Foreseeably, the ongoing moderate rise in interest rates will ultimately emit a timely signal to companies to adjust their investment and business expansion projects to real future earnings possibilities. In that way the financial risks that might jeopardise the continuity of investment will be lessened. The financial institutions of all countries benefited from an exceptionally benign environment, in both macroeconomic and financial market terms. Specifically, the balance sheets and income statements of Spanish credit institutions were notably sound, with returns on equity not only greater than those of the previous year but also far above those relating to risk-free assets. Their ROE stood at around a level of 20%, 3 bp up on 2005, with a spread of 16% over long-term government bond yields. These trends are similar to those observed in major international institutions, which show sound levels of returns on equity along with wide spreads over government bond yields. Yet this situation should not lead to complacency. On the contrary, it is precisely the favourable circumstances of financial institutions, as reflected in their levels of profitability and solvency, that allows us to discuss more freely the risks and uncertainties they must face in the coming years. Financial innovation and the activity of new market agents should be viewed as positive developments.
On the other, in a climate of buoyant sales, the widening of business margins continued, albeit at a lesser rate than in previous years. All these factors, combined with the rise in oil prices in the first half of the year, meant that inflation rose in 2006 and that the inflation differential with the euro area stood at 1.4 pp. Inflation began to perform more favourably in the closing months of 2006, a trend that has run into 2007, with the related differential being cut to 0.5 pp. Foreseeably, these inflation dynamics will remain in place for several months. But it should not be forgotten that the improvement has a temporary component, linked to the path of oil prices, and that core inflation remains at 2.5%, despite the continuing restraint of import prices. Price and cost increases in 2006 once again outpaced those of our competitors, prolonging the deteriorating trend of the indices that measure relative prices and costs. Insofar as this difference is not warranted by quality improvements, the trend of these indices reflects a loss in competitiveness, whose adverse consequences for growth will become patent once domestic demand moves back onto a normal footing. The outlook for the Spanish economy points to the continuation of the main features recently observed, namely: the restructuring of spending, thanks to a gradual easing in domestic demand, particularly in consumption and residential investment, and an improvement in the contribution of net external demand.