PM136 en

Quarterly - no.
136 2
nd
quarter 2012
Markets still looking for meaning

In exceptional times (the correction of the great debt cycle), markets tend to overreact; mostly because the business cycle is no longer the main driver of expectations. As long as the private sector in different parts of the US and Europe faces an ongoing deleveraging, the usual cyclical developments of private demand will be altered. At the same time, policymakers appear less able to smooth the joint cycle of company and household spending, simply because use of their tools has been overstretched in the past couple of years: on the government side, deficit and debt have reached highs rarely recorded; and on the central bank side, official rates are not far from the zero threshold while balance sheets have greatly inflated since the beginning of the crisis. In the end, investors are facing a lack of historical references. Given the high degree of uncertainty, market participants cannot keep their expectations stable. In early autumn 2011, they were clearly excessively pessimistic; slightly less than six months later, the risk is probably skewed to the other side. For sure, the ECBs LTRO initiative and an orderly resolution of the Greek solvency crisis have allowed the worstcase scenarios in Europe to disappear. At the same time, issues seem easier to resolve or more medium-term in both the US and China. However, not all anecdotal evidence points in favour of a rosy picture. First and foremost, the crude oil price remains at a high level and uncertainties over Iran do not suggest a quick downward correction. How will a weak recovery be able to bear an energy bill that could remain high for a long time? In the end, it should be admitted that the probability assigned to the consensus scenario of a gradual improvement in Western economies and the progressive return of risk as a basis for investment is lower than that generally given to a central projection. Investors, chasing a return, should keep this point in mind.
Contents:
The world is changing: Far-sightedness is everything! ............. 2 Monetary policy: New frontiers, new challenges ....................... 5 US Interest Rates: Markets begin to think for themselves ........ 8 Eurozone Interest Rates: Indirect bid for core bonds to wane .. 9 Exchange Rates: Increasing influence of yield ....................... 10 Gold: Gradual fall ................................................................... 11 Energy: Not just a geopolitical premium ................................. 12 US: Muddling through as momentum builds in 2012 .............. 13 Japan: Robust recovery followed by a soft landing ................ 15 Eurozone: Standing the test of realism ................................... 16 France: Recession only just avoided ...................................... 18 Germany: Caught up by the Union ......................................... 19 Italy: What is at the end of the tunnel? ................................... 20 Greece: Overcoming its debt problem? .................................. 21 Spain: Between austerity and pragmatism ............................. 22 Portugal: Fighting off the stereotypes ..................................... 23 UK: Oil prices cast a shadow over the economic outlook ....... 24 Australia: Growth around trend ............................................... 25 New Zealand: Recovery to be delayed ................................... 25 Canada: Weaker external demand limits growth ................... 26 Emerging markets: Landing softlybut watch oil prices ........ 27 Central Europe: On the back foot........................................... 28 Russia: Stability for now......................................................... 28 South Africa: Current account deficit widens ......................... 29 Turkey: Market sentiment rules .......................................... 29 India: Close to bottom? .......................................................... 30 China: Hard-landing fears will pass........................................ 30 Mexico: Riding the improved US momentum ......................... 31 Brazil: The BCB surprises again ............................................ 31 Saudi Arabia: Sustained public spending............................... 32 Egypt: Positive economic signals ........................................... 32 Exchange rate forecasts ........................................................ 33 Interest rate forecasts developed countries ........................ 34 Interest rate forecasts emerging countries .......................... 35 Economic forecasts................................................................ 36 Economic forecasts quarterly breakdown ........................... 37 Economic forecasts................................................................ 38 Commodities forecasts .......................................................... 38
The world is changing: Far-sightedness is everything!

At the start of this year, markets are hovering between hope and fear: hope that the worst is behind us, and fear of a rerun. There are some beacons of hope, but no-one is sure how robust they are. Grey areas are still pervasive, but their intensity seems to be fading. Central banks balance sheets
35% 30% 25% 20% 15% 10% 5% 0% 07 5% 0% 08 09 10 11 12 ECB balance sheet / GDP FED balance sheet / GDP (rhs) 15% 10% 25% 20%
Source: Bloomberg, Crdit Agricole CIB
In the early months of 2012 the economic data has been better than expected in the US and Europe, while presentments of a soft landing for the Chinese economy look like being borne out. But it would seem reckless to succumb to the temptation to extrapolate from these more positive trends. In the US, uncertainties about the timing and scale of the fiscal tightening ahead can only weigh on plans to buy consumer durables or invest. In addition, the household savings ratio has fallen considerably in the past 12 months and more, from 6% to scarcely more than 3.5%. It now seems too low, at least relative to trends in personal wealth. Any increase would penalise the growth rate. In Europe, more-reassuring-than-expected business climate surveys cannot allay fears about emptying order books, wholesale fiscal tightening, and very modest lending trends. In China, managing the property price correction in order to avert any disorderly downward spiral, which due to a negative wealth effect would encourage households to save more and so hamper the switch from exports to consumption as the main growth driver, is as much a burning obligation as it is delicate to carry out. The intensity of the crisis in Europe has decreased, thanks to the ECBs decision to provide unlimited medium-term liquidity for commercial banks. The fact remains that the balance of the ongoing initiatives has yet to emerge clearly: where is the point of equilibrium between an unavoidable commitment to rebalancing the public accounts and the need to sustain a certain level of growth? Then again, how does one get Europe moving along the twin paths of reduced interdependence among commercial banks and sovereign states, and a reduction in the external imbalances among Eurozone countries? It must be admitted that the range of possibilities is broad, and the consensus scenario of a gradual improvement in Western economies and a progressive return of risk as a basis for investment is seen as relatively unconvincing simply because the probability assigned to it is lower than that generally given to a central projection, and because the probability assigned to a worst-case scenario, involving political crisis in Europe and the US and renewed recession, is relatively high. Faced with a fairly unreadable immediate future, there would seem to be two obvious responses. In the short term there is a need to continue opting for a crisis management mode, ie, a preference for lowering the breakeven point and retaining a considerable share of assets in liquid instruments. In the medium term, one should start preparing right now to take advantage of a new environment whose main outline is becoming discernible. So just what does it look like? The environment in industrialised countries over the next few years will be characterised by necessary deleveraging. There are four means of achieving this: a reduction in spending relative to receipts, default, inflation and growth: Defaults will take place, but major, highly-interconnected players will be very loath to go down that road. Inflation will remain very low so long as the world economy remains an open system (ie, so long as there are no major protectionist initiatives) and as production capacity remains in surplus in many sectors. The scale of public debt and the swelling balance sheets of central banks do not seem to be enough of a condition, in the current environment, for a marked, lasting price acceleration.
Current account in the Eurozone

