Global economic activity has weakened significantly in recent months after strengthening considerably in the first half of 2002 and while the outlook remains uncertain the prospects bode well for a recovery in 2003 and 2004. As 2002 progressed activity slowed and events over recent months regarding corporate governance, volatility in equity prices and the possibility of military action on Iraq have served to depress both consumer and business confidence. For the year as a whole we continue to expect global GDP growth (measured at Purchasing Power Parity exchange rates) to be around 2.8 per cent, which whilst below long-term trend levels, would be a welcome improvement on the growth of under 2.2 per cent seen in 2001. Most of the major world economies are now expected to return towards potential growth levels during 2003 and sustain this momentum into 2004.
Our view is that the Euro area and broader EU economy will grow by 1 and 1.1 per cent respectively this year in real Gross Domestic Product (GDP) terms. The Euro area is expected to grow by 1.6 per cent in 2003 and 1.9 per cent in 2004 in real GDP, still somewhat below potential growth levels. The EU economy is expected to grow in real GDP terms by 1.8 per cent and 2.2 per cent in 2003 and 2004 respectively. The outlook for price developments in Europe using the Harmonised Index of Consumer Prices (HICP) is for inflation to moderate from just over 2 per cent in 2002 to around 1.5 per cent in 2003. In 2004, the HICP in the Euro area is expected to fall to 0.8 per cent and 1.3 per cent in the EU economy. The euro exchange rate is expected to continue its appreciation over the next two years towards a bilateral rate of €0.95 per US$ by the end of 2003 and remaining close to this in 2004. This forecast appreciation of the euro, in both real and nominal effective exchange rate terms, help modify the inflationary outlook for 2003 and 2004 given the anticipated recovery in output growth. Interest rates in Europe are expected to move downward through 2003 before rising back towards current levels by 2004.
The contribution from the public sector is expected to be more muted than in recent years. Government expenditure is expected to moderate from rises of 1.8 per cent in 2002 to 1.5 per cent and 1.2 per cent in 2003 and 2004 respectively. The general government deficits in the Euro area are forecast to improve marginally from 2.1 per cent of GDP in 2002 to 2 per cent and 1.7 per cent of GDP in 2003 and 2004.
The below potential growth outlook for the Euro area means that the rate of unemployment is set to rise from 8.3 per cent in 2002 to 8.4 per cent in 2003 and 8.6 per cent in 2004. Average earnings growth in the Euro area is expected to moderate from 3.6 per cent in 2002 to 3.3 per cent and 2.8 per cent in 2003 and 2004 respectively. Real personal disposable income growth is expected to rise from 1.9 per cent in 2002 to 2.4 per cent in 2003 before easing to 2.1 per cent in 2004.