FRANKFURT (MNI) – Monetary policy stimulus in the Eurozone should
be withdrawn only gradually, and further increases in policy rates are
not required immediately, the OECD said in its World Economic Outlook on
Wednesday.

The policy recommendation is based on the OECD’s baseline scenario,
which forecasts the recovery to continue and inflationary pressures to
remain weak.

The organization revised its Eurozone GDP growth forecast for 2011
to 2.0% from 1.7% and left its 2012 forecast unchanged at 2%. It also
sharply hiked its headline inflation forecast to 2.6% from 1.3% for 2011
and to 1.6% from 1.2% in 2012.

However, the report said that while headline inflation rose
sharply, “this was primarily due to a jump in energy prices” and
unusually large increases in indirect tax rates. Core inflation, on the
other hand, should remain far more benign and should stand at around
1.2% in 2011 and 1.4% in 2012.

“Inflation is likely to pick up only slowly, and the large degree
of remaining slack suggests that the energy price increases will not
trigger pronounced second-round effects,” the OECD said.

Looking at the economic outlook, the report said that the recovery
should continue to gain strength during 2011 and 2012 as consumption
should accelerate, private investment bounce back and export growth
remain strong.

However, “required fiscal consolidation implies only very modest
growth in government spending over the forecast horizon. Growth will
also be held back by on-going balance sheet adjustment and rebalancing
of demand in several countries,” the report warned.

“The growth rate of potential output, in the absence of further
major structural reforms, would be lower than in previous recoveries,
continuing past trends in productivity growth and reflecting the impact
of demographic ageing,” it said.

The OECD said that uncertainty surrounding its outlook has
increased but that risks remain broadly balanced. In particular, the
report warned that the “euro area is sensitive to uncertainty around
future energy prices and world trade” in the wake of the March 11
earthquake in Japan.

It also warned that “weaknesses in government and bank solvency
could lead to wider financial tensions and contagion, which would test
the European Financial Stability Fund (EFSF) and the banking system.”

To minimize these risks and ensure ongoing improvement of the
financial sector, “the publication of the third EU-wide stress tests
should be used to address remaining weakness in the banking system,” the
OECD demanded.

At the same time, a “prolonged consolidation and tight public
finances will be required for many years in numerous countries to meet
the 60% ceiling set out in the Stability and Growth Pact.”

“More credible and detailed multi-year plans need to be put in
place,” the report said. It also said that the commitment to
consolidation would be boosted by reforms to the Stability and Growth
Pact and to national fiscal institutions.

The OECD welcomed the creation of the European Stability Mechanism
(ESM) as it could add to much needed stability in the Eurozone, but
stressed that “its credibility requires that banking system exposure to
governments is well managed.”

Turning to non-standard policy measures of the European Central
Bank, the OECD said that those “should continue to be wound down as
conditions allow.” It hinted that it does not expect a return to
competitive bidding in June, when it will have to announce details of
longer-term refinancing operations for the third quarter.

“Three-month refinancing operations allocated with full allotment
will continue, at least for the coming months,” the report said.

–Frankfurt newsroom +49 69 72 01 42; e-mail: jtreeck@marketnews.com

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