. the increase in market liquidity may reflect structural changes in financial markets ; for example, the liberalisation of international flows of capital, the securitisation of loans, the development of new financial instruments, and the rapidly growing market presence of highly active financial market participants, such as hedge funds. however, buoyant market liquidity could also reflect excessive risk appetite, indicating that liquidity risk could be under - priced, as well as high leverage. to the extent that high risk appetite is an important determinant of market liquidity, the current favourable liquidity conditions could suddenly, and unexpectedly, fade away, if there were a loss of confidence or an abrupt and lasting increase in risk aversion. this could expose several underlying vulnerabilities in the financial system on which i will elaborate later on. global financial institutions turning to global financial institutions, with the exception of the fact that the hedge fund industry has grown further in size, all other backward - looking indicators suggest that potential risks to financial stability posed by hedge funds have not changed materially since the december 2006 fsr. however, market risks posed by hedge funds remain. they arise largely from information which suggests that over - capacity, and indeed over - crowding, could be taking place in the sector after a simultaneous increase in the number of funds and a reduction of profitable trading opportunities over the last couple of years. on the one hand, as illustrated in the chart on the left of slide 7, average hedge fund returns have been on a downward trend since the early 1990s. this trend could point to overcapacity and to a consequent lowering of the amount of profitable investment opportunities available, although other explanations are also possible. at the same time, the degree of correlation between hedge fund returns across different strategies, shown in the chart on the right of slide 7, remained around the same relatively high level as in mid - 2006. there are concerns about the implications for market dynamics if there was to be an event which would prompt many funds into “ rushing towards the exit ” at the same time due to the crowding of trades, i. e. that many funds are positioned similarly. 4. euro area financial system euro area corporate sector let me now focus on the euro area corporate sector. against a background of strong economic conditions, low financing costs and abundant market liquidity, the rate of borrowing by the euro area corporate sector began to quicken after mid - 2005. as a result, key indicators of the

moreover, we cannot know how the financial crisis will develop in future and how long it will last. falling house prices have affected not just the united states, but many other countries. we have not been affected by this, although there appears to be a cooling in the housing market here, too. another shock that has occurred during this downturn is that energy and commodity prices have risen substantially. last summer the oil price reached new top levels and inflation rose around the world. however, since then prices have fallen. seen in a longer - term perspective, rising commodity prices are not an uncommon feature prior to a turnaround in the economic cycle. this was the case, for instance, in the 1970s. as a consequence of the rising inflation, central banks around the world have been faced with a difficult situation, where the risk of contagion effects on other prices and wages must be assessed in an uncertain economic situation with receding growth. another common cyclical pattern that is now repeating itself is that labour productivity is low, which is significant for cost pressures. productivity growth usually slows down when economic activity slows down, but in recent years productivity growth has been unusually low. it is also unusual that productivity growth falls as long as eight quarters in a row, as it has now. it is difficult to find a simple explanation for the low productivity growth in recent years. the national institute of economic research has studied the composition effects, to put it simply, if the composition of industries with different rates of productivity has changed, and it finds no great effect on productivity. 13 another possible explanation could be that the recent increase in employment has meant that new groups with a lower productivity than others have entered the labour market. for instance, it can take time to train new employees. it may also be the case that companies have prepared for coming retirements by employing additional staff so there are currently two to a job in some cases. when productivity slows down, unit labour costs increase, and this puts further pressure on companies to raise prices. there is thus risk of higher inflation. we are currently facing a situation where it is difficult to predict how companies will adjust to high unit labour costs. it is always difficult to dismiss staff, but indicators such as job vacancies, redundancies, companies ’ employment plans, etc. point towards an adjustment having begun. at the same time, a general decline in demand makes it difficult for companies to pass on cost increases to consumers. commodity prices have also begun to