4 THE ECONOMIC AND FINANCIAL SITUATION 5 1 THE ECONOMIC AND FINANCIAL SITUATION THE ECONOMIC AND FINANCIAL SITUATION 6 1.1 THE ECONOMIC SITUATION AT THE INTERNATIONAL LEVEL 1.1.1 Short-term interest rates and monetary policy decisions Chart 1.1: Key policy rates of the Eurosystem, the EONIA and the three-month EURIBOR (percentages per annum) 7 6 5 4 3 2 1 0 99 00 01 02 03 04 05 06 07 08 09 10 Three-month EURIBOR Deposit facility EONIA (Euro overnight index average) Main refinancing operations Marginal lending facility Sources: ECB, Bloomberg Between January and May 2009, the interest rate on the main refinancing operations was lowered by 150 basis points. The interest rate on the deposit facility and on the marginal lending facil- ity was lowered by 175 and 125 basis points respectively. Since May 2009, key ECB rates have remained unchanged. Thus, the interest rate on the main refinancing operations stands at 1.00%, while those on the deposit facility and on the marginal lending facility stand at 0.25% and 1.75% respectively. The Governing Council also adopted a series of non-standard measures in order to cope with dysfunctional money markets and facilitate the monetary transmission mechanism. These meas- ures are temporary in nature and designed to maintain price stability over the medium term. Annual HICP inflation stood at 0.3% in 2009, the lowest level on record since the launch of the euro, after a record high of 3.3% in the preceding year. The inflation rate has however edged up gradually, reaching 1.5% in April 2010; according to Eurostat's flash estimate, annual HICP inflation stood at 1.6% in May. Looking ahead, inflation rates should remain moderate over the medium term. Regarding economic activity in the euro area, annual real GDP contracted by 4.1% in 2009. Quarterly growth rates of real GDP turned positive in the second half of the year. In the third and fourth quar- ters of 2009, quarterly real GDP progressed by 0.4% and 0.1% respectively. According to Eurostats' flash estimate, euro area real GDP progressed by 0.2% quarter-on-quarter in the first quarter of 2010. The rebound in economic activity is linked to the ongoing economic recovery at the global THE ECONOMIC AND FINANCIAL SITUATION level, the accommodative monetary policy stance and the measures adopted to restore the func- tioning of financial markets. Looking ahead, the Governing Council expects real GDP to grow at a 7 moderate and still uneven pace. Turning to the monetary analysis, the annual growth rates of M3 and of loans to the private sector have continued on their respective downward trends. However, the annual growth rates stabilised in the fourth quarter of 2009 and subsequently evolved in a relatively narrow range. In April 2010, the annual growth rate of M3 stood at -0.1%, unchanged from the previous month, while the annual growth rate of private sector loans turned positive (+0.1%). The fall in M3 is largely attrib- utable to the decrease in M3-M2 and M2-M1, while the narrow spread between interest rates applied to different short-term deposits encouraged the allocation of funds to the most liquid instruments. As for the counterparts of M3, loans to the private sector fell by 0.2% between end-2008 and end-2009. The annual growth rate of loans to non-financial corporations stabilised in the course of 2009 while remaining negative, reaching -2.6% in April 2010. The available data pertaining to consumer credit also point to a stabilisation of the annual growth rates (-0.3% in April), while loans for house purchase recovered even if their annual remains weak (+2.9% in April). 1.1.2 Long-term government bond yields In the course of the period under review, long-term government bond yields in the United States and in the euro area were subject to a considerable degree of volatility but generally followed opposing trends. Between January 2009 and mid-May 2010, ten-year government bond yields decreased by 43 basis points in the euro area and increased by 124 basis points in the United States, reaching 3.26% and 3.45% respectively at the end of the period. Chart 1.2: Long-term government bond yields in the euro area and in the United States (LHS: Percentages per annum; RHS: Percentage points) 5.0 2.8 4.8 2.4 4.6 2.0 4.4 4.2 1.6 4.0 1.2 3.8 0.8 3.6 0.4 3.4 3.2 -0.0 3.0 -0.4 2.8 -0.8 2.6 -1.2 2.4 2.2 -1.6 2.0 -2.0 Jan. Mar. May July Sep. Nov. Jan. Mar. May July Sep. Nov. Jan. Mar. May 08 08 08 08 08 08 09 09 09 09 09 09 10 10 10 Euro-area 10-year bond (LHS) Spread euro area / US (RHS) T-Note 10 years (LHS) Spread 10 years / 2 years (RHS) THE