Most financial markets are showing encouraging signs of stabilization although conditions remain fragile. Spreads on money and bond markets have narrowed on the back of improved economic sentiment and lower risk aversion. Financing conditions in the euro area have also improved as the cost of bank loans, equity capital and market debt have all declined. However, m oney and credit growth have slowed further in recent months, mainly reflecting very weak economic activity but also some supply constraints. Euro-area GDP dropped by 2.5% in the first quarter of 2009, according to Eurostat's release of 3 June, driven mostly by an inventory adjustment and a continued sharp fall in investment. On the positive side, the fall in private consumption was contained by the deceleration of consumer price inflation and comparatively supportive developments in nominal disposable income. While hard data have so far remained depressed, survey data have begun to show a pick up in confidence in most euro-area countries. World trade growth has also shown signs of improvement but stays depressed.
The substantial banking support measures implemented by Member States since autumn 2008 have helped to avert financial meltdown. The measures, mainly in the form of recapitalisation, debt guarantees and asset reliefs have had a positive impact on banks' capital and access to wholesale funding. Developments in price indicators of financial distress suggest that the functioning of interbank markets has improved significantly. However, the convergence process towards more normal conditions has only been partial and the situation remains fragile. In particular, further significant asset write-downs are still to be expected, as confirmed by a recent ECB study.
Budgetary policy is significantly supporting economic activity in the euro area. At the same time, pressure on public finances is increasing. From its low in 2007, the euro-area average debt ratio is projected to increase by 18 percentage points to reach 84% of GDP in 2010 and will rise further in the years beyond because of high government deficits. Coupled with an expected increase in age-related expenditure and an adverse impact on potential output, this raises sustainability concerns and calls for robust exit strategies.
The economic and financial crisis is also likely to result in a lower growth potential in the years ahead due to lower employment and productivity levels as research and development and capital investment are likely to decrease or stagnate. Euro area potential growth averaged 1.8% in the period 2000-2006 but is estimated to have fallen to 1.3% in 2008 and to be only 0.7% this year and next. Historical evidence shows that financial crises tend to have a deeper and more lasting impact than recessions caused by other factors and can be followed by lower productivity growth. A return to pre-crisis potential growth is also likely to be much slower. This calls for timely and appropriate policy responses to create new jobs, for example in low-carbon industries, and by upgrading skills through apprenticeships and the fight of early-school leaving, as proposed by the Commission. It is also important to avoid the policy mistakes of the past (e.g. protectionist policies undermining the Single Market or measures reducing labour supply).
Beyond the crisis, population ageing is expected to weigh substantially on growth during the next decades, becoming apparent already from 2020. Being active and healthy well into old age is now a realistic prospect for a very large number of people. But an ageing population also raises challenges for our societies from a cultural, organisational and economic point of view. The working age population is assumed to start to decline early next decade. This will have a negative impact on potential growth as well as on budgetary conditions. The priority is now clearly to concentrate the efforts in resolving quickly the crisis and to swiftly return to sound public finances. Structural reforms required by demographic change should be pursued vigorously. In particular, these should aim at raising employment rates substantially and at encouraging the ageing baby-boomers to stay in the labour market rather than retire early.
