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Monthly Report, num 310 - February 2008
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Financial upsets grow worse at start of 2008
Gradual easing of monetary interest rates but financial instability persists. International financial instability broke out back in the summer of 2007 with the subprime mortgage crisis, still a long way from being contained, and remains virulent at the beginning of 2008. While increases in short-term interest rates have eased thanks to monetary policy moves (the Federal Reserve drastically cut its reference rates and all the central banks have worked to provide the necessary liquidity), in other segments of the market the upsets continue. Credit differentials have increased in an environment of dropping government bond yields. The stock exchanges have suffered a notable increase in volatility and seem to have moved into a bear market, anticipating a situation of great weakness or recession in the economy of the United States.
From the beginning of December of last year, the most important world stock exchanges have dropped between 14% and 20%. The vicissitudes of shares, however, sharpened in January. On Monday, January 21, when US markets were closed for a holiday, Asian and European markets suffered major drops. One of the factors that set off the crisis of confidence among investors was the announcement on Friday January 18 of a cut in the credit classification of some major US credit insurance companies, the so-called monoline insurance companies. The effects of this move involved lowering the classification of bonds issued for an amount of 2,400 billion dollars with the subsequent impact on bond prices, reorganizing of portfolios and the taking up of bank capital for those issues included in financial institution balance sheets.
Fourth week of January sees further episode of sharp fluctuations on stock exchanges... The recovery at the end of the week, Thursday and Friday, was mainly due to the decision to adopt a rescue plan through which to recapitalize the monoline insurance companies in order to guarantee the stability of the financial system. Beforehand, however, the Federal Reserve decided to apply an exceptional cut in its reference rate, given that this decision was made before the monetary policy meeting set for January 30. In fact, on Tuesday, January 22, the US monetary authority reduced the Federal Funds rate by 0.75 points putting it at 3.50%. This was the biggest cut in the past 23 years. The speed and size of the move are significant and indicate the risk perception of the central bank.
...with Federal Reserve applying drastic cut in reference rates. In contrast to this move, the governor of the European Central Bank (ECB), Jean-Claude Trichet, made it clear that he was not thinking of following the course taken by the Fed and that his main concern was to maintain inflation prospects steady. The position of the euro monetary authority is that, while economic slowdown in the United States will certainly affect the rest of the world, the effects in the Euro Area will not be noted until much later and will be milder than in the case of previous episodes. In fact, the indications from the ECB are to maintain its policy and wait and see.
Within this complicated financial picture, we should point out the improvement in short-term interest rates. The injections of liquidity and rate cuts by some central banks has managed to reduce pressures in monetary markets. Normalization has been most complete in those monetary areas where there was greater pressure at the end of last year, that is, United States and United Kingdom. In the Euro Area as well the 3-month Euribor, which had reached 4.8% at the end of November, has dropped to 4.4%. For example, the 1-year Euribor, to which most mortgages in Spain are referred, has halted its upward move and, whereas a few months ago it seemed to be heading toward 5%, has now gone back toward 4.4%.
Bank lending terms harden in Europe because of worse forecasts and higher cost of capital. On the other hand, the tightening of credit terms has increased compared with the easy situation operating up until six months ago. The latest survey of loans granted carried out by the ECB, covering the fourth quarter of last year and prospects for the first quarter of this year, shows that banks are maintaining a firm position in granting credit to companies and this is expected to sharpen for large companies in the first quarter. Factors contributing to this situation in order of importance are the worsening of prospects in the economic sector, increased cost of capital for banks and, to a lesser extent, less competition among banks to attract new customers in the business sector.
Resolving financial upsets will depend on course of US economy over coming quarters. What happens now in these financial upsets will very much depend on the trend followed by the US economy. There is no doubt the year began badly with the likelihood of recession included and the key lies in the performance of private consumption. The low level of savings, the drop in housing prices, the hardening of credit terms and the increased cost of energy may leave very weak those factors that up until now have been the main support of economic activity in the United States and the world in general. As mentioned earlier, monetary policy is still adequate to the task but in view of all these pressures it was necessary to provide a rapid specific fiscal stimulus so that everything would not fall on low interest rates. This is the objective of the plan announced by president Bush that is currently being negotiated between the White House and the Senate, the main point of which is the issuing of cheques to taxpayers in order to increase spending.
Europe moving into a slow-down but for now rise in inflation seems more troubling. With regard to the European economy, the situation remains one of slowdown. On the demand side, the drop in retail sales in November (1.3% year-on-year) and the collapse of consumer confidence suggest weakness in private consumption. In any case, the fact that the unemployment rate in November stood at 7.2% year-on-year, that is to say, a figure seven decimals less than one year earlier, represents a support for household spending. Can the foreign sector counteract this lower domestic drive? It would seem less and less. Following 14 months with a trade balance tending to recover, this profile was broken in November. This was only a relative surprise, given that the gradual drop in exports from September to November, combined with maintenance of growth in imports, indicated this result was coming. In this process, the appreciation of the euro may be having a major role given that, measured by the nominal effective exchange rate, the single currency was revalued some 4% only in the fourth quarter.
Nevertheless, as pointed out earlier, the figure that most troubles the ECB monetary authorities is inflation seeing that this is well above the threshold of 2%. In December, the harmonized consumer price index (HCPI) was again 3.1% year-on-year with no change over November. In any case, from this point on it is to be expected that the rise in prices will not go much beyond this. Forecasts of a slowdown in the industrialized economies would indicate a drop in oil prices in coming quarters because of lower demand, which would ease pressure on the energy component in the harmonized CPI.

