Euro area GDP growth decelerated from 2.6% year-on-year in the third quarter of 2007 to 2.2% in the fourth quarter. This deceleration owes much to a weakening of private consumption on the back of surging consumer prices. In February, inflation was running at 3.3%, up from 1.7% in the summer of last year.

However, continued strong growth in investment supported by high capacity utilisation and the high profitability of the non-financial corporate sector is encouraging. According to the Commission’s interim forecast of February 2008, economic growth in the euro area is expected to slow down to 1.8% for 2008. This is borne out by the hard and soft data released since. Confidence indicators in the manufacturing sector have generally held up relatively well in recent months and the latest reading of industrial production was stronger than expected.

The recent increase in inflation differentials among euro-area Member States is analysed in this QREA. It shows that the economies of Member States have reacted somewhat differently to the increase in energy and food prices since summer 2007, as a result for example of differences in the weight of food and energy in the national HICP basket, the degree of competition in retail markets and the position in the economic cycle. How far the appreciation of the euro has moderated inflation also depends on the pattern of international trade, cyclical conditions and degree of competition in the domestic retail markets.