Financial Markets

The international interest-rate markets were generally subject to increases in 2006. Short-term interest rates typically rose more than long-term rates, so that the yield curves became flatter. The development in the US 10-year yield had a decisive impact on the development in yields in many other countries.

The US dollar weakened by approximately 11 per cent against the euro in 2006, partly due to more positive growth expectations in the euro area than in the USA.

The global stock markets rose in 2006 despite falling prices in mid-year. The price increases were relatively high in the USA, the euro area and Scandinavia, while Japanese stocks rose more moderately.

INTEREST RATES

The yield on the benchmark 10-year US government bond increased from approximately 4.4 per cent at the beginning of 2006 to approximately 4.7 per cent at year-end, cf. Chart 14. The increase in the 1st half-year was driven by high economic activity and rising core inflation. In the same period the Federal Reserve raised the fed funds target rate by a total of 1 percentage point in four increments to reach 5.25 per cent. From then on it was not raised further. The 10-year yield fell in the 2nd half-year amid declining economic growth as a result of a slowdown in the housing market, among other factors. This led to expectations that the fed funds target rate would be lowered in the 1st half of 2007.

In the euro area, the yield on the benchmark 10-year German government bond increased from approximately 3.3 per cent at the beginning of 2006 to approximately 3.9 per cent at year-end, cf. Chart 14. Viewed over the year, the development mirrored the course in the US with a rising yield in the 1st half-year, and a falling yield in the 2nd half-year. However, the decline in the 10-year German yield in the 2nd half-year was less marked than in the USA. This is presumably attributable to the sound economic growth in the euro area, which led to expectations of further monetary-policy tightening. During 2006 the European Central Bank, ECB, raised its key interest rate in five increments from 2.25 per cent to 3.5 per cent, and then to 3.75 per cent in March 2007.

Long-term interest rates generally tended to increase less than short-term interest rates, and the yield curves thus flattened in 2006, cf. Chart 15. In the USA, the yield curve inverted around the turn of the year 2005/06, and the spread between the US 10-year and 2-year yields was negative for most of the year. The rising short-term interest rates reflected monetary-policy tightening in reaction to the global upswing. Unlike in previous upswings, long-term interest rates have not increased; in fact they are low in a historical perspective. This is attributable to such factors as low and stable inflation expectations and purchases of government bonds by pension funds and Asian central banks.

The yield on the benchmark Japanese 10-year government bond rose from approximately 1.5 per cent at the beginning of 2006 to approximately 1.7 per cent at year-end, cf. Chart 14. In the 1st quarter, the upswing in the Japanese economy led the 10-year yield to rise to above 2 per cent. Subsequently, economic growth receded, and long-term interest rates fell. Combined with rising inflation, the upswing was sufficiently robust for the Bank of Japan to abandon the zero-interest-rate policy pursued since 2001. In July 2006 and again in February 2007 the Bank of Japan raised its official interest rate by 0.25 percentage points to a total of 0.5 per cent from a level of 0 per cent.

In the UK, the yield on the benchmark 10-year government bond increased from approximately 4.1 per cent at the beginning of 2006 to approximately 4.7 per cent at year-end, cf. Chart 14. The long-term interest rates rose up to the beginning of May and – in contrast to several other countries – then remained stable. At the end of November, the 10-year yield exceeded the equivalent US yield, inter alia reflecting renewed momentum in the British housing market and improved growth prospects for the UK.

The 10-year Danish yield spread to the euro area was modest and stable in 2006, cf. Chart 16. The yield on the benchmark 10-year government bond increased from approximately 3.3 per cent at the beginning of 2006 to approximately 3.9 per cent at year-end. At end-2006, the yield spread to Germany was slightly negative.

During 2006 and the beginning of 2007 Danmarks Nationalbank followed all of the ECB's interest-rate adjustments and moreover unilaterally raised the lending rate by 0.1 percentage point in February 2006, cf. p. 33f. After the interest-rate increase in March 2007 the lending rate was 4.0 per cent, while the discount and current-account rates were 3.75 per cent.

The yield on the benchmark Swedish 10-year government bond rose from approximately 3.4 per cent to approximately 4.1 per cent in the 1st half-year. In the 2nd half-year, the yield fell again to approximately 3.8 per cent at end-2006. The interest-rate drop in the 2nd half-year was more pronounced in Sweden than in the euro area, and the yield spread narrowed, cf. Chart 16. The yield spread ended the year at -0.2 percentage points. Sveriges Riksbank raised the repo rate by 1.5 percentage points in six stages in 2006. In February 2007, Sveriges Riksbank increased the repo rate by a further 0.25 percentage points to 3.25 per cent.

In Norway, the yield on the benchmark 10-year government bond increased from approximately 3.7 per cent at the beginning of 2006 to approximately 4.4 per cent at year-end. During 2006 Norges Bank raised the sight deposit rate on five occasions by a total of 1.25 percentage points. In January 2007, Norges Bank again raised the sight deposit rate by 0.25 percentage points to 3.75 per cent.

