DOMESTIC DEMAND IMPROVING

    Peaking price of oil had been blamed for the sluggish growth of the euro zone in 2005. It is true that lower oil price did help economic recovery this year, but it is not the main driver.

    According to the European Commission, the economic growth was mainly supported by robust domestic demand, in particular investment that rose at an annual rate of 6 percent in the first half of 2006. Investment in equipment, especially, is set to grow by more than 5 percent in 2006. Consumer spending is expected to pick up more gradually, mirroring an improved labor market. Exports, on the other side, continue to be supported by the strong world economy.

    Domestic demand and exports are regarded as the two engines of the euro-zone economy, but weak domestic demand has always been the Achilles' heel before.

    Reflecting the economic activity, employment growth has also increased more strongly since the last quarter of 2005. In October, the euro-zone jobless rate kept declining and stood at 7.7 percent, much lower than 8.5 percent registered in the same period last year.

    Meanwhile, inflation has remained remarkably stable this year at an expected 2.2 percent. Core inflation, which excludes energy prices and unprocessed food, remains subdued, indicating that the oil price hikes have not had any significant second-round effects.

    Inflation expectations also remain relatively contained. The ECB recently cut its forecast for 2007 inflation to 2.0 percent from 2.4 percent and its projection for 2008 inflation to 1.9 percent, which will be in line with the ECB's target of a rate below but close to 2.0 percent.