2 1 2 0 -1 -4 -2 02 03 04 05 06 07 08 09 10 11 12 Eurozone Current Account Eurozone GDP (rhs) -6 0 -2 ppt GDP % 6 4
Herv Goulletquer
herve.goulletquer@ca-cib.com +33 1 41 89 88 34
Macro Prospects no. 136 2nd quarter 2012
Savings ratios in the Eurozone

20%
There seems to be no notable improvement on the growth front: household and business confidence is low, there is little scope for recovery fuelled by economic policy, and world trade is slowing. Ultimately, a relative fall in spending and higher savings rates in order to increase the ability to generate cash flow will be the principal means of paying down debt. That process will be long, will adversely impact growth, and could trigger economic, social and possibly even political difficulties.
15%
10%
5% 00 01 02 03 04 05 06 07 08 09 10 11 12 EZ Germany France Italy Spain
Source: Eurostat, Crdit Agricole CIB
At the same time, new restrictions on the financial industry are emerging. While the sovereign debt crisis is impacting the confidence placed in banks, new prudential rules are increasing bank commitments and reducing capital and making it more expensive at the same time as they require higher capital ratios and also placing greater restrictions on liquidity and leverage ratios. Banks are being forced to re-think their strategy and to reduce their exposure in some branches of banking. This means that bank intermediation is likely to play a reduced role, and market intermediation will play a bigger role, in the process of financing the economy in Europe. In terms of financing, the debt economy will be superseded by a savings economy. An accumulation of cash flow will be a pre-condition when tapping external finance (and at the macroeconomic level, this is likely to involve the banks progressively less and the market more). An ability to reconcile savers preference for protective instruments and the need for risktaking on the part of issuers or borrowers will become necessary. We should also expect political change. The classic dichotomy between state and market regulation must be left behind: surely the crisis experienced since 2008 has been a market crisis that has morphed into a state (ie, sovereign) crisis? And the answer is more likely to come in the shape of a requirement for more good management standards and a transfer of more power to independent agencies along the lines of those devolved to central banks. Of course, this kind of rule could be perceived by some as undermining the principles of democracy, and thus would be controversial. Emerging countries will not be immune to the transformations taking place in Western countries. Their growth rates will be affected on three levels. In the first place (and we can already see this happening), the demand addressed to emerging countries from Europe and the US is lower. Secondly (and this should emerge gradually), the partial retrenchment of European banks from a number of structured financing business areas will affect the way world trade is financed and hence its growth rate simply because it will take some time for other banking systems to substitute for Europe. Growth rates in the emerging worlds big exporting countries will suffer as a result. Finally, the reduced dynamism in the export sectors of emerging countries could adversely affect the catch-up process in terms of the economic efficiency of the productive system and hence the pace of productivity gains. Again, the pace of growth will be affected. The globalisation process will no doubt become more complicated. The idea of widespread convergence towards the Western economic and policy model has been short-lived, simply because the West is no longer sufficiently dominant to impose it. The fact remains that two lines of force are intact: the Concert of Nations will need to make room for new entrants (ie, the BRICs et al.) and all have an objective interest in preserving an open economic system. We will need to be prepared for more uneven international relationships with more tensions from time to time around political, trade or financial issues.
Basel III impact on capital ratios: higher !

Lower "Core Tier 1 equity: due to tougher eligibility criteria Core Tier 1 Equity Core Tier 1 RWA Higher RWA due to stricter calculus Ratio
Source: Crdit Agricole CIB
China: change in exports and private consumption

60 8 6 30 4 0 2 -30 00 01 02 03 04 05 06 07 08 09 10 11 12 Exports % Private Consumption % (rhs) 0
Source: Bloomberg, Datastream, Crdit Agricole CIB
Public accounts in developed countries

6 4 2 0 -2 -4 -6 US UK Average 2001-2010 France 2011 ppt GDP
All this being so, what should we do? This is a very big question, to which, for the time being, we can offer only a few pointers. In the sphere of the industrialised countries, those with an excess of savings and a relatively consensual political system should perhaps be preferred. The countries of Northern Europe would be at the forefront in this respect. The US could emerge as the exception that proves the rule. In an environment perceived as uncertain because it is changing, there will be no let-up in the search for safe havens quite the contrary. The US should benefit from this. In the emerging sphere, perhaps it will be necessary to rank countries according to the scale of their efforts to drive domestic consumption in order to retain a more or less constant growth rate, and those for whom this is not too great an effort, given that the approach must also always be tempered by an ability to preserve the main macroeconomic balances. All in all, this means that countries such as Malaysia and Mexico, and even India, Korea and Brazil, should be preferred. With respect to sectors/counterparties, the ability to generate working capital could be a rather more discriminating factor than in the past, simply because it would influence access to the external finance that will have become more difficult to obtain. In this respect, sectors that produce capital goods and their main clients could face more difficulties than the pharmaceutical, luxury goods or retail sectors. We will pay closer attention to all of this in the months ahead!
Monetary policy: New frontiers, new challenges

