Experience with TARGET demonstrates the importance of the market infrastructure in allowing arbitrage to operate effectively. Let me now turn from wholesale activities to banks’ customer business. As European banks are typically universal banks, they combine a wide range of products within a single institution. The markets for these products have varying degrees of integration - some are already global or European, while others have remained national or even local in character. At least the major banks already operate in highly internationalised markets for a number of their products and have geographically diversified activities. Even if banks remain nationally based, they are increasingly subject to international market developments. National tendencies are increasingly influenced by international developments. Hence, the usual argument that cross-border mergers and acquisitions are a necessary condition in order to achieve a more integrated and international banking system does not seem very strong. In particular, many of the asset management and investment banking services are already quite internationalised as the capital markets have taken significant steps towards integration and growth following the introduction of the euro. Banks’ own holdings of securities have also become BIS Review 83/2000  4  increasingly diversified across borders. The trend has been quite strong for government securities, as well as for corporate bonds. To take an example of the financial services provided by banks in the capital market area, the leading underwriters of bonds issued by European firms are the major European banks, alongside the largest US investment banks.
In this context, we expect internal demand to continue weakening over 2008. Indeed, the most recent economic projections released by the Bank of Spain show reduced GDP growth in 2008 and 2009. At the same time as we face a slowdown in growth, we are seeing sharp increases in headline inflation. These have been driven by large energy and food price rises at the global level. The price boom has affected Spain to a larger extent than some other countries, partly due to the higher relative weight of these items in household expenditure. And the Spanish economy may be more vulnerable than other countries to second-round effects due to the widespread existence of indexation mechanisms. I would like to make a few comments about what economic agents should and should not do to face these challenges. On inflation, the key issue is how firms and workers respond to the recent shocks. I would like to make two points: •  First, firms should not view the shocks as permanent. In other words, they should not consolidate price-rises over the longer term. •  Second, workers should understand that inflation cannot be offset by demanding wage increases that are not justified by productivity developments. This would just keep inflation persistently high, as the 1970s experience painfully showed. BIS Review 70/2008  1  From the perspective of GDP growth, if we are to see a quick return to our potential, we need flexibility in supply and demand responses.