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MACROECONOMIC ENVIRONMENT

The world’s economic activity has recovered during 2010 mainly due to a strong contribute of the developing countries and a progressive improvement of the developed economies.

The utilization of expansionary policies has partially fulfilled the intended impact but at the same time has uncovered other challenges. Inflationary uncertainties have returned, imbalances of public finances have remained unsolved, regional asymmetries have emerged and thus latent institutional tensions are still prevailing. More than 3 years after the beginning of the crisis in the uS subprime market, there is still no substantial change in the global macroeconomic unbalances. But once the turbulence of the crisis is over, an equally or even more challenging stage emerges: sustainability.

In this context, different strategies came out to solve excessive debt: in the US, priority was given to the reinforcement of nominal growth stimuli, congregating innovative liquidity measures with reinforcement of public expenditures; in europe, by contrast, the course of action was the normalization of monetary policy on par with budget austerity; in asia, the economic policy has been assuming a more restrictive nature, to prevent the overheating of specific market sectors.

In 2011, it is expected that the global economy keeps recovering, however at a moderate pace. Several actions and decisions are expected to have significant impact over the next years both on the development of countries and on the behavior of financial markets, namely in what regards institutional relations (specifically in the european context), preventive actions over systemic global risks and regulatory frameworks.

World economy recovers but faces complex challenges

2010 may have marked the beginning of a new expansion cycle of the world’s economy. In what concerns sustainability, slight changes in the contributions to global growth must be pointed out. those changes are materialized by the increasing importance of the domestic expenditure in emerging economies to stimulate the export sectors of the advanced economies. For the period from 2010 to 2012, the IMF estimates a global growth rate in line with its growth potential (4,5% to 5%), as for the “euro” zone, even if at a lower level (1,5% to 2%).

The progress verified in terms of economic growth still presents few repercussions in the job market. the climate of uncertainty, high volatility and adverse financial conditions impose prudence in the evaluation of investments and personnel admissions. For that reason, only recently it is visible a slight reduction in overall unemployment rates.

Deflationary risks decrease and give room to inflationary pressures

The rise in the prices of raw materials, restoring or even slightly surpassing the levels of the pre-crisis period, was due not only to an increase in global demand and rigid global short-term supply, but also to atypical factors, such as climate adversity or natural catastrophes, as well as other structural factors, such as the complexity and additional requirements for the extraction, treatment and shipment of raw materials. these conditions should prevail in 2011 and thus provide stability to current prices.

The intensified growth of the emerging economies facilitated the transmission of these cost rises into consumer prices, with greater relevance in developing countries, where the utilization of raw material resources is fundamental, as opposed to developed economies where this effect only became visible later and with a smaller impact. In europe, due to the budget consolidation process, the rise in prices was reinforced by the impact of the change in indirect taxation. the inflation rate rapidly grew to 2,4% in the beginning of 2011, a value higher than the price stability target set by the ECB.

Risk adverse environment

As the economic recovery seems more realistic and the financial markets become more balanced, the central banks feel more comfortable to review their parameters of monetary policy. the accommodative nature of the monetary policies in asian and some european economies is changing. the interest rates started to rise again and some requisites associated with credit concession are becoming more restrictive. In the case of the USA, the non-conventional liquidity measures were even reinforced by the end of 2010, in contrast with the ECB’s policy that decided for the opposite course of action for the euro zone.

Even if there were no changes in the key interest rates, the transition from an insecure deflationary environment to a regime of inflationary tensions has influenced the expectations concerning the evolution of interest rates. Euribor interest rates rose and yield curves gained slope.

The risk adversity environment has smoothed as the year finished. Market indexes have been appreciating, reflecting the release of strong corporate results and attractive valuations in comparison to historical standards. the foreign exchange volatility was not accompanied by a clear trend in the most important currency exchange rates, nevertheless the currencies of the emerging markets tended to appreciate. the EUR/USD exchange rate has been fluctuating in function of interest rate spreads and institutional instability in the euro area.

The repercussions of institutional instability on the Euro area financial markets

The improvement in the world’s economic environment and in the behavior of the financial markets contrasts with the specific circumstances within the european union. the revision of sovereign ratings in the second quarter of 2010 for Greece, portugal, Spain and, in a later phase, for Ireland, marked a context change. the aversion to risk was so significant that it was necessary to implement special mechanisms, within the EU and with the support of the IMF, in order to provide support to the financing needs of Greece and Ireland, avoiding more pronounced damages to both their economic activity and social stability.

The skepticism about the effectiveness of these plans over the medium term, related with the punitive nature of the negotiated conditions and with the complexity of financing the assistance funds, supported the design of a new european Stability Mechanism, which should be active by 2013 with the primary objective of preserving the financial stability of the Euro area. Simultaneously, the reformulation of the “Stability and Growth pact” is in preparation, under the new designation of “Competitiveness pact” to be submitted for approval by all the member states, by the end of the first quarter of 2011. the reinforcement of the european institutional framework, implicit in the reformulation of these control and assistance mechanisms, might have great relevance to the future of the Euro area.

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