With the crisis, central banks have found themselves in the front line when it comes to cushioning financial shocks and underpinning the fragile process of recovery. They have used every weapon in their arsenal, beginning with the conventional by flooring interest rates, and then moving on to the non-conventional by opting for active management of the size and structure of their balance sheets. While these measures were dictated by the need for an emergency response to a crisis of historic proportions, the fact of putting the financial system on life support in this way raises concerns about possible addiction to such support, with inevitable questions about the side-effects of such ultra-accommodative policies. The exit routes looks risky, with a difficult balance to be achieved between a monetary policy that must not hamper the necessary purging of private and public balance sheets, and a policy that must also accompany this deleveraging process to make it bearable, at a time when states themselves or most of them at least do not have the resources to act as crisis shock-absorbers. ECB: short-term interest rates
6 5 4 3 2 1 0 07 08 09 10 11 12 Refi Euribor 3M Eonia (DoD) Deposit rates %
Source: Bloomberg, Crdit Agricole SA
Fed: short-term interest rates

6 5 4 3 2 1 0 07 08 09 10 11 Fed Funds Effective Fed Funds Libor 3M 12 %
Isabelle Job
isabelle.job@credit-agricole-sa.fr + 44 207 214 5767
All-powerful central banks The worlds central banks have been at action stations since the start of the financial crisis in summer 2007. Their energetic and often unprecedented actions were above all designed to avert a disorderly deleveraging of excessive debt levels, whether among households, governments or banks, with, in the background, the ever-present threat of triggering a deflationary spiral similar to the mechanisms described by Fisher (1933) during the Great Depression. The toxic sequences of events from the reduction in debt leverage to falling financial asset prices and plummeting confidence and activity levels have reappeared sporadically on the radar screens of central banks, which have sought to stave off the threat of deflation at all costs by continually offering more stimuli or by massively intervening in malfunctioning market segments. So much so, in fact, that market players began to believe in the omnipotence of central banks, which in their eyes were able not only to combat inflation but also to do the opposite, to stimulate growth and employment, resolve balance sheet excesses, influence interest rates, and counter undesirable shifts in exchange rates. One has to acknowledge that the central banks have played a vital role in managing the crisis, even if that has meant taking liberties with a certain monetary orthodoxy. Key interest rates have fallen to historic lows everywhere, in places even flirting with the bottom limit of zero. Some, including the Fed, sought to influence the long end of the yield curve more directly by undertaking to keep interest rates low for a long period1. For over three years, therefore, real short-term interest rates (adjusted for inflation) have been trending in negative territory, notably in the industrialised world, demonstrating the extremely accommodative nature of monetary policies. Yet, these aggressive policies have not succeeded in making an impression, as hoped, on the overall financing conditions for economies and subsequently on activity, due to the higher offsetting risk premiums demanded, which have inhibited transmission mechanisms. In view of this lack of efficiency, and once the traditional ammunition had been used up, the central banks deployed a wide range of heterodox mechanisms to make their policies even more accommodative. Whether they used the terms non-standard or non-conventional, central banks all deployed quantitative easing (QE 2) policies in one form or another, with active management of the size and structure of their balance sheets. By turns they were Lenders of Last Resort (LLR), providing liquidity at any cost to stand in for interbank lending and the wholesale markets, with the aim of avoiding any break in the chain for financing economies: this applies to the Fed, but above all to the ECB; or else they were Buyers of Last Resort (BLR) of private or public debt in order to sustain liquidity and finance segments of markets damaged by the crisis (this applied to the ECB to a degree, but above all to the Fed and the Bank of England).
Such massaging of expectations about the future direction of key rates is supposed to shift the whole curve downwards, according to a rationale driven by the term structure of interest rates. 2 In the widest sense of the term, QE corresponds to an increase in base money, the amount of money in circulation, and bank reserves deposited with central banks.
BRIC: FX reserves (USDbn)

4500 4000 3500 3000 2500 2000 1500 1000 500 0 02 03 04 05 06 07 08 09 10 11 Brazil Russia India China
In this way, they took the place of the competitive mechanisms that generally ensured stable price formation. The ultimate rationale of these policies was to ease the global conditions for financing economies, either by putting a lid on public interest rates the benchmark on which market rates are formed and/or by encouraging the reduction in risk premiums demanded by investors for taking bolder gambles (or, which comes to the same thing, by rebuilding the value of these assets, which were present on the balance sheets of private agents banks or households). In the emerging countries this activism led to an accumulation of foreign currency reserves, far higher than the safety cushion generally supposed to protect their economies from swings in international finance (ie, the sudden stop phenomenon of withdrawal of private capital), thereby providing solid resistance to any increase in their exchange rates, and in some cases being accused of manipulation (as in the case of the CNY). Japan and Switzerland also intervened in the currency markets to put a stop to the frantic rise in their currencies, which were seen as safe havens. Overall, central bank balance sheets have grown steadily since the start of the crisis, to over USD18trn, having doubled in the space of four years. For the time being, there is nothing to suggest that this trend is reversing the exceptional quietly becoming the norm, with the markets being quick to demand even more at the slightest financial upset. While these measures were dictated by the need for an emergency response to an historic crisis, the fact of putting the financial system on life support in this way raises doubts about possible addiction to such support, with inevitable questions about the side-effects of such ultra-accommodative policies, especially if they last. Yet, central banks, with the Fed in the lead, have in the past been more likely to show asymmetrical behaviour being highly active in cleaning up the damage in the aftermath of a bubble bursting and showing excessive caution during the normalisation phase.
Source: Central banks, Crdit Agricole SA
Fed/ECB: balance sheet size in % of GDP

25% 20% 15% 10% 5%
99 00 01 02 03 04 05 06 07 08 09 10 11 12
The dangers of omnipotence