Spain’s economy: less job creation
Figures for Spain’s labour market beginning to reflect slowdown in economic activity. With regard to Spain’s economy, this does not lie outside the situation of a general slowdown. In 2007, it again showed an increase in gross domestic product of close to 4% but in recent months the loss of drive in economic activity has become more noticeable. Figures from the labour force survey for the fourth quarter provide a serious warning in this respect. The figures show a slowdown in job creation to an annual rate of 2.4%, seven decimals less than in the previous quarter. For the first time since 1995 jobs were lost in a fourth quarter, while the unemployment rate rose to 8.6%, six decimals more than in the previous period. In 2007 as a whole, unemployment rose by 117,000 persons, the first annual increase since 2003.
In spite of everything, the tendency to create jobs is being maintained. At the end of 2007, those registered at Social Security with jobs amounted to somewhat more than 19 million persons, an all-time high for a year-end. This figure meant a year-on-year increase of somewhat more than 2%, a rate practically identical with that of the labour force survey. In absolute figures, the increase in registrations with Social Security during the year was 425,496 persons, a considerable number but which accounts for the lower increase in absolute terms since 2003. Of this figure, 268,364 were Spanish workers, making up 63.1% of the total. Registered foreign workers rose by 8.6% as against 8.0% recorded at the end of 2006. As a result, the participation of foreign workers in the total continued to increase going to 10.3% in December.
Nor is 2007 inflation balance favourable with CPI rising to 4.2%. Nor was there a favourable balance for inflation in 2007 due to the sharp rise in prices as of the summer. The annual CPI change rate rose to 4.2% in December, 1.6 points more than in 2006, recording the biggest year-end increase since 1995. The cause lay largely in higher-cost oil and food in international commodities markets. Nevertheless, the average annual change in CPI was 2.8%, the lowest rate in the past eight years. This difference was due to the peculiar profile of the year-on-year CPI rate over the year which, up until August, was running between 2% and 2.5% only to rise to the rate mentioned in the final months of the year. What are the prospects for inflation in 2008? Lower demand pressure should help a gradual decrease in background pressures. In coming months, however, there will still be some increases arising from inflationary pressures on food and energy.
Decrease in demand for credit both by companies and households. The financial upsets, along with the hardening of credit terms and prospects of lower growth, lie behind the drop in growth rate of funding granted to companies, something that has sharpened in recent months. Year-on-year growth thus went from 23.4% in August to 19.3% in November. Commercial credit, used to finance working capital of companies, showed a reduction in annual change rate to less than 10%. Nevertheless, funding of investment, in an approximate estimate based on leasing operations, continued to show a good level. With regard to funds granted to households, these also continued to gradually ease. In any case, for the past 12 months ended November they showed an annual increase of 14.2%.
In this context defined by stock market upsets and the worsening of prospects, the economic authorities have tried to put out messages urging calm, reminding one and all of the strong aspects of Spain’s economy, notable among which is the sizeable surplus in the public accounts.
January 29, 2008

Chronology
CHRONOLOGY
2007
January 1 European Union enlarged to 27 member states following inclusion of Romania and Bulgaria; and euro area numbers 13 members following adoption of European single currency by Slovenia.
    Reforms to Personal Income Tax and Corporate Tax go into force.
March 8 European Central Bank raises official interest rate to 3.75%.
April 13 Publication of Law 6/2007 in Official Government Bulletin (BOE) modifying the regulations applying to takeover bids which come into force in mid-August.
June 6 European Central Bank raises official interest rate to 4.00%.
  14 Parliament approves new Law on Safeguarding Competition with creation of National Competition Commission.
  21 EU Council of Ministers approves adoption of euro as national currency for Malta and Cyprus as of January 1, 2008.
August 9 European Central Bank injects extraordinary liquidity into interbank market as early emergency move to ease pressures set off by subprime mortgage crisis in United States.
  13 US Federal Reserve reduces discount interest rate from 6.25% to 5.75% in order to relieve effects of subprime mortgage crisis.
September 18 Federal Reserve reduces reference rate to 4.75%.
October 9 Dow Jones index for New York stock exchange marks up all-time record (14,164.5), a rise of 13.7% compared with end of 2006.
  19 European Council agrees to adopt the Treaty of Lisbon in place of the European Constitution.
  31 Federal Reserve cuts reference rate to 4.50%.
November 8 IBEX 35 index for Spanish stock market marks up all-time high (15,945.7) with cumulative gains of 12.7% compared with end of December 2006.
December 11 Federal Reserve cuts reference rate to 4.25%.
  13 Central banks in United States, Euro Area, United Kingdom, Switzerland and Canada announce plan for coordinated measures to relieve difficulties in monetary markets brought about by financial upsets.
2008
January 1 Further enlargement of Euro Area with entry of Cyprus and Malta, making 15 member states.
  3 One-month forward price of Brent oil moves up to all-time high level of 98.25 dollars a barrel.
14 Euro exchange rate at 1.4895 dollars, highest value since launch of single European currency at beginning of 1999.
  22 Federal Reserve reduces reference rate to 3.50%.
  30 Federal Reserve reduces reference rate to 3.00%.

Agenda
AGENDA


February
5 Industrial production index (December).
7 Governing Council of European Central Bank.
14 Preliminary GDP for Spain (4th Quarter).
GDP for EU (4th Quarter).
15 CPI (January).
Balance of payments (November).
20 Quarterly national accounts (4th Quarter).
Foreign trade (December).
21 Central government revenues and spending (January).
25 Producer prices (January).
29 Preliminary HCPI (February).
Harmonized CPI for EU (January).


March
5 Industrial production index (January).
6 Governing Council of European Central Bank.
13 CPI (January).
14 Balance of payments (November).
Labour cost (4th Quarter).
Harmonized CPI for EU (February).
18 Fed Open Market Committee.
19 Foreign trade (January).
25 Producer prices (February).
Central government revenues and spending (February).
31 Preliminary HCPI (March).




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