Financial markets

Prices of risky assets continued to rise throughout most of 2006 and early 2007. Two sell-offs during the period proved to be short-lived corrections rather than prolonged downturns. A number of equity markets reached historical highs, while various credit spreads touched new lows, despite a weaker economic outlook in the United States and indications that global growth might have peaked. In this environment, government bond yields in the advanced industrial countries levelled off around mid-2006 and then began to edge downwards. The United States, in particular, saw long-term bond yields falling during the second half of the year, reflecting investor concerns about US growth prospects and expectations that monetary policy would be easing. The economic outlook in Japan remained more positive, lending some support to bond yields, while the economic outlook for the euro area brightened progressively and eventually brought about rising euro bond yields.

An important ingredient behind the gains in developed equity and credit markets was continued strong earnings growth. Moreover, ongoing changes in capital structure boosted equity markets, as share buybacks rose further while merger and acquisition activity grew substantially. Similarly, gains in emerging markets coincided with improved credit ratings and generally strong macroeconomic conditions. However, in all these markets, increasing risk appetite probably helped fuel the upward trend in prices.