Macroeconomic environment

The world’s economic activity slowed down during 2011 mainly due to structural imbalances in developed economies, the normalization of monetary policy and changes in productive cycle dynamics. Additionally, unforeseen natural and socio-economical events also had a significant impact, such as the earthquake in Japan, deep social and political changes in some Arab countries, uncertainty in European governing bodies and the instability in the global financial markets.

The European debt crisis was the main focus of risk, but was not its only source. Instead it became the most visible manifestation of the insufficient progress in correcting global macroeconomic imbalances, such as the excessive debt levels of developed economies when compared with their low growth potential and the vulnerability of the growth efforts in some developing economies, closely linked to weak internal demand and changing social structures.

The resolution of both structural barriers, as well as the economical, social and political challenges will result in solid and sustainable future economic growth. In the meanwhile, the creation, negotiation and implementation of global economic policies consistent will this objective will strongly influence economic activity and the risk appetite through 2012.

The correction of structural imbalances dampens the global economic recovery

Contrary to what was initial thought, the economic growth process that started in 2010 was not sustained, especially since the second quarter of 2011. The economic climate was affected by higher uncertainty and volatility. Forecasts for global economic activity have since been lowered, to below 4% for the 2011-13 period, a level that is both inferior to the long-term trend and the growth rate in 2010.

The divide between the performance of developed and emerging economies widened. The expected growth rate forecast for 2011-2013 for the emerging economies is approximately three times that of the of their developed piers (5.8% vs. 1.6%, respectively). Despite this high growth, emerging economies remain sensitive to a downturn in international commerce, increasing the relevance of policies that stimulate internal consumption. Such policies have already been implemented during the last quarter of 2011, by way of a less restrictive monetary policy.

In developed economies, the normal boundaries to economic policy are now restricted by budgetary constraints, a heightened level of disciple demanded by financial markets, and low interest rates that are close to their level of effectiveness.

Lower inflationary pressures disguised by the impact of indirect taxation

Upward inflationary pressures decreased, due to the lower price on base commodities, at a global level, the lack of substantial inflationary pressures in developed economies and the effects of a more restrictive monetary policy in emerging markets, for the majority of the year. However, the increase of indirect taxation methods has limited the impact on final consumer prices. Inflation rates in the developed economies should decrease throughout 2012, mainly due to the effect of the price evolution of base commodities.

Dysfunctional markets lead ECB to take stern measures to stabilize financial markets

The global increase in risk aversion intensified throughout the second quarter of the year, following the downgrade of the USA’s credit rating and higher tension in European markets. The complexity of the negotiation process and the implicit demands of the financial stabilization policies for the euro area, were the main drivers for strain in Europe. Rumours about the possible redefinition of the group of euro countries were common, contributing to the downward spiral of instability in European markets. By contagion this uncertainty affected global markets.

Equity markets increased loses, especially in European markets and in financial institutions; credit spreads tended to increase based on their level of exposure to financially vulnerable countries; the euro depreciated, having gone below 1.30 dollars. Conversely, investments perceived as safe, such as German and US sovereign debt, gold and short-term instrument in currencies like the Swiss Franc or the Yen registered unprecedented rises in demand.

The significant decrease in confidence affected the normal functioning of financial markets, bringing with it substantial risk for the financing of European economies. The troubles in interbank lending markets coupled with the low demand in other debt markets justified a change in monetary policy. The ECB reduced its exchange rates to 1% and increased the maturities on its liquidity facilities to 3 years. The exchange rate implied by derivatives trading suggests that the rates will remain low for a longer period of time.