In a series of papers on the future of central banking3, economists at the Bank for International Settlements (BIS) sounded the alarm about the dangers of prolonging these crisis measures. One of those dangers is that of deferring the necessary clean-up of balance sheets, both private and public. The abundance of liquidity must obviously enable the banks to deleverage in an orderly manner without too great an adverse effect on growth. But that very abundance could also reduce the inclination to continue the painful clean-up process, which could have the perverse effect of maintaining doubts about the solidity of the banking system. Low interest rates can, for example, lead to undesirable arbitrages by lowering the opportunity cost of carrying non-performing loans4, thereby delaying the essential process of disclosing losses. Moreover, this abundance of cheap liquidity at a time when risk-free assets earn virtually no return encourages carrytrade transactions. Part of the liquidity auctioned during the ECBs two 3Y refinancing operations has, for example, been recycled in the shape of purchases of public debt securities that earn a higher return, especially in Spain or Italy. While this may have helped to re-establish a hierarchy of yield more in tune with reality by eliminating the irrational component linked to financial stress, the interdependency between sovereign and bank risks is also strengthened, with potentially destabilising risks in the event of any upsurge in worries about the debt sustainability of states with fragile public finances.
25% 20% 15% 10% 5% ECB Fed
Source: Fed, BCE, Crdit Agricole SA
Caudio Borio (BIS, WP No.353, Sept. 2011), Herv Hannoun (speech February 2012), Stephen Cecchetti (speech, October 2011), Jaime Caruana (speech December 2011), Philip Turner (BIS, WP No.367, Dec. 2011) 4 The arbitrage between the cost of refinancing this debt versus the cost of the writedown, which influences the banks bottom line.
Fed: composition of assets

3,000 2,750 2,500 2,250 2,000 1,750 1,500 1,250 1,000 750 500 250 0 USDbn
In the public sector, rates that are too low, by leading to a reduction in debt service, may give the illusion of a viable debt trajectory and increase tolerance to public deficits. This is essentially one of the reasons why the ECB has always refused to act as a large-scale Buyer of Last Resort of public debt not to mention the formal ban on monetising deficits enshrined in the ECBs articles of association. The Berlusconi governments about-turns, with the dropping of the austerity measures it promised in the summer of 2011, no doubt vindicated the ECBs choice of not artificially relaxing pressure on spendthrift states. In the US, the ease with which public debt is refinanced at exceptionally low rates has, no doubt, reduced the urgency of the need for fiscal consolidation, whereas the deficit continues to stand at unsustainable levels. The markets easy-going attitude may also stem from the belief that the Fed, which is already a major player on the fixed income market, will continue, in case of necessity, to wield its unlimited power to print money to finance the public deficit a form of insurance against the risk of a crash or a default.
12
07
Source: Fed, Crdit Agricole SA
08 09 10 11 ABCP & MMFF TAF Other credit extensions Other Fed Assets Primary Dealers Credit Misc. Gold Stock Repo RMBS Agency securities Treasury securities
ECB: composition of assets

3,000 2,750 2,500 2,250 2,000 1,750 1,500 1,250 1,000 750 500 250 0 07 EURbn
In this respect, the boundary between monetary and fiscal policy is becoming increasingly tenuous. The stated aim of the programme of firm purchases of public debt by the US and UK central banks is to keep a lid on rates in order to underpin the recovery process. One can always feign ignorance, but the fact is that this also constitutes a salutary helping hand for heavily-indebted governments. The Feds Operation Twist, which consisted in changing the maturities in its bond portfolio, went hand in hand with a lengthening of the maturities of US Treasury issues, for example, demonstrating that the government can seek to instrumentalise the Feds initiatives. The growing burden of this type of intervention can end up raising questions about the degree to which monetary policy is subordinated to achieving fiscal targets, especially if debt continues to balloon. Such a loss of independence supposed or real on the part of central banks would inevitably damage the credibility of their ultimate objective of medium-term price stability, with, as a corollary, a slide into selffulfilling inflation expectations. This is probably not an immediate threat because the crisis has left deep scars in the productive sphere, leaving major resources under-used, and on the labour market, with record-high unemployment rates, which make it unlikely that an inflationary spiral could be triggered. This rationale could nevertheless be overturned in the event of permanent damage to potential growth levels, in which case the inflation risk could materialise at higher unemployment levels and lower trend industrial capacity utilisation rates. Finally, monetary policy, by setting the price for liquidity, influences the markets perceptions and tolerance levels with respect to risk (Borio & Zhu, 2008). Rates that are too low can artificially boost asset price valuations based on the calculation of future discounted cash flows. In a low-rate world, the search for yield can encourage investors to take increasingly reckless positions regardless of the risk involved. Not to mention the fact that the asymmetry of central bank behaviour a lax approach during the bubble and an active one after it bursts may constitute another incentive to take more risk, with the certainty that the generous monetary authorities will put out the fire (a form of ex-ante insurance, reinforced by the conduct of central banks during the last cycle). In other words, rates that are kept excessively low over excessively long periods send the wrong signals to the markets. Of course, part of that abundant, cheap liquidity is hoarded and finds its way back on to central bank balance sheets in the shape of excess reserves, but another part will be injected into the financial markets, especially high-yield emerging markets, with the attendant risk that they will feed asset price bubbles in those economies. In a way, this testifies to the globalised character of monetary policies, with impacts that go beyond domestic borders. While the Brazilians are alarmed about the appreciation of their currency as a result of hot money inflows, the Americans are complaining about the Chinese authorities mercantilist policy. While these monetary policy choices (low interest rates in the industrialised countries, brakes on appreciating currencies in the emerging world) are dictated by purely domestic concerns (giving them a degree of legitimacy), they also carry within them tensions that over time could degenerate into currency wars or revive economic and/or financial protectionist temptations.
08 09 10 11 LTRO OMO Claims on residents Other Assets Claims on non-residents Gold
12
Source: BCE, Crdit Agricole SA
US Interest Rates: Markets begin to think for themselves

