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Annual report and accounts 2016

34 Economic

34 Economic landscape Ongoing developments that impact our industry Global GDP growth Actual 2016 +3.1% International Monetary Fund (IMF) forecast (January 2016) +3.4% Actual 2015 +3.2% Once again, global GDP growth came in below IMF expectations in 2016, but broadly similar to the performance in 2015. The IMF expects the rate of GDP growth to increase in 2017, especially in emerging market and developing economies. However, the IMF noted that there is a wide dispersion of possible outcomes around its projections, given uncertainty surrounding the policy stance of the new US administration and its global ramifications. UK GDP growth Actual 2016 +2.0% IMF forecast (January 2016) +2.2% Actual 2015 +2.2% UK GDP growth came in at 2.0 per cent in 2016, slightly down on the performance in 2015 and below IMF forecasts issued in January 2016. The rate of GDP growth accelerated during the year, with the economy growing +1.8 per cent in the first quarter, +2.0 per cent in the second quarter, and +2.2 per cent in the third and four quarters. The GfK Consumer Confidence index started the year positively at +4 in January compared to +2 in December 2015, but fell throughout the year, reaching a low point of -12 in July 2016 following the UK vote in favour of leaving the EU. Whilst the index improved later in the year, it remained at -7 in December 2016. In contrast the UK unemployment rate continued to fall during 2016, ending the year at 4.8 per cent, compared to 5.1 per cent in December 2015. For 2017, both the OECD and IMF forecast a significant slowdown in UK GDP growth; +1.2 per cent and +1.5 per cent for the OECD/IMF respectively. In its forecast, the IMF stated “slower growth is expected since the referendum as uncertainty in the after-math of the Brexit vote weighs on firms’ investment and hiring decisions and consumers purchases of durable goods and housing”. However, there is a very large divergence in UK GDP growth forecasts from the various forecasting bodies with a range of +0.8 per cent to +2.6 per cent for 2017. Eurozone GDP growth Actual 2016 +1.7% IMF forecast (January 2016) +1.7% Actual 2015 +2.0% Economic growth in the Eurozone dipped compared to 2015, but was in line with IMF forecasts issued in January 2016. Growth remained stable across the year, with GDP growth of +1.7 per cent in the first quarter, and +1.8 per cent in the remaining quarters of the year. The political backdrop remained difficult with the rejection of constitutional reforms in Italy and a variety of terrorist incidents across Europe damaging sentiment and investment. In March 2016, the ECB announced a significant package to ease monetary policy, shifting the focus away from rate cuts to quantitative and credit easing, a process that the ECB has confirmed will be continuing throughout 2017. The unemployment rate continued to fall, reaching 9.8 per cent by the end of 2016, compared to 10.4 per cent at the end of 2015. Both the OECD and IMF forecast a slight dip in the rate of GDP growth for 2017, forecasting +1.6 per cent and +1.5 per cent respectively. US GDP growth Actual 2016 +1.6% IMF forecast (January 2016) +2.6% Actual 2015 +2.6% The US GDP growth rate slowed in 2016 compared to 2015, and IMF forecasts issued in January 2016. The US economy lost momentum in the first half of the year, with GDP growth of +1.6 per cent in the first quarter, +1.3 per cent in the second quarter, down from the fourth quarter of 2015 at +1.9 per cent. However, growth accelerated in the second half, with quarter three GDP growth of +1.7 per cent and +1.9 per cent in quarter four. A strong labour market remained a key driver as the unemployment rate dropped to 4.7 per cent at the end of 2016 from 5.0 per cent at the end of 2015. Following the first US interest rate rise in seven years in December 2015, the US Federal Reserve voted in favour of a further rate rise in December 2016 following the on going recovery in GDP and decline in unemployment. The OECD and the IMF are forecasting GDP growth of +2.3 per cent in 2017. Latin America GDP growth Actual 2016 –0.7% IMF forecast (January 2016) –0.3% Actual 2015 +0.1% Latin America continued to experience challenging conditions, with GDP contracting in 2016 compared to flat growth in 2015, and lower than IMF forecasts issued in January 2016. Once again, there was a divergence in regional performance, with recession in South America worsening (GDP growth -2.0 per cent in 2016 