Mortgage credit markets in Europe will stay sharply in focus in 2008 for two reasons. One is the much-debated issue of how far the US subprime debacle could spill over into Europe. Given the stormy development on submarkets such as Ireland, Spain or the UK, for which there is no exhaustive fundamental explanation, rising risk premiums and interest rates would seem to point to the inevitability of marked corrections. On the other hand, publication by the European Commission shortly before Christmas of the White Paper on the Integration of EU Mortgage Credit Markets rekindled discussion on the appropriate regulation of EU mortgage markets. Rules on early repayment are the major bone ofcontention, with legislative measures perceived as the mosteffective option. However, their actual use is made contingent onfurther impact assessments. So the threat to put an end to the German practice through the European channel has simply been deferred, not dismissed.

Financial assets in Germany scaled new heights in 2006 to hit EUR 4.53 trillion. Together with property worth EUR 4.8 trillion1 anddurables in the region of EUR 1 trillion, German households possess total assets of EUR 10.3 trillion. This puts Germany roughly on a par with Italy and France among the G7 countries. Inrecent years, however, assets have developed less dynamically in Germany than in its neighboring countries. The main reason was the subdued development on the real estate market.

Both the German financial system in general and SME financing a sa key component of this system have been undergoing aconsiderable structural transformation since the beginning of the 21st century. This development means that markets and valuations in line with market conditions are becoming increasingly important. Traditional financing instruments that previously characterized the German SME segment, such as loan and supplier financing, have developed by leaps and bounds due to the increased risk requirements of the international capital markets and the greater emphasis placed on the individual risk profiles of banks. In practice, we are seeing an increase in the number of capital market-based financing options and new financial market institutions for the broad SME segment.

Warnings about the stability of the international financial systemare certainly not in short supply at present. They ring out from stability reports penned by the International Monetary Fund, the European Central Bank and many national central banks, with the Bank of England as the latest harbinger. At first sight this is surprising given the extremely positive way in which global financial markets have developed by and large in recent years, with marked price gains at every turn and declining volatility in stocks, bonds and exchange rates. But it is precisely this that central banks pinpoint as “blithe unconcern” on the markets. In other words, the risks to the system could stem precisely from investors seemingly failing to identify almost any risks.

Can the stock markets hold their high level until the end of 2006? Will the year now coming to a close be remembered as an equity vintage owing to the bond market’s negative run during the first six months? And will the same go for 2007? Judging by them acroeconomic backdrop, developments on the capital markets will at least be stable. Sustained, if more moderate, global economic expansion, amid easing inflationary pressure, heralds a modest upward movement next year in security yields. On the stock markets the upward trend will remain intact, although gains are likely to be less than in 2006. With bond markets looking set to yield scarcely more than the coupon, 2007 could reenact this year’s stocks-beat-bonds scenario.

Due not least to soaring oil prices, prices and interest rates are rising around the globe. Nonetheless, long-term bond yields remain low. Will the rise in interest rates continue and what are the possible explanations?

Following the extremely expansive stance of monetary policy in recent years, monetary growth has got well ahead of economic activity, giving rise to substantial excess supply. As long as external factors such as globalization curb the rise in unit labor costs, there are justified grounds to hope that this will not fuel inflationary trends. However, even if the euro area economy were to slow further, there is no scope for a further rate cut.

The Asian markets stand out among the equity markets in emerging market economies in terms of both market capitalization and performance. For many investors, however, their structure is still a closed book.

On October 11, the Royal Swedish Academy of Sciences announced this year’s winners of the “Nobel Prize for Economic Sciences”: Finn E. Kydland and Edward C. Prescott. Their academic papers have not only had an impact on the thinking of many economists and monetary policymakers. Indeed, there is much to suggest that traces of their work can even be seen in capital market trends.

One of the most important questions that arises in the assessment of equity markets is the correlation between stock prices and inflation. It is commonly believed that rising prices also push up corporate profits and hence share prices. But is this fact or fiction?

Interest rate increases go hand in hand with falling share prices, whereas rate cuts buoy stocks. That, at least, is the rule of thumb for the correlation between stock and bond prices. This rule has, however, been suspended in the past four years by negative stockbond correlation. This has necessitated a retreat to a more general position: not everything that is good for bonds is also good for stocks.

Are shares under- or overvalued? Are they cheap or expensive? Are European shares preferable to American equities? Experts seldom agree over their assessment of the current situation on the stock markets.