During the first quarter of 2002 the Central Bank eased its monetary policy stance further, lowering both the central intervention rate and the discount rate by 25 basis points to 4% on January 31. Official interest rates where then left unchanged for the remainder of the first quarter and throughout the second. The Bank's decisions were based on its analysis of economic and financial developments in Malta and abroad and were consonant with its monetary policy strategy, which is based on pegging the Maltese lira to a basket made up of the euro, the US dollar and sterling.

In analysing key indicators on the local economy, the Bank observed that domestic demand remained subdued. This view was supported by developments in the labour market as well as the monetary data, which showed that underlying credit growth remained sluggish. Meanwhile, in the international economy, the persistence of weak conditions had prompted central banks in major industrial economies to reduce official interest rates up to the end of 2001. However, during the first quarter of 2002, with global economic conditions improving slightly, official interest rates in the United States, the euro area and the United Kingdom were left unchanged.

As a result of these developments, the premium on Maltese lira short-term interest rates remained relatively wide, which contributed to an increase in the Central Bank's net foreign assets during the second half of 2001 and into most of the first quarter this year. In turn, this supported the Bank's decision to cut official interest rates in January. However, the increase in the Bank's net foreign assets was partly reversed towards the end of the first quarter and into the second, although they stabilised in May. Subsequently, therefore, the Bank adopted a more cautious monetary policy stance.

The latest data on the economy published in June showed that during the first quarter of 2002 the Maltese economy began to recover from the decline recorded during the previous three quarters. Overall, Gross Domestic Product grew by 1.4% in real terms, driven mainly by a recovery in private consumer spending and an increase in Government recurrent expenditure. Furthermore, the turnover of the electronics industry fell at a slower pace and the decrease in tourist arrivals moderated substantially. In addition, imports fell faster than exports in both nominal and real terms. These factors offset reductions in investment spending and in inventories.

Meanwhile, responses to the Bank's latest business perceptions survey, which was carried out between April and May 2002, also indicated that activity levels rose during the first quarter compared with the final quarter of 2001. This was especially so in manufacturing industry, as activity levels int he tourism sector remained considerably below normal. Looking ahead, although the rebound in business sentiment reported in the previous survey had lost momentum, signs of an incipient export-led recovery remained, with a number of firms stating their intentions to expand their labour force.

Although the twelve-month moving average rate of inflation continued to rise, reaching 3.6% in March from 2.9% in December, inflationary pressures abated during the quarter. In fact, the year-on-year measure, which is a more timely indicator of price developments, dropped by more than a full percentage point to 3.1% over the same period. In particular, food prices fell during the quarter as the impact of the supply-side factors that had driven them during 2001 subsided.

Labour market activity remained subdued, with the proportion of registered unemployed rising from 5.1% in December 2001 to 5.5% in February 2002, the latest month for which data were available at the time of writing. Full-time employment dropped as jobs in manufacturing industry, the hospitality sector and the public sector decreased. Employment income, however, remained stable during the quarter.

As the GDP data referred to already indicate, fiscal policy was more expansionary during the first quarter of 2002. The deficit widened considerably when compared with the previous quarter, although it was only slightly larger than that recorded during the corresponding quarter of 2001.

In the external sector, the deficit on the current account of the balance of payments narrowed during the March quarter of 2002, as the merchandise trade gap shrank and the surplus on trade in services widened. At the same time, higher net inflows on the capital and financial account resulted in an overall surplus that translated into an increase in the official reserves. In fact, during the three months to March, the Central Bank's net foreign assets expanded for the fourth consecutive quarter, rising by Lm22.6 million.

An increase in the net foreign assets of the banking system was also the main counterpart to monetary expansion during the quarter reviewed. Rapid deposit growth contributed to excess liquidity in the system, which exerted downward pressure on interest rates in domestic financial markets.

The Central Bank's projections for 2002 remain broadly similar to those published in its latest Annual Report, with real GDP growth forecast to rise to between 2.5% and 3%. The timing of the recovery will, however, depend on the extent of the rebound in the major industrialised economies, which is expected to stimulate demand for exports. Public and private consumption are both expected to continue growing. Investment is expected to recover following the sharp fall recorded in 2001, although to a lesser extent than the Bank had originally forecast. In turn, slower growth in investment spending is expected to lead to a smaller rise in imports. Unemployment remains on tract to end the year between 5% abd 5.5%, while the Bank continues to expect inflation to fall to between 2.3% and 2.8% by December.