reflects the significant degree of uncertainty that has been building up over recent months. early indications for the fourth quarter of 2002 suggest that the pace of economic growth has remained broadly unchanged. for the time being, the main scenario for the euro area remains that economic growth should return to rates close to potential in the course of 2003. this expectation is consistent with forecasts published by international organisations and private institutions. in addition, financial markets have shown signs of stabilisation in recent weeks, although volatility in the stock markets has remained high by historical standards. the expectation of an improvement in economic activity in the euro area is contingent on the unwinding of the current high level of uncertainty and on a recovery of growth in private consumption, which has shown signs of resilience in the recent past. in addition, this expectation is also based on a gradual recovery of world demand which, together with the low levels of interest rates, should help to strengthen investment. however, there are several downside risks to this scenario. they relate to the persistence of macroeconomic imbalances in the global economy, geopolitical tensions and the uncertainty about the size of the adverse effects of the past sharp declines in stock prices on aggregate demand in the euro area and in the other major regions of the world. moreover, risks also stem from the fact that structural rigidities in the euro area economy do not facilitate the process of price and wage adjustments to external shocks. thus, overall, it remains difficult to predict at this juncture the timing and strength of the acceleration of economic activity. regarding price developments, annual hicp inflation rates have been slightly above 2 % in recent months. these annual hicp inflation rates are likely to increase in the remainder of 2002 and stay above 2 % in the early months of next year, mainly on account of base effects and increases in indirect taxes and administered prices in a number of countries. subsequently, however, hicp inflation rates should fall again, and provided that oil prices do not increase significantly and wage moderation prevails, reach levels in line with our definition of price stability in the course of 2003. looking further ahead, both the strengthening of the euro exchange rate this year and the subdued economic activity continue to contribute towards reducing inflationary pressures. furthermore, for price pressures to be contained, it is crucial that the upward trend in labour cost indicators observed in recent years does not continue. the notable inertia in wages despite the subdued economic expansion has been of some concern, although

recent developments may suggest that wage costs have not accelerated further in the course of this year. at our last monetary policy meeting on 7 november we discussed extensively whether or not to reduce the key ecb interest rates, in view of the high uncertainty surrounding future economic growth and its implications for medium - term inflationary pressures. summing up, there were elements in favour and against both alternatives. on the one hand, the subdued trends in economic activity and the stronger exchange rate of the euro supported the view that inflationary pressures should decline. on the other hand, the stubbornly persistent rate of inflation excluding the volatile components of energy and food prices as well as monetary and wage trends, argued for caution. overall, on that occasion the view to keep the key ecb interest rates unchanged prevailed. however, we also indicated that we needed to monitor the downside risks to economic growth for their impact on medium term inflationary pressures. since our last meeting, the evidence has strengthened that inflationary pressures are easing somewhat and downside risks to economic growth have not vanished. regarding fiscal policy in the euro area, i would like to reiterate that budgetary discipline is indispensable for the success of emu. fiscal discipline strengthens the conditions for strong sustainable growth conducive to employment. sound fiscal positions also provide scope for dealing with the expected fiscal challenges caused by population ageing. clearly, therefore, sound public finances, as enshrined in the treaty and further developed in the stability and growth pact, are in the interest of all member states. i want to stress that the current fiscal framework strikes the right balance between discipline and flexibility. by prescribing a medium - term objective of budgetary positions close to balance or in surplus, the stability and growth pact guarantees that fiscal policies will preserve the sustainability of public finances while providing sufficient flexibility for automatic fiscal stabilisers to operate. while it is clear that, for many – partly formal – reasons, annual budgetary targets always need to be set in nominal terms, the assessment of fiscal policies naturally must take into account cyclical developments. though the discussion surrounding this issue may, at times, appear confusing, it does not reflect a flaw in the pact as some critics claim. in this context, it is worth recalling that most member states have reached budget positions which are " close to balance or in surplus ". current fiscal problems in other countries have arisen not because the rules are inflexible, but because countries have