compared to -1.3 per cent in 2015), but Central America’s GDP growth rate remaining robust (+3.9 per cent in 2016 compared to +4.2 per cent in 2015). Brasil and Venezuela remained in recession, but while Venezuela’s recession worsened, the rate of decline in GDP in Brasil slowed compared to 2015 (-3.3 per cent in 2016 compared to -3.8 per cent in 2015), despite the challenging political situation. Both Argentina and Ecuador slipped into recession in 2016, and with the exception of Paraguay and Peru, every other country in South America experienced slower economic growth in 2016 compared to 2015. The IMF expects a recovery in Latin America in 2017, forecasting GDP growth of +1.6 per cent. This mainly reflects an improvement in economic conditions in South America, with Brasil and Argentina forecast to emerge from recession and return to growth. Likewise, the IMF also forecasts a better performance in 2017 in all other South American countries with the exception of Ecuador, where the IMF forecasts the recession to worsen. Economic growth in the other parts of Latin America is expected to remain strong in 2017. The significant depreciation in sterling (GBP) Sterling endured a significant sell-off following the UK’s vote in favour of leaving the EU. Against the euro, pound sterling fell 5.8 per cent on the day the referendum result was announced (June 23 rd ), but 8.1 per cent against the US dollar, which represented the largest one-day fall since the introduction of free-floating exchange rates in the early 1970s. Following the vote, the Bank of England cut interest rates by 0.25 per cent to a record low of 0.25 per cent alongside a variety of monetary stimulus measures including the purchase of UK Government and corporate bonds. INTERNATIONAL AIRLINES GROUP Annual Report and Accounts 2016

35 However, continued weakness in the second half of 2016 saw pound sterling close the year down 13.6 per cent against the euro and 16.3 per cent down against the US dollar. Increasing oil prices Brent crude increased significantly in price during 2016, starting the year trading at $37.28/bbl but ending the year at $56.82/ bbl, the overall high for 2016. Oversupply concerns and demand uncertainty had subdued oil prices through the year. However, an agreement in principle to cut supply was announced by OPEC in September, followed by an agreement to the first supply cut in eight years in November. The importance of this accord was underlined by the +8.8 per cent rise in Brent crude on the day of the announcement, with prices rising a further +12.6 per cent by the end of the year. Industry outlook IATA is forecasting industry operating margins to 6.6 per cent in 2017, 1.7 percentage points below the operating margins in both 2015 and 2016. IATA forecasts seat capacity to increase 5.6 per cent in 2017, lower than the 6.2 per cent growth in 2016 and the 6.7 per cent growth in 2015. Passenger load factor is expected to dip slightly to 79.8 per cent compared to 80.2 per cent in 2016. Passenger yield is expected to be flat compared to 2017; the first time since 2011 that passenger yields have not fallen year-on-year. IATA expects Africa to continue to generate the lowest profitability and to be the only region with negative net post-tax margins in 2017 at -5.7 per cent which IATA attributes to regional conflict and the impact of low commodity prices. North American airlines are once again expected to generate the highest margins, although IATA’s forecast for 2017 (+8.5 per cent) is lower than the performance in 2016 (+9.7 per cent) and 2015 (+9.8 per cent). For Europe, IATA forecasts net post-tax margins of 2.9 per cent, lower than 2016 (4.0 per cent) and 2015 (3.8 per cent). Regulatory controls The airline sector continues to be among the most heavily regulated industries in the world and 2016 saw some significant developments including agreement at the International Civil Aviation Organisation (ICAO) on a Global Market Based Mechanism to deal with airline carbon emissions. See page 45 for developments in sustainability. Air Passenger Duty (APD) The UK government continues to impose APD on airlines, still the heaviest tax of its kind in the world, and which costs the industry over £3 billion a year. Although the Scottish Government has published its Air Departure Tax bill that will introduce a revised charge and reduce the rate of tax at Scottish airports by up to 50 per cent from April 2018, IAG continues to believe that reducing tax only in Scotland will distort competition between airports