The backdrop to the current press briefing is one of continued turbulence in financial markets. Pressures have tended to spread to new markets and institutions, reaching beyond the origin of the US sub-prime mortgages and derived products and leading to a generalised wariness and re-pricing of risks. As concerns the real economy, near-term global growth prospects have weakened more than projected in the December 2007 OECD Economic Outlook.

The real economy is not sheltered from financial turmoil. New issuances in various segments of the financial market have dried up, with some reintermediation at work, spreads have widened and lending standards are being tightened. The effects on demand are likely to be significant but are hard to gauge. In addition, share and housing prices declines, particularly in the United States, are also holding back demand, with some lags.

The global housing cycle has turned; in the United States the direct effect of the residential investment slump has been subtracting around one percentage point from annual real GDP growth over the past two years and will continue to do so this year.

Household real incomes are being squeezed by soaring energy and food prices, even if in the euro area and to a lesser extent in Japan, currency appreciation has provided some offset.

Against this backdrop, short-term forecasting models taking on board the most recent dataflow, including the decline in payroll employment witnessed in the first two months of 2008, suggest that the US economy is now essentially moving sideways, if not contracting outright. It may be premature to declare a recession, but with the pace of activity so far below potential, economic slack is widening rapidly. In the euro area, the deceleration has been less abrupt but growth is set to remain on the low side of potential for some time, even though exports so far seem to hold up well in the face of euro appreciation. In Japan, quarterly national accounts are volatile and prone to large revisions, but overall the pace of underlying growth seems to be softening as well, notwithstanding the support from still buoyant neighbouring Asian economies.

As concerns inflation, both headline and core measures well exceed comfort levels in many economies and on some indicators inflation expectations have been trending up. US headline CPI inflation stood at 4 % last month, and the latest core PCE reading, at 2.2%, suggests some pass-through of higher energy and food prices into other prices. In the euro area, notwithstanding euro appreciation, headline HICP inflation reached 3.3% in February 2008, whilst statistical measures of core inflation continue to inch up, approaching 2½ per cent. Japan stands out, with headline inflation at 0.8% but core – excluding food and energy prices – still in negative territory.

How macroeconomic policies should react is contingent on the outlook for activity and inflation beyond the near-term projection horizon as well as on the balance of several risks. First, oil and other commodity prices may continue to rise for some time from their already high levels, despite slowing activity. Second, the extent of any financial turbulence and the magnitude and duration of the restraint exerted on economic activity by banks’ and investors’ newfound prudence, and by their need to recapitalise, is unclear. Third, short-run trade-offs between inflation and output may have changed in recent years, casting some doubts on the exact extent to which subdued growth will moderate inflation pressures.

In this light, the case for policy stimulus is stronger in the United States than in Europe or Japan and both US monetary and fiscal policymakers have already acted forcefully. In the euro area, by contrast, the near-term outlook for activity and inflation does not point to a need for stimulus and automatic fiscal stabilisers will provide more support than in other regions. In Japan, there is limited scope for responding to greater weakness.