2009 remains credible.

Growth should remain strong in 2006 and 2007, close to potential rates (slightly above 3%), driven by buoyant domestic demand and some pick-up in exports following recovery in Europe. Headline inflation is expected to abate somewhat after its recent hike, and core inflation should remain broadly stable, but the differential with the euro area average is likely to persist, further eroding competitiveness.

Moving to a tighter fiscal stance would be desirable to reduce domestic demand pressures and to prepare for the fiscal consequences of ageing. Halting the deterioration in competitiveness will also require making the automatic wage indexation system more flexible. The priority given by the authorities to redirecting government spending to enhance productivity growth is welcome.

Despite a slowdown in exports, economic growth remains robust and is being increasingly driven by domestic demand. The expansion should continue with household consumption projected to benefit from an improvement in employment. Investment, and in particular construction, should continue to grow rapidly in response to low interest rates.

The government’s plan to improve the labour market situation includes increased public spending for 2006. Inflation remains well below target and the central bank has lowered short-term interest rates to historically low levels. Hence, both fiscal and monetary policy are currently expansionary and will have to become more restrictive over the projection period.

Despite the slowdown in foreign demand in late 2004 and the rise in oil prices in the second half of 2005, the Swiss economy is expected to grow by 1¼ per cent in 2005, which is close to potential. Activity should accelerate in 2006, as the European recovery gathers strength, prompting an improvement on the employment front without generating inflationary pressures.

In the absence of tension on prices, maintaining accommodating monetary conditions in the short term is appropriate until the recovery is firmly established. Control over public expenditure needs to be reinforced, however, particularly in the area of social spending, if sustainable fiscal consolidation is to be ensured. The recent series of measures directed to bolstering competition needs to be pursued in order to stimulate productivity growth.

On the back of further improvements in domestic and international confidence following the opening of accession negotiations with the European Union, GDP growth is expected to remain strong at around 6% in 2006 and 2007.

The rigorous macroeconomic policy framework should be maintained. Growing capital inflows are putting upward pressure on the currency, emphasizing the need for an acceleration of the reforms needed to improve the flexibility and competitiveness of the economy.

Output growth has gained momentum since the second quarter and should pick up further over the near term. Private consumption has been resilient, and investment is on the rise. Both the trade and the external current accounts remain in healthy surpluses, despite the rising demand for imports as a result of the strengthening of the real.

Prudent macroeconomic management needs to continue to anchor expectations. Rapid disinflation has paved the way for on-going monetary easing, and the end-year inflation target is now within reach. Fiscal performance remains strong, benefiting from buoyant revenue, and a further fall in the public debt-to-GDP ratio in 2005-07 would be desirable.

Economic growth in China has remained rapid in 2005 buoyed by a strong contribution from the external sector. During the projection period, output growth may stay above 9% and seems likely to be driven by domestic demand, as fiscal and monetary policies have been eased, moving to a more neutral stance, while the effective exchange rate has appreciated slightly. Nonetheless, the current account surplus, after increasing markedly in 2005, is unlikely to fall relative to GDP and may continue to increase in nominal terms. Inflation is projected to decline to under 4%, when measured by the GDP deflator.

Increasing stress is likely to emerge in the interaction between the authorities' exchange rate and monetary policies, given the continued size of the current account surplus and capital inflows. A further appreciation of the exchange rate would help to resolve these problems and guard against resurgence in inflation. It would also help move economic policy towards the use of market instruments, reducing the need for administrative control of credit and thereby reinforcing the progress that has been made in reforming the banking sector in the past year.

Despite extremely favourable shifts in the terms of trade, real GDP growth has slowed in 2005 and is set to decelerate gradually over the projection period. This is largely the result of a policy-induced deterioration in the investment climate at a time when capacity constraints were already starting to affect performance.

In these circumstances, mounting pressure for further fiscal easing should be resisted. The cut in the value-added-tax now being considered by the authorities would be particularly ill advised, as it would needlessly stimulate already booming consumption, fuelling inflation and undermining competitiveness. A renewed structural reform effort, underpinned by fiscal discipline, could boost investor confidence and contribute to increasing potential output.