ECONOMIC AND FINANCIAL SITUATION Sources: ECB, Bloomberg 8 In early-2009, government bond yields on both sides of the Atlantic first increased owing to sub- stantial issuance of securities aimed at propping up the economy and the banking sector. This upward trend was nevertheless interrupted around mid-June. The accommodating monetary policies and the unconventional measures taken by the central banks supported the absorp- tion capacity of the market. Besides the direct purchase programmes of the Fed and the Bank of England, the expected low level of reference rates for an extended period, in association with contained inflation pressures, led investors (in particular banks) to diversify their bond portfolio toward longer-term maturities. At the end of the period, the tensions encountered in euro area "peripheral" countries translated into a rise in risk aversion and hence a flight to quality, resulting in a fall in US and German long-term yields. As for the spread between two-year and ten-year government bond yields in the euro area, the yield curve continued to steepen at the beginning of 2009 to reach a historically high level. Intra euro area yield spreads also widened substantially in the course of the period under review. In a context characterised by the decrease of liquidity premia in bond markets, these persistent spreads have reflected the risk premium associated with the quality of the sovereign issuers. In December 2009, the downgrading of Greek bonds by the main rating agencies caused the risk premium on Greek debt to reach record levels, before speculative attacks led to contagion effects on Portuguese, Irish and Spanish bonds. The conditional 110 billion euro support to Greece approved by the European Union, however, did not reduce market uncertainty. The ECB's decision to buy government debt securities on secondary markets and the joint 750 billion euro EU-IMF stabilisation plan finally managed to put an end to this self-fulfilling prophecy. Despite these measures, which should enable national governments to implement austerity measures under satisfying conditions, the intra euro area yield spreads remained, on May 15, 2010, at historically elevated levels. 1.1.3 Stock markets After the record losses posted in 2008, major stock markets witnessed a significant rebound from March 2009 onwards. This rebound was considerably supported by the measures put in place to prop up the financial system and the economy at large. Between end-2008 and mid-May 2010, the Dow Jones EURO STOXX rose by 13.7%; while the Standard & Poor's 500 and the Nikkei 225 rose by 25.7% and 18.1% respectively. Chart 1.3: Major stock indices in the euro area, the United States and Japan (index 01/01/2008 = 100) 100 90 80 70 60 THE ECONOMIC AND FINANCIAL SITUATION 50 9 40 30 Jan. Mar. May July Sep. Nov. Jan. Mar. May July Sep. Nov. Jan. Mar. May 08 08 08 08 08 08 09 09 09 09 09 09 10 10 10 Euro area United States Japan Source: Bloomberg In the first three months of 2009, major stock indices continued to record further losses. This was due to uncertainty regarding the magnitude and length of the recession, as well as investors' concerns regard- ing the health of the financial sector. After the troughs recorded in early-March, the Dow Jones EURO STOXX, the Standard & Poor's 500 and the Nikkei 225 rebounded sharply and embarked on an upward trend which lasted until September. The prospective end to the crisis, substantiated by the progressive release of optimistic economic data and the non-conventional measures adopted by central banks and governments, led to a fall in risk aversion which provided further impetus to stock markets. However, by mid-January 2010, the recovery in stock markets was sharply interrupted by a downward correction, which in turn was owing to profit-taking by firms. This was soon exacerbated by a number of unfavourable elements, most notably potential contagion effects from the fiscal crisis in Greece. The sta- bilisation plan adopted by European finance ministers and the IMF, as well as the non-conventional meas- ures adopted by the ECB, led to a rebound in stock markets towards the end of the period under review. 1.1.4 Foreign exchange markets In the course of 2009, the nominal effective exchange rate of the euro (NEER) at first followed an upward trend, before recording significant losses from December 2009 onwards. On May 15, 2010, the NEER stood at its lowest level since March 2006. This is largely attributable to the appreciation of the US dollar and the British pound, given their weights in the basket of the NEER.