The European Central Bank (ECB) criticised Euro zone governments yesterday for wasting opportunities to put their public finances in order and said reforms were essential to prepare for a sharp rise in welfare costs in the next century.

In its May monthly report, the ECB also said economic activity in the Euro zone was still sluggish and headline inflation was likely to rise in coming months because of higher energy prices.

However, it added: "At this juncture it does not appear that these developments will have a negative impact on the outlook for price stability in the medium term, provided that the subdued path of wage growth continues in the future."

Annual consumer price inflation rose by 1 per cent in March. The central bank said the Kosovo conflict had made the Euro's exchange rate more volatile, but the currency's prolonged weakness against the dollar since January did not yet represent an inflationary risk.

Only three of the euro zone's 11 states - Finland, the Republic and Luxembourg - had last year met the European Union's stability and growth pact requirement that budgets should be close to balance or in surplus, the ECB said. Denmark, Sweden and Britain, which are outside the zone, had also met this requirement, the ECB noted, but "all the remaining EU member-states were still relatively far from the targets they had indicated in their programmes".

The ECB said demographic changes could cause pension and health expenditure in the Euro zone to rise by seven percentage points of GDP by the end of the third decade of the next century.

"The prevailing attitude towards the scale and timing of consolidation is to aim for the least ambitious targets consistent with formal compliance with the stability and growth pact," it commented.