Nominal convergence is also proceeding, aided by exchange rate stability and a decline in wage awards. The rate of inflation is now within the Maastricht reference value. This attests to a continued flexibility of the Portuguese labor market, stemming primarily from real wage flexibility. Rigid employment protection regulations, however, remain on the books. The current account deficit is expected to narrow slightly in 1997.
Monetary policy continues to be geared toward maintaining exchange rate stability.
The escudo's relative strength within the ERM and declining inflation have allowed the Bank of Portugal to progressively reduce official interest rates over the past year, with the three-month interest rate differential against Germany narrowing to some 150 basis points. Bond yields have fallen even more markedly, bringing the long-term differential against Germany to new lows, of under 40 basis points. The root cause of this increase lies in the dynamics of transfer payments, notably for health and civil service pensions. The convergence program for 1998-2000 recognizes the need for continued fiscal adjustment and structural reforms. Public spending will continue to be reoriented toward education, poverty alleviation, and infrastructure investment.