Global economy, economic climate and crisis on the US real estate market

The expansion of the global economy, driven primarily by the growth engines of China and India, continued during 2007. The economy in the USA slowed down somewhat compared to the previous year, while growth remained very robust in the euro zone. The economic climate clouded over in the second half of the year due to the crisis on the US real estate market and the turbulence in the financial and stock markets. In addition, the inflationary pressure increased noticeably due to the exceptionally sharp rise in raw materials prices.

Economy weakens somewhat

Investments and consumption remained the primary driving forces in the euro region during 2007. Early indicators such as business climate and consumer confidence showed a weakening of the economic dynamic towards the end of the year. The strength of the euro was not able to compensate for the enormous increase in petroleum and raw materials prices. Inflation also exceeded the target set by the European Central Bank of just 2.0%.

Austria’s economy remained on a growth course in 2007, thanks to the export boom and the intensive investment activity. The gross domestic product increased as much as in the previous year, exhibiting growth of 3.4%. A continued rise in employment brought unemployment down once again. The unemployment and inflation rates remained below the EU average.

Subdued developments in the insurance business

Austria’s insurance sector continued to be characterised by slight growth in 2007. The total of premiums increased by 1.9% to €16 billion. Excluding single premium transactions, the insurance industry grew at 3.0%, roughly the same rate as the overall economy.

Health insurance exhibited a growth of 3.2% to €1.5 billion in 2007, the strongest dynamics in the industry. Life insurance performed less strongly than in 2006 and only grew by 0.4% to €7.2 billion. This was the result of an increase in recurring premiums of 2.8% and a further decline in single premium business of 6.6%. Property and casualty insurance performed better than in 2006, with an increase in premiums of 3.1% to €7.2. The driving forces here were general liability, household insurance and legal expenses insurance. No growth impulses due to the stiffer competition came from motor vehicle liability and comprehensive insurance.

Heavy turbulence on the financial markets

The international money and financial markets were marked by turbulence and uncertainty during the second half of the year, triggered by the crisis in the US real estate market. The result was the need for massive corrections in the IFRS balance sheets of financial institutes, due to the required revaluation of securities supported by American sub-prime mortgages. This led to a liquidity squeeze with significant irritations on the money market.

The central banks in the USA and euro region made billions available to the business banks for a short period. Despite increasing inflationary pressure, the European Central Bank declined to implement an increase in the base interest rate, although this had already been indicated. It left the minimum refinancing rate, which had been raised in March and June by 25 basis points, at 4% until the end of 2007. The US central bank, on the other hand, lowered its base rate in October and December by 25 basis points each to 4.25%.

Inverse yield curve

The credit crisis and interest rate increases in the euro region and Switzerland drove money market interest rates upward. The 3-month EURIBOR reached a peak value of 95 points above the minimum refinancing rate of the European Central Bank in December. The inter-bank market was characterised by significant restraint up to the end of the year.

The yields of government bonds increased during 2007 in the euro zone and in Switzerland, while falling in the USA and Japan. The yield curve of long-term euro bonds was the inverse of the money market, as a result of the financial crisis.

The dollar lost roughly 10% against the euro and the yen between June and December. The rise in value of the euro does encumber the competitiveness of producers in the euro region with regard to price, but it also absorbs price increases for imports invoiced in dollars.

World stock markets make gains despite disruptions

After record levels up to mid-year, the international stock markets experienced highly erratic fluctuations in the second half but, nevertheless, finished the year up almost across the board. The DOW JONES INDUSTRIAL AVERAGE rose by 6.4%. The representative index for Europe, the DJ EURO STOXX 50, saw a gain of 6.8%. The Eastern European index CECE climbed by 10%. The German stock index DAX once again achieved two-digit growth of 22.3%. Top results were reported by the Chinese CSI 300 Index (+162%), as well as by the stock market index of the Ukraine PFTS (+135%), and Slovenia (+78%).

Economic climate cooling in 2008

The growth of the global economy may decline more than previously expected in 2008. The driving economic engines remain China and India. However, above-average expansion is also seen in most Eastern and southeastern European countries. The economy of the euro region will grow by only about 1.5% during 2008, with increasing inflation risks.

In Austria, a decline in economic growth by roughly 2.0% is expected. The effects of slightly decreased consumer activity will, once again, be felt. Investment intensity will abate somewhat. The employment level will remain high, but consumer prices will rise more sharply.

The insurance industry in Austria will grow in 2008, at about the level of the previous year, with a premium growth of roughly 1.9%. Health insurance (+3.1%) and property and casualty insurance (+2.6%) should achieve a solid upward course despite the stiffer competition in motor and industrial insurance. Increased volume of 1.0% is expected in life insurance. While the recurring premiums should rise 4.6%, a decline of roughly 10%, as in 2007, is expected in the area of singe premiums.

Gradual calming of the financial markets

In particular, long-term yields on the European capital markets may fall due to the slowing growth. The money market interest rates should decrease further in the euro zone and the USA over the course of the year. After the decision in January 2008 to lower the base interest rate by a total of 125 basis points to 3.0%, in order to shore up the American economy, the US central bank as well as the European Central Bank may loosen up on monetary policy over the course of the year, despite growing inflation risks.

The international stock markets will suffer from the continued uncertainty. If fears regarding drastic cooling of the American economy, a further increase in the oil price and the euro-dollar exchange rate prove unfounded, a broad recovery could occur in Europe.