The euro-zone economy is gaining momentum with GDP growth accelerating to rates above potential during the second half of 2005, the European Commission, the executive body of the EU, said in a report on Tuesday.

As leading indicators suggest that economic activity in the euro-zone remained sustained during the last months of 2005, the sources of growth are also becoming more balanced, said the quarterly report.

While exports continue to be buoyant, domestic demand is strengthening on the back of a strong pick-up in investment, it said.

As exports remain a key engine of growth and euro-zone exporters benefit from a robust growth in world trade, domestic demand is finally showing signs of significant strengthening on the back of a recovery in investment, which recorded its strongest increase in the last five years, said the report.

Meanwhile, long-term interest rates, despite some recent increases,remain close to the lowest levels observed over the past two decades, creating favorable financing conditions, it said.

The report also analyzed the impact of oil prices on inflation.

Since the beginning of the year, higher prices have had a significant direct effect on the energy component of consumer prices.

Indirect effects, which occur when producers pass through higher input costs into their final prices, are beginning to be felt, but they have so far remained modest and masked by favorable developments in unit labor costs.

However, in 2006, indirect effects could exert more significant upward pressures on inflation.

Moreover, the report singled out aging as a pressing economic policy challenge.

The euro-zone population will undergo dramatic changes in coming decades due to low fertility rates and continuous gains in life expectancy.

As a result, the size of the working-age population is projected to start falling as of 2010 and drop by as much as 37 million, or 18 percent, by 2050. Over the period 2004-50, the older population -- 65 years or older -- would increase by more than 40 million, or 80 percent.

This means that the euro-zone is likely to go from the current situation of four people of working-age for every elderly citizen to a ratio of 2 to 1.

Unless policies are changed, aging will increase public expenditure on pensions, health care and long-term care by between 4 and 8 percentage points of GDP in most member states, something that is simply not sustainable, said the report.

At the same time, economic activity and living standards will fall steadily to levels well below those observed in recent decades.

The report recommended changes in government policies and labor-market reform.

Increasing employment rates and investing more in priority areas, such as education and research and development, would drive productivity growth and raise Europe's potential GDP growth, said the report.

Source: Xinhua