, npl resolution continued in 2020, notably through the disposal of legacy npls. our central expectation is for a sustained recovery. this would help create a virtuous circle between : improving corporate sector health, improving profitability in the banking sector and strong sovereign ’ s credit standing, permitting governments to continue to support households and businesses where necessary. but it is worth noting that the recovery could well turn out bumpy, and if future developments inhibit a strong recovery, bank provisions may turn out to be insufficiently conservative. that could risk creating a negative chain of events, through rising defaults, greater deterioration in asset quality, a restricted flow of credit to the real economy, and destabilising feedback loops between banks, sovereigns and corporates. in all cases, the apparent decoupling of asset quality trends from economic developments can mainly be explained by the unprecedented policy support provided to the economy. this support could also just prolong the typical lag between the recession and the rise in npls rather than prevent npl formation. there are already some early signs of weakening credit quality, for example the share of loans reported as subject to heightened credit risk has risen significantly and asset quality is likely to deteriorate once support measures are phased out. as the coronavirus shock affected the euro area economy very unevenly, credit risk metrics have varied widely across sectors. the deterioration is most visible in sectors that were hit harder by the pandemic, such as services, while loan performance problems are less prevalent in manufacturing. yet even with the projected improvements, the outlook for bank profitability remains subdued. analysts expect euro area banks ’ return on equity to recover only gradually, reaching 6 % by 2022. on average, this would still fall short of their cost of capital. 1 moreover, bank profitability in the euro area is expected to trail well behind that of large us banks, whose return on equity is currently projected to reach about 12 % by 2022. euro area bank valuations remain low when compared with those of their peers around the world, particularly those of us banks. looking beyond the challenges presented by the coronavirus pandemic, addressing pre - existing structural weaknesses remains crucial to sustainably improve profitability. the relatively lower valuations of euro area banks predate the pandemic, even if they have been accentuated by recent developments. profitability continues to be hampered by overcapacity. banks continue to operate in a competitive environment, with revenues under pressure not

shorter term. at longer horizons, risks lie mainly on the downside. the main risks relate to fears of a rise in protectionist pressures, the possibility of a renewed increase in oil prices, and concerns about possible disorderly developments owing to global imbalances. with regard to price developments, it is essential to stress the importance of taking a medium - term perspective and to look through the possible volatility of inflation rates over the course of 2007. in this respect, it may be helpful to consider the potential volatility of inflation in greater detail. in the very short term, it appears that the changes in vat in a large euro area country were not fully reflected in prices in january. thereafter, it should be noted that on the basis of current prices for oil and oil futures and previous oil price developments, significant favourable base effects may progressively lead to lower inflation rates in the spring and summer. however, these effects will be temporary. later in 2007 inflation rates are expected to rise again as a result of unfavourable base effects. the medium to longer - term outlook for price stability remains subject to upside risks. they continue to include a stronger pass - through of past oil price rises into consumer prices than currently anticipated and additional increases in administered prices and indirect taxes beyond those announced thus far. furthermore, renewed increases in oil prices cannot be excluded. more fundamentally, stronger than currently expected wage developments pose substantial upward risks to price stability, given the favourable momentum of real gdp growth observed over the past few quarters, the fact that survey measures of capacity utilisation are approaching the peak levels reached in 2000, and the ongoing improvement in labour market performance. it is therefore crucial that the social partners continue to meet their responsibilities. in this context, wage agreements should take into account productivity developments while recognising the still high level of unemployment and price competitiveness positions. indeed, the governing council will monitor the upcoming wage negotiations in the euro area countries very carefully. the monetary analysis confirms the prevailing upside risks to price stability at medium to longer horizons. annual m3 growth rose further to 9. 7 % in december, marking the largest increase seen since the introduction of the euro. of course, monthly figures can be volatile and we should not overemphasise short - term developments. however, continued strong money and credit growth confirm the view that the underlying rate of broad money expansion in the euro area remains vigorous, with no evidence as yet that the steady upward trend observed since mid - 2004