Economic environment

Spain, Germany and Ireland are among the European countries with the best prospects of recovery following the structural reforms implemented.

The robustness of the US economy is in contrast to the return to recession in Japan and the weakness of the emerging countries.

Uneven growth. World economic recovery continues, although it is by no means free of obstacles. Trends in the various different regions continue to be asymmetric. The United States, for example, stands out due to the strength of its economy, but in the euro zone there are clearly considerable differences in the pace of advance of the member countries. Germany, Ireland and Spain stand out positively, while France and Italy lag behind somewhat as a result of not having implemented sufficient structural reforms. Japan is advancing slowly, despite the aggressive monetary policy applied by its central bank and, finally, the emerging countries are in the weakest position as far as global economic recovery is concerned, affected by serious internal and external imbalances.

The common denominator of the main developed economies has been the strong support shown by their respective central banks to the economy, applying highly accommodative monetary policies with the aim of stimulating GDP growth in a context in which the level of price inflation is generally very low.

In Europe the central bank has cut the reference interest rate on two occasions, to the current 0.05%, with a negative deposit rate (-0.20%) and offering strong support to the economy. The upturn in Europe continues, as is reflected by four consecutive quarters of year-on-year growth in GDP. This objective has been attained in spite of the process of deleveraging that is under way, the orders to reduce public spending and the insufficient introduction of structural reforms by certain member countries. Lastly, the European economy has benefited from the fall in the price of oil, a low level of inflation – which even turned negative in December – and the depreciation of the euro, which makes its companies' exports much more competitive.

Spain continues to face profound internal imbalances, such as unemployment, and external ones such as the loss of momentum of the euro zone and particularly of France, its main trading partner. Despite this, the situation is encouraging: the introduction of structural reforms is starting to bear fruit, there has been an improvement in external competitiveness and a reduction in financing costs – as can be observed in the narrowing of the spread over German bonds - which, together with cheaper energy and the depreciation of the euro, has allowed the economy to grow at considerably faster rates than the rest of the surrounding countries (+1.6% YoY in Q3 2014). Moreover, although unemployment remains high, the improving trend is consolidating and in 2014 apparently just over 417,000 jobs were created.

In the United States the Federal Reserve, despite having ended its last asset purchase programme (QE3), continues to apply an expansive monetary policy, holding interest rates at low levels. Major macro indicators reflect the robustness of the US economy, such as strong job creation, improving confidence, the uptick in consumer spending and the good progress of the real estate market and industrial output.

Japan faces a complex situation including the return to recession and the fiscal adjustment that it has to complete, not forgetting last April's increase in VAT, which had a negative impact on consumer spending. In the political sphere, Prime Minister Shinzo Abe won new elections, but has yet to announce any measure suggesting that the ‘third arrow’ of so-called ‘Abenomics’ is about to be launched. All this, together with the high level of debt (226% of GDP), prompted Moody´s credit rating agency to reduce the country's rating by one notch from Aa3 to A1. On the positive side, the yen continued to depreciate, which provides support to growth through exports.

The emerging countries for their part are showing obvious signs of weakness. Some of them are affected by large fiscal deficits, depreciation of their currencies, high levels of inflation and the fall in commodity prices, particularly oil. This situation has very damaging consequences for Venezuela, Brazil and Mexico, and is especially difficult for Russia, 50% of whose fiscal revenue comes from oil and gas, to which must be added the depreciation of the rouble and a scenario muddied by the international sanctions in connection with the crisis with Ukraine.

The situation is different for China, where the central bank decided to cut the key interest rate to support the real estate sector and avoid a ‘hard landing’ of its economy. In this case, the problem stems from the fact that the aggressively expansive monetary policy was proving insufficient to solve the main problems of its economy, which are excess production capacity, slowing demand, the real estate sector and the credit bubble. Lastly, India stands out as the exception among the emerging countries, since it is showing early signs of economic recovery.

Interest and currency rates

In 2014, the all-time record low interest rates in the developedcountries contrasted with the increases seen in the emergingcountries in an effort to control inflation.

The strength of the US and UK economies compared with Europe caused their currencies, the dollar and the pound, toappreciate against the euro.

Relaxed monetary policies. Key rates at low levels were the dominant notes in the main developed countries. The dollar strengthened against other currencies, while most emerging countries' currencies posted sharp falls.

Inflation in the developed countries continued low, which allowed accommodative monetary policies to be applied and key interest rates to be held at all-time record low levels. In contrast, in many emerging countries the high level of prices and, in some cases also large capital outflows, prompted central banks to raise interest rates in order to curb inflation. Especially notable
examples in 2014 were Brazil (to 11.75% from 10% in December 2013) and Russia (to 17% from 5.5% at the beginning of the year).

The dollar's appreciation against the euro is explained on the one hand by the strength of the US economy in comparison with that of Europe with its slow advance, and on the other hand by the divergence between the monetary policies applied by the Federal Reserve and the ECB. Whereas the ECB is preparing an ambitious bond purchase programme, the Federal Reserve has ended its monetary expansion programme (QE3) and is even studying a possible increase in rates in 2015. The yen has depreciated against the euro, due to the aggressiveness of the monetary policy pursued by the Bank of Japan, which includes a massive injection of liquidity into the system.

As regards the other major currencies, we would point out that during 2014 there were no substantial differences in the published rates for the Swiss franc (although it did depreciate slightly) since it was pegged at 1.20 to the euro by its central bank; in the first few weeks of 2015, however, the Swiss National Bank discontinued the peg, leading to the consequent appreciation of the currency against the euro.

Lastly, the trend of the pound has been to appreciate against the euro due to the divergent rates of growth in the economies.

Situation on the stock exchanges

The Ibex-35, with a gain of 3.7%, achieved the best performance among European stock markets.

The modest results obtained by the European indices contrast with the double-digit gains posted by US indicators.

The year 2014 ended with modest gains on the main European stock markets, while US indices posted strong gains, driven by the recovery in the US economy and improved corporate earnings. The European stock markets, in contrast, were weighed down by a variety of factors, such as the low rate of economic growth across the region, fear of deflation, and geopolitical tensions,
basically between Russia and Ukraine, and in consequence corporate earnings have remained weak.

The biggest rallies in developed countries were in the US, but the advance of Japan's Nikkei index also stood out. In Europe, the main indices ended 2014 with moderate gains, the Ibex-35 being the best performing index, followed by Germany's DAX. In the emerging markets, whereas India, Venezuela, Argentina, Thailand and Indonesia ended the year with substantial gains, the South Korean and Brazilian stock markets posted declines.

Furthermore, the increase in perceived risk on some economies, deriving from geopolitical tension, the fear of lower global growth and the expectation of a large-scale asset buying programme in Europe have led to greater flows of funds into fixed income.

The following table shows the changes in the major stock markets in 2013 and 2014, all in local currency: