THE global recovery that began in 2002 continues, with world GDP advancing 4.9pc in 2006 and 4.4pc in 2007. This makes the 2004-2007 expansion the fastest since the early 1970s. Around the G7, growth generally accelerates this year and moderates next, although the US and UK are clear exceptions. Growth in the US slows progressively through 2006 and early 2007 to a pace below its 3.2pc potential growth rate. Conversely, monetary tightening in 2004 succeeded in slowing UK growth to less than 2.0pc in 2005, but domestic demand is now recovering, boosting growth to around 2.5pc both this year and next. In Japan, the recovery stays on track, with GDP rising 3.0pc in 2006 before slowing to around 2.0pc in 2007. Growth also accelerates in the eurozone, but still only averages a rather lacklustre 1.9pc over the next two years.

Headline inflation in the advanced economies decelerates gradually over the forecast interval as energy prices first stabilise and then ease slightly. Meanwhile, core inflation remains benign as inflationary expectations stay contained and central banks prevent over-heating. The G7 tightening cycle continues. US administered rates rise through the third quarter of 2006, with the funds target eventually reaching 5.5pc or possibly more if either growth or inflation surprise to the upside.

Eurozone rates rise by another 25 or 50 basis points this year as the European Central Bank frets about rapid money growth and possible second-round effects from oil prices. Japanese rates rise during the third quarter as the Bank of Japan drains remaining excess reserves and then abandons the zero interest rate policy. And the Bank of England comes back off the sidelines, tightening in the fourth quarter as economic growth reaccelerates toward trend.

The eurozone recovery lost momentum in the second half of 2004 and failed to regain it in the first half of 2005. However, the widely anticipated improvement finally materialised in the third quarter of last year. Growth subsequently slowed over the final three months of 2005, but quickly re-accelerated to 0.6pc quarter-over-quarter in the first quarter of this year.

Growth is expected to remain close to that pace throughout 2006, allowing it to reach a slightly faster-than-trend 2.1pc for the year as a whole. Through the early part of last year, growth was heavily dependent on exports.

But while exports remain the fastest growing component of demand, business investment has picked up, providing additional breadth to the recovery, although lacklustre household confidence is preventing personal consumer spending from playing much of a role-particularly in Germany.

Unfortunately, the cyclical improvement does not gather additional momentum in 2007, as rising interest rates, a strengthening currency, and a VAT tax hike in Germany eventually take a toll. Indeed, growth slips back below 2.0pc next year. The run-up in oil prices buffeted headline consumer price inflation throughout 2005, briefly pushing it as high as 2.6pc in September, well above the European Central Bank’s 2pc target ceiling.

However, some economists are of the opinion that sluggish growth and benign wage gains have dampened core inflation allowing it to decelerate to just 1.3pc in May. Currently the inflation is expected to remain at recent levels over the forecast interval, with the headline CPI increasing 2.1pc in both 2006 and 2007, exactly the same as in 2004 and 2005.

The slower growth of the unit labour costs in the euro area compared with the main trading partners would also appear to limit the potential negative effects from the recent appreciation of the euro on exporters’ competitiveness. Oil prices have reached new highs during the first half of the year thereby pushing up inflation somewhat, but these developments do not seem to have overly affected business or consumer confidence.

Market turmoil: The recent financial market turmoil is a possible source of downside risk but, at this juncture, its impact need not be overestimated, since it has mostly concerned financial markets in emerging countries. In the euro area, it has been confined to equity markets and can be seen as a correction to the “mini-boom” in the preceding few months.

Overall, therefore, the risks to the near-term outlook appear to be tilted to the upside rather than the downside. The EC Commission forecast signals that the fiscal consolidation targets for 2006 of the stability programmes are at risk in half of the member states.

To meet the budgetary consolidation plans set by the members in their stability programmes, budgetary improvements in 2006 would need to be better than forecast and complemented by ambitious 2007 budgets.

UK growth slowed to just 1.8pc in 2005 on a marked deceleration of consumer spending. However, household spending has since regained traction allowing growth to reaccelerate steadily to 2.4pc this year and 2.6pc next.

The 2005 slowdown opened up some slack in the economy, which together with more stable energy prices, helps to keep consumer price inflation around the Bank of England’s (BoE) 2pc inflation target over the forecast interval.

Nevertheless, the re acceleration of growth leads the BoE to take back last summer’s 25 basis point rate cut before the end of this year. Administered rates then remain stable in 2007.

Germany