For a long time, the Fed has tried hard to convince the market that yields can and should be this low, but slowly doubt infected the front end of the curve and then moved aggressively to the longer maturities. No longer does the market blindly accept the Feds intentions, and so yields are freer to rise. Months to first hike vs 10Y UST
30 25 20 15 10 5 0 Dec-08 months % 1.5 2.0 2.5 3.0 3.5 4.0 4.5 Dec-09 Dec-10 Dec-11 Time to first hike 10Y UST inverted - rhs
There is little doubt that the US economic recovery is now looking more selfsustaining, that inflation has been surprisingly resilient, and that the European sovereign crisis is less menacing. Bond yields have started to react to these inputs. It has taken a while for debt markets to react because investors have seen green shoots turn into brown grass before. Bond markets have a self-doubt that equity markets do not possess. Secondly, and perhaps more importantly, the Fed has orchestrated 10Y rates lower. The Maturity Extension Programme has been more influential than we initially thought, but the most effective tool has been telling the market not to expect higher rates for a very long time. To illustrate this, the first chart on the left shows the time period that the market is discounting to the first rate hike against the level of 10Y yields. If the Fed can convince the market that the time to first hike is more than two years from today, then the 10Y UST yield will hover at around 2%. With the improvement in the economy, the Fed is finding it more difficult to pin the market to the date of the first hike in mid-2014. Already, Fed Funds futures are entertaining the date of the first hike in late 2013, and this has allowed 2Y maturity yields to creep up to 0.39%, more than doubling their 0.15% yield from September last year. The next question mark is how the market might respond to either an extension, cancellation or change to Operation Twist. With more inflation and growth than expected, we no longer believe that full QE3 is required. The low hanging fruit for the Fed is a prolongation of the Maturity Extension Programme (MEP), which it could continue in its current form until November/December.
US 2Y & 3Y UST yields

0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 Sep-11 Nov-11 2Y Jan-12 3Y Mar-12 %
Source: Bloomberg
For the market, the most important aspect is the signal component. What does it tell us about when rates might rise? A continuation of the MEP is a placeholder approach to monetary policy since it is a well rehearsed programme that has shown no sizeable unintended consequences. It will demonstrate that the Fed is not willing to take a large gamble to create jobs and that the US economy is out of surgery and in rehab. We do not believe that an extension to the MEP will drag down yields significantly. By breaking out of the Fed-induced trading range, the Treasury and swap markets have recently proven that they can shake off the constant Fed purchases, and markets have moved beyond the blind acceptance that the Fed will hold rates unchanged for almost three years. We are maintaining our negative view on the debt markets driven by the maturing of the recovery that brings us closer and closer to the day when the Fed hikes rates. It must never be forgotten that yields close to 2% are a long way from normal and provided only at the discretion of the Federal Reserve. Without strong support from the Fed in terms of language and its operations, a 10Y Treasury would not offer a negative real yield whilst the budget deficit is 9% of GDP and employment is growing quickly.
Primary dealer positions (USTs)

150 100 50 0 -50 -100 -150 Mar-08 Mar-09 Mar-10 Mar-11 USDbn
Source: Federal Reserve
David Keeble
david.keeble@ca.cib.com +1 212 261 3274
Eurozone Interest Rates: Indirect bid for core bonds to wane

Although periphery sovereign risk is not entirely gone, the turnaround in market aversion towards all credit risk suggests that core yields can push higher, in light of moderately positive economic prospects. That suggests some curve steepening, given how keen the ECB is to support the fragile EMU economy. Among all the determinants of Eurozone rates such as the macroeconomic cycle, the performance of investment alternatives, monetary policy expectations and credit risk perceptions the latter has arguably dominated market dynamics for many months now. With risk aversion gradually receding from a high point in late-2011, that leaves more room for other factors to assert themselves over Eurozone rate levels. As late as November of last year, periphery countries faced a vicious circle whereby their financial institutions were penalised for being heavily exposed to domestic sovereign debt, which in turn was being pushed ever lower on the back of adverse flows. The spectre of illiquidity loomed over the remaining peripheral issuers. Soon thereafter, the combination of capping capital pressure on the banks and, especially, a flood of ECB liquidity reassured the market that periphery banks would remain liquid and, with them, Italy and Spain, causing grossly inflated yields to move sharply lower. Broadly speaking, we believe this process will continue, albeit at a less frantic pace, going forward. The ECB has bought the issuers some time but they all still face serious fiscal and growth issues. Spain is showing somewhat reduced urgency in bringing its deficit down while Italian economic reform will take time to show results. Most importantly, despite what we view as a generally successful fiscal rebalancing effort, Portugal is still priced by the market as bearing non-trivial default risk. On the fundamental side, data has improved quickly enough to push economic surprise indexes into more buoyant territory; sufficiently so to suggest the need for EUR yields to catch up from their current low levels. Although we do not expect the pace of recovery to accelerate appreciably, the fact is that bond markets are increasingly less able to justify a recessionary view and also face a stubbornly profitable corporate sector. Analytically, one way to formalise the interplay between moderate but decent economic expectations and retreating risk premia is through a simple multivariate model incorporating both factors. Based on that framework, we would expect the 5Y OBL yield, which is currently well south of the 1% mark, to head roughly towards 1.5% by the end of June. One final factor that suggests reducing duration is the fact that markets are increasingly looking forward to the end of bond-market direct-support programmes by most central banks, with the BoE the only major Atlantic central bank still committed to a proper QE programme beyond Q212. In our central scenario, the rise in yields should be accompanied by a mildly steeper curve, in line with the inverted direction/slope dynamics that have been in place since 2010. This relationship is largely a function of the contrast between the normal fluctuation in medium-term rates expectations on one hand and the long-term prospect of very loose ECB monetary policy. Despite rising German agitation over the latter, with EU unemployment still high and varying widely from country to country and the sovereign crisis a very recent memory, our economists expect the ECB to leave the refi rate at current levels or even reduce it while maintaining excess liquidity at a high percentage of GDP. As a result of this, the 10Y-3M slope in German yields should increase from the current level around 100bp to over 150bp. The steepening in 2s10s is expected to be less pronounced, medium term. First of all, we expect the Schatz ASW spread to continue to tighten as basis spreads are reduced, Secondly, maturities from 2Y to 3Y are sufficiently extended to begin to price in some ECB risk further out in 2013-14.
Yields should catch up with economic surprises

1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 Jan-05 Jan-08 5Y chg - QoQ % 80 60 40 20 0 -20 -40 -60 -80 -100 -120 Jan-11 G10 ESI (rhs)
Source: CESI, Crdit Agricole CIB.
Risk aversion is less extreme, thanks to the ECB

1000 bp 900 800 700 600 500 400 300 200 100 0 Jan-10 bp 450 400 350 300 250 200 150 100 50 0
Jan-11
Jan-12
Bank 10Y CDS (rhs)
10Y periph. ASW
Source: Bloomberg, Crdit Agricole CIB.
Low starting point for rates conditional to risk aversion