and we continue to argue vigorously for the abolition of APD which is holding back UK industry. UK visa policy The UK introduced a two year visa for Chinese visitors in 2016, but IAG continues to press the Government to deliver the promised trial of a ten year visa, similar to that offered by the US, to improve the UK’s attractiveness to visitors from China and to make similar improvements for travellers from other key markets, including India. UK airports On October 25, 2016 the UK Government announced it would accept the recommendation of the Airports Commission for a new runway to the North West of Heathrow. The scheme will be taken forward in the form of a draft National Policy Statement for consultation, with a first draft expected in early 2017. IAG believes that expansion of Heathrow represents a very positive development for its business and for the wider UK economy, but has continued to challenge the excessive costs of the proposals put forward by Heathrow’s operator, HAL. IAG continues to argue that costs must be reduced and charges remain flat for the new capacity to be commercially viable. The UK government indicated its support for IAG’s position stating: the “aim should be to deliver a plan for expansion that keeps landing charges close to current levels.” IAG will actively engage in the forthcoming consultations with the operator and regulators to ensure that the new capacity is delivered cost effectively. UK Referendum vote to leave the EU On June 23, 2016 the UK voted to leave the EU. After careful evaluation, IAG has concluded that over the long-term, the UK’s secession from the EU will not have a significant impact on our business. We will continue to engage with the relevant authorities over the coming year to ensure that our views on future aviation relations between the UK, EU and other markets continue to be taken into account. Irish National Aviation Policy In 2016, the Irish Government established a National Civil Aviation Development Forum to facilitate consultation with the industry on national, EU and international policy. Aer Lingus is an active participant including on regulatory matters, aviation training, skills and employment. A comprehensive review of the regulatory regime for airport charges in Ireland was completed in 2016 and a policy statement by the Government on its proposed plan of action is expected in early 2017. Spanish airports IAG welcomes the recent decision by the Spanish Council of Ministers to recognise the importance of encouraging demand to benefit its economy by reducing charges at Spain’s airports by 2.2 per cent during each of the next five years. IAG also awaits the decision of the Spanish Supreme Court on a previous ruling that mandated a reduction in the use of one of Madrid-Barajas Airport’s main runways to mitigate noise impacts in certain weather conditions. However, should this restrict capacity, we do not anticipate that it would have a material impact on IAG as there remains significant room for growth. European aviation strategy In line with the European Commission’s 2015 Aviation Strategy the remit of the European Aviation Safety Agency is being expanded to cover security and ground handling and IAG continues to engage with EU Institutions and Member States to ensure its interests are taken into account in this and all areas. Working with the new Airlines for Europe campaign group, IAG continues to urge the EU Commission to reduce the impact of air traffic controller strikes, reform the out of date Regulation on airport charges and to discourage the proliferation of taxes on aviation. Following the UK’s vote to exit from the EU, IAG will continue to encourage both sides to ensure liberal air transport services continue to facilitate competition and benefit to passengers. European Union Emissions Trading System (EU ETS) Intra-European flights have been subject to the EU ETS since 2012. A global system to regulate international aviation emissions was agreed at the ICAO General Assembly in October 2016, to commence from 2021. In light of this agreement, we expect the EU to make an announcement for the post 2020 EU ETS regime during 2017. The EU Commission will develop proposals outlining the options for the treatment of intra-European international flights from 2021. IAG is opposed to double regulation of these flights in two separate market-based mechanisms. Strategic report Corporate governance Financial statements Additional information www.iairgroup.com

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