FOREIGN-EXCHANGE MARKETS

The US dollar weakened against the euro in 2006, Cf. Chart 17. In total, the dollar depreciated by approximately 11 per cent against the euro, to 1.32 dollars per euro at year-end. The dollar's weakening in relation to the euro is attributable to such factors as expectations of rising growth in the euro area compared with the outlook for the US economy. In addition, the ECB was expected to tighten its monetary policy relative to the Federal Reserve.

The Chinese renminbi strengthened by approximately 3 per cent against the dollar to 7.81 renminbi per dollar at end-2006. As in previous years, the People's Bank of China made substantial foreign-exchange purchases in order to curb its currency's strengthening against the dollar. As a consequence, the foreign-exchange reserve increased further. In mid-2005 the People's Bank of China switched to a managed float of the exchange rate.

During 2006 the Japanese yen weakened by approximately 13 per cent against the euro and by approximately 1 per cent against the dollar. The weakening was to some extent attributable to the yen's role in financing carry trades, whereby investors borrow in low-interest currencies such as the yen and invest in high-interest currencies like the US dollar. The depreciation of the yen vis-à-vis the dollar in 2006 was, however, not as pronounced as in 2005. This in part reflected expectations of a narrowing of the yield spread between the two countries, which would reduce the expected gain from carry trades. At the end of 2006 the exchange rate was 156.86 yen per euro.

The pound sterling appreciated by approximately 2 per cent against the euro in 2006. In the 1st quarter sterling weakened, but then the trend reversed to an overall strengthening for the year, cf. Chart 18. The background includes relatively high interest rates in the UK compared with elsewhere.

The Swedish krona strengthened against the euro in 2006, partly in response to positive growth prospects and expectations that Sveriges Riksbank would raise the repo rate. At end-2006, the krona had appreciated by approximately 4 per cent, to 9.04 kronor per euro. In February 2007 part of the strengthening from 2006 fell away. The weakening was due to declining interest-rate expectations after Sveriges Riksbank signalled that interest-rate expectations in the market were excessive.

To a great extent the Norwegian krone fluctuated with oil prices in 2006. Rising oil prices in the 1st half-year led the Norwegian krone to strengthen vis-à-vis the euro. As oil prices began to ease downwards in the late summer, the Norwegian krone weakened. Oil prices picked up again from around mid-October, and the Norwegian krone strengthened, but not sufficiently to counteract the weakening. Overall, the Norwegian krone depreciated by approximately 3 per cent in 2006, to 8.23 Norwegian kroner per euro.

The Icelandic krona weakened substantially in 2006, cf. Box 4.

STOCK MARKETS

The global stock markets rose in 2006 despite a downturn in mid-year. There were sound increases for US and European stocks, while the increase for Japanese stocks was more moderate, cf. Chart 19. The lower prices in mid-year were attributable to greater investor uncertainty and a resulting shift to safer assets.

The US S& P 500 stock index rose by 14 per cent in 2006. A slight increasing trend was seen up to mid-May, when uncertainty regarding future US monetary policy increased. The economic indicators pointed to slower growth, but there were continued indications of rising inflation. This led to fears that US monetary policy would be tightened more than so far expected, with the risk that growth would dampen further. The uncertainty pushed down US stocks and led to general unrest in the global stock markets, particularly in the emerging markets, cf. Box 5. In the 2nd half of 2006 there were sound price increases in the US market. The underlying factors included dampened inflation expectations, among other things related to falling oil prices. In addition, sound corporate earnings, falling long-term interest rates and increasing merger and acquisition activity contributed to the positive price development.

Stocks in the euro area mirrored US stocks closely again in 2006, but with a general tendency for slightly stronger increases. Underlying factors included the positive economic development in the euro area, a high level of acquisition activity, and sound corporate earnings. The European stock index, S& P Euro, rose by 19 per cent in 2006.

The Japanese Nikkei 225 stock index increased by a modest 7 per cent in 2006. This should be viewed against the background of the previous year's very substantial increase.

The Scandinavian stock markets took the same course as euro area stocks in 2006. However, Danish stocks did not perform near as well as Swedish and Norwegian stocks in 2006, cf. Chart 20.

The Danish OMXC20 index improved by 12 per cent in 2006. Most stocks in the index rose. The largest contributions to the positive development in the index came from Vestas, which increased by 130 per cent, and Novo Nordisk. The A.P. Moller - Maersk stock fell in 2006, thereby reducing the increase in the overall index.

The Swedish OMX index rose by 20 per cent in 2006. TeliaSonera, Nordea Bank and H& M contributed most to the increase in the index. LM Ericsson, which accounts for a very large share of the Swedish index, rose marginally in 2006.

The Norwegian stock index, OBX, rose by 34 per cent. Telenor and Norsk Hydro, the two largest stocks in the index, contributed most to the increase. In 2007 Norsk Hydro and Statoil plan to merge their oil and gas activities in a new company that will become the world's largest offshore operating company.