5.0 % 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 DBR 5Y macro+risk fit macro fit 5Y
Source: Crdit Agricole CIB.
Luca Jellinek
luca.jellinek@ca.cib.com +44 20 7214 6244
Exchange Rates: Increasing influence of yield

Yield will take greater prominence in driving currencies over the medium term. We expect the USD to strengthen against the EUR, JPY and CHF due to higher relative yields, although the downside risks for the EUR will be limited due to official buying and a firm external position. The USD will lose out against high-beta emerging-market and commodity currencies. USD set to rise against majors including EUR, JPY and CHF
125 115 105 95 85 75 65 01 03 05 07 09 USD Index 11 13 forecasts
FX market activity has been characterised by relatively low volatility since the start of the year amid generally well-behaved currency market action. Risk appetite has continued to improve over Q112 despite the odd setback, a trend that was established in Q411. High-beta/risk currencies have been clear beneficiaries, with the biggest losers of 2011 reversing their losses over Q112 led by the likes of the BRL, MXN, NZD, NOK and ZAR. The only currency to lose ground against the USD this year has been the JPY, which finally appears to be living up to the markets bearish expectations. Over recent weeks the USD has firmed, partly recovering from its losses registered over January and February 2012. The fact that the USD has pulled back despite an ongoing improvement in risk appetite reflects the fact that the power of yield on currencies is beginning to dominate direction. While risk aversion is still very influential for FX market direction, as reflected in the high correlations between the Crdit Agricole CIB Risk Aversion Barometer, over the next few months yield will become an even more powerful influence. The USD will not be a loser in an environment where yields matter. Our forecasts of higher US bond yields over the course of 2012 will result in USD strength against the EUR, JPY and CHF in particular. Although the Fed may embark on a fresh round of quantitative easing, it is looking increasingly likely that any further QE will be sterilised. In other words, the impact on the Feds balance sheet will be offset with reverse repo operations. In this event, the net impact on the USD would be limited. In fact, economic improvement, as is becoming evident, combined with plenty of bond supply suggests that US bond yields will rise in relative terms. Central bank behaviour will matter and will be a key influence on yield. The BoJs action to increase its asset purchase fund and set an inflation goal implies lower JGB yields and in turn downward pressure on the JPY, while the ECBs injection of liquidity, or QE through the back door, will be a factor that helps to undermine the EUR. However, assessing FX reaction to QE is not straightforward. GBP, for instance, has actually strengthened in reaction to additional QE from the Bank of England but, nonetheless, the impact on UK gilt markets of keeping yields relatively low will imply some constraints on the ability of GBP to strengthen over coming months. Clearly, attraction to yield forms an important role in determining our currency forecasts. The rationale for our generally bullish calls for many emerging market currencies partly rests on the relatively high yield they offer compared to many developed currencies. The policy actions of the Fed and ECB resulting in relatively low interest rates in the US and Europe ensure that many emerging currencies will outperform the USD and EUR over the coming months. In fact, EM currencies are expected to do better than most major currencies, with the exception of commodity currencies, including AUD, NZD and CAD. Given that yield will be essential to determine currency performance, EM and commodity currencies will offer the best opportunities especially in an environment of improving risk appetite. Against this background the best performers in our carry-adjusted forecast grid over the next three months are a combination of commodity and high-beta EM currencies including IDR, BRL, INR, AUD and NZD. Further out, TRY, AUD, IDR and CAD will fight it out for top performers in the grid. JPY and CHF remain the biggest losers in our 12-month profile, suffering as they regain their status as funding currencies. Most other major currencies come somewhere in the middle although the SEK will be an underperformer. We continue to expect the EUR to weaken but are not particularly bearish given that it will find support from ongoing demand from official investors and a healthy external balance, with our forecast remaining at 1.26 versus USD by end-2012.
Source: Crdit Agricole CIB, Bloomberg
Commodity currencies offer the best G10 FX returns

8 6 4 2 0 -2 -4 -6 -8 -10 -12 % 12M Carry-adjusted Return (vs USD)
CHF
CAD AUD
EUR
Source Crdit Agricole CIB, Bloomberg
Most currencies set to strengthen versus EUR

10 8 6 4 2 0 -2 -4 -6 -8
CHF USD NOK GBP CAD NZD JPY SEK
% 12M Carry-adjusted Return (vs EUR)
Mitul Kotecha
mitul.kotecha@ca-cib.com +852 28 26 98 21
NOK
GBP
AUD
NZD
JPY
SEK
10
Gold: Gradual fall

We look for some limited downside pressure on gold prices in the months ahead. We do not see an improvement in risk appetite undermining gold significantly. Higher bond yields will result in some weakness in gold prices, but any drop will be limited by continued accommodative G3 monetary policy, strong investment and demand from China. Speculative gold demand supporting gold prices
200 190 1850 180 170 1750 160 150 1650 140 130 120 1550 Sep-11 Dec-11 Mar-12 Net Gold Speculative Contracts (000) Gold price (USD/oz, rhs)
Gold had a stellar year over 2011 beating many asset classes in terms of returns, in large part due to the impact of elevated risk aversion. However, since around mid-September last year the relationship between gold prices and risk appears to have changed. In part this can be explained by the fact that the CME increased margin requirements on gold in August and September. The riskgold relationship has become asymmetric. When risk aversion is increasing gold prices rise but when risk appetite improves gold prices do not necessarily drop. In large part this can be explained by the fact that speculative flows into gold have increased sharply over recent months while investment demand in the form of ETFs has also risen strongly. Gold has been highly correlated with the movements in the S&P stock index, copper prices, USD index and G3 FX volatility over the past three months while over a two-year period US Treasury yields have a greater influence, as well as risk aversion. Given our view that US Treasury yields will move higher this year, this will exert some negative influence on gold prices. Our regression models analysing the longer-term influences on gold prices including M2 money supply, USD index and oil prices reveals downside risks to gold, albeit more limited than our previous forecasts. However, as our forecasts show, any drop in gold will be limited by strong investment and speculative demand as well as firm demand from China. Moreover, although the Fed may implement only sterilised QE in the months ahead, overall monetary policy in the US, Eurozone and Japan will remain highly accommodative, suggesting gold will find continued support.
Mitul Kotecha
mitul.kotecha@ca-cib.com +852 28 26 98 21
11
Energy: Not just a geopolitical premium

Obviously, some of the Q112 upsurge in oil prices is related to the Iranian crisis, but things are far more complex than that, as endemic supply disruptions or threats of disruption have become the norm. Meanwhile, global demand continues to remain solid, still led by EM countries. With such a tight supply balance, oil prices should remain over USD110/bl this year, while the upside risk related to the Iran-specific risk looks greater than the downside risks. Iranian risk oil premium
130 125 120 115 110 105 27/12/11: First Iranian threats in regard Strait of Hormuz 200 190 180 170 Current Iran 160 premium <=> 10USD ? 150
So far in 2012 Brent prices have escalated from USD105/bl to USD125/bl, helped by overall better global economic prospects, worldwide QE initiatives and the specific Iranian threat (blocking the Strait of Hormuz if Western countries interfere further in its nuclear programme). A proxy of this current Iranian risk premium on oil prices can be made by comparing the trajectories of base metals prices and crude oil prices in early 2012, as they are both positively affected by the global growth and QE themes. This proxy suggests the premium would currently stand around USD10/bl. The Iranian story will remain one of the major drivers of oil prices in 2012, as a quick resolution of the issue looks unlikely. Iran has good reasons to seek nuclear safety; Israel also has good reasons to fear these ambitions, while the US, after withdrawing from Iraq and in a presidential election year, stands in a very uncomfortable position for an intervention. Our central case would be one of still aggressive communication by Israeli and Iranian officials throughout 2012 but not followed by concrete action because it would be a lose/lose game. In that case, the specific Iranian premium should gradually ease, as it becomes obvious that all the talk is not morphing into tangible action. This is one of the factors behind our end-year target of USD110/bl for Brent. One of the upside risks, of course, is an increase in tensions between Iran and Western countries. Prices could then easily skyrocket to USD150/bl even before any blockage of the Strait of Hormuz or military intervention starts. Theoretically, the strategic reserves can offset the loss in supply should the strait be blocked for a few days, but historical references argue in favour of a very violent oil crisis in that event. We see this as a typical fat-tail risk of a very intense crisis. Apart from the specific Iranian crisis, the supply-demand equation remains tight. While Libyan production continues to resume (currently 70% of pre-revolution level, at 1.15mbd), smaller suppliers (South Sudan, Syria) are facing a collapse in their production. All in all, the normal regime of non-OECD exports has become one of endemic, localised disruptions. Thanks to non-OPEC increases in production (China, Brazil, US, Canada mainly), however, the overall supply should increase by 1mbd between Q112 and Q113. Crude oil demand remains driven by the rising consumption in emerging countries (+1mbd expected in 2012, YoY), while the overall impact of OECD countries will be close to zero according to the US Department of Energy. All in all, the supply-demand balance will remain tight throughout 2012, with a supply that will gradually catch up with demand. Furthermore, spare capacity is limited, as Iran can be considered out of the equation and Saudi Arabia already increased its production in H211. The attitude of OPEC especially Saudi Arabia given that Iran will not increase supply towards prices remains an interesting indicator. In that respect, recent communications from Saudi officials show a keenness to have oil prices stabilised around USD100/bl, which is understandable given that (1) the country needs high oil revenues for its budget to break even and (2) Western economies absorbed the shock of oil high oil prices in 2011 relatively well. Bottom line, unless there is a global recession (or fears of such an outcome), Brent prices have no reason to come back under the USD100/bl threshold in 2012. Of course, should there be a serious crisis in the Hormuz region, the surge in oil prices could be devastating. In a central scenario, our target for Brent prices is USD120/bl by end-June and USD110/bl by end-year. Prices should gradually appreciate again thereafter, to USD114/bl by end-2013.
100 140 Oct-11 Dec-11 Feb-12 Apr-12 Brent Base metals Index (rhs)
Growth in global oil demand

4 3 2 1 0 -1 -2 -3 -4 Q107 Q108 Q109 Q110 Q111 Q112 Q113 OECD Emerging markets YoY growth (mbd) in oil consumption Forecasts (US DoE)
Source: US DoE, Crdit Agricole CIB
Supplydemand: tight in 2012

90 90 89 89 88 88 87 87 86 86 85 Oil supply/demand (mbd)
Forecasts
Q110 Q310 Q111 Q311 Q112 Q312 Q113 Total demand Total supply
Source: US DoE, Crdit Agricole CIB
Jean-Franois Perrin
jean-francois.perrin@ca-cib.com +33 1 41 89 94 22
12
US: Muddling through as momentum builds in 2012

The US economy continues to recover at a moderate pace with momentum building in consumer spending. However, further declines in the elevated unemployment rate will require stronger demand growth. Core inflation remains subdued and monetary policy exceptionally accommodative. Fiscal policy uncertainty remains a negative for growth. Improving job market
600 400 200 0 -200 -400 -600 -800 2.0 -1000 0.0 Jan-06 Jan-08 Jan-10 Jan-12 Change in total Nonfarm employment (SA, Thous) Civilian unemployment rate: 16 yr + (SA, %) rhs 8.0 6.0 4.0 12.0 10.0
Source: Bureau of Labor Statistics
Rising confidence and pent-up demand

100 90 80 70 60 50 40 30 Cash for Clunkers 16 15 14 13 12 11 10 9
20 8 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Conference Board: Consumer Conf (SA, 1985=100) Total light vehicle retail sales {Imported+Domestic} (SAAR, Mil. Units) rhs
Source: Autodata, The Conference Board
Earnings growth remains soft

10 9 8 7 6 5 4 3 2 1 0 Jan-90 Jan-95 Jan-00 Jan-05 Jan-10 5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%
Personal saving rate as a % of DPI (SAAR, %) (lhs) Avg hourly earnings: prod & nonsupervisory: total private industries (SA, USD/hour) % Chg - Year to Year
In the first quarter of 2012 we look for real GDP growth to slip to about 2% but gradually accelerate during the year. The 3% real GDP growth in the final quarter of last year reflected consumer spending above 2%, a softer pace of business investment spending and a significant boost from inventory building. Meanwhile, government spending contracted sharply and net exports were little changed. Household spending has benefited from improving job market conditions. Average monthly nonfarm payroll gains have moved from +200K over the past six months to +245K over the past three months. The unemployment rate, at 8.3% in February, has declined 0.8 percentage points from August. However, it remains elevated and it has been difficult for the unemployed to find jobs, as indicated by the high level of long-term unemployment. Consumer confidence has improved, albeit from low levels, and this has helped release some pent-up demand. Spending on motor vehicles, for example, has picked up nicely to a 15.1 million unit sales rate in February vs 13.1 million in September of last year. Households postponed car purchases early in the recovery (due to financial caution or supply disruptions) and that resulted in the average age of a vehicle on the road rising to a record 10.8 years at the end of last year. We figure that pent-up demand will continue to support motor vehicle sales in the months ahead; and automotive production will rise to meet the increase in demand. Disposable income has benefited from the extension of the reduced payroll tax rate through the end of the year. However, income growth remains sluggish with average hourly earnings running only 1.9% ahead of last year. This could reflect the mix of job creation towards lower-paying jobs over the past year. The recently revised GDP figures saw sharp upward revisions to income and to the savings rate in the second half of last year, so there is the possibility that income growth could be stronger than the earnings data suggests. Income growth will be crucial for the ongoing improvement in household spending as we believe that consumers will be cautious with debt following a period of deleveraging. Household debt growth did turn slightly positive in Q4 and likely continued higher in Q1. The savings rate is projected to decline in our forecast given real consumer spending around 2.2% over the four quarters of 2012. As for headwinds facing the consumer, we highlight the near-term impact of higher gasoline prices, which have risen over 16% since the beginning of the year. The higher prices act like a tax, reducing consumers discretionary spending. Some of this has been offset by low natural gas prices and easing electricity costs. Fiscal contraction at the federal, state and local level is also a restraint on household income growth, and overall home values have remained soft, which limits any positive wealth effect. The excess supply of homes currently on the market and tight mortgage lending conditions have acted as a restraint on homebuilding, keeping it well below demographically derived trends. We see house prices ending the year down slightly with modest price gains in 2013, as the market continues to strengthen and excess supply including the shadow supply from foreclosures is whittled down. We look for a healthy pace of capex on equipment and software for the balance of the year helped by healthy corporate balance sheets with ample cash on hand and low borrowing costs. Business fixed investment spending slowed in the final quarter of last year, with a decline in spending on structures. Later this year and next, business investment could benefit from capital deepening given the rising long-term trend in the capital/output ratio.
Source: BLS, BEA
13
Excess supply continues to weigh on housing

10 9 8 7 6 5 4 3 2 1 m
One restraint for both businesses and households is the elevated level of uncertainty over policy changes on the fiscal front. The Bush tax cuts of 2001 and 2003 are scheduled to expire at the end of the year, raising income tax rates across the board in 2013. President Obama proposes maintaining the current lower tax rates for most taxpayers, while raising taxes for higher-income earners. This is roughly the assumption that we have used in our forecast. We expect an agreement on taxes to be linked to broad income tax reform measures, including corporate taxation, which increases uncertainty and is not helpful for business planning. We also assume that the temporary lower payroll tax rate and emergency unemployment benefits expire at year-end. Furthermore, there is the planned sequestration of USD1.2trn in budget authority over ten years that followed from the inability of the Joint Select Committee to come up with a grand deficit-reduction deal. The cuts, half of which are slated for defense, will be difficult for many to accept, and we have assumed in our forecast that Congress will find some way to reduce the impact of the mandated cuts. Again, there is much uncertainty about the fiscal outcome for next year, which we believe will dampen economic activity as both businesses and households await further clarity before committing to higher levels of investment, hiring and spending. We see the drag on growth from our fiscal policy assumptions trimming a bit more than 1% from GDP growth in 2013, but the risk is to the upside if Washington cannot reach agreement before year-end on a budget deal. Risks still exist on the external sector but the sovereign debt stress in Europe has eased for now. The direct impact of the slowdown in European growth on the US is limited by the fact that only 18% of US exports go to the Eurozone and exports are only 14% of GDP. However, while the downside tail risk from financial contagion has been cut, it has not been eliminated, and the ability of policymakers to respond is limited by the current exceptionally accommodative policy stance and political gridlock on the fiscal policy front. The Fed remains in wait-and-see mode in our view. Inflation is not a prime concern for the Fed at the moment. The economic slack in labour and product markets and relatively well anchored inflation expectations are expected to keep inflation at or below the Feds 2% medium-term inflation goal. The impact of higher energy prices is expected to result in only a temporary boost to prices. However, the unemployment rate remains well above the level consistent with the Feds employment mandate. That is why the Fed expects to keep policy exceptionally accommodative well into 2014. We see no change in the Fed funds rate through our year-end 2013 forecast horizon. Near-term monetary policy would be eased further if the slower pace of growth we expect in the first half of the year leads to a rise in the unemployment rate. If no progress is made in lowering unemployment, it would be a close call, but we believe that the FOMC majority would likely see additional accommodation as warranted in that case. If the unemployment rate makes reasonable declines, no further policy accommodation would be forthcoming. Non-standard monetary policy measures such as quantitative easing (sterilised or not) and the maturity extension program all have the same policy goal to remove duration from the market, keeping downward pressure on long rates and providing generally supportive conditions for the broader financial markets (portfolio balance effects). If it is a close call, a fully-fledged resumption of asset purchases might be seen as disproportionate and the Fed could choose to extend and augment its maturity extension program through the end of 2012, although the scope of expansion is likely less than USD200bn, given SOMA holdings. That could be paired with modest quantitative easing tilted toward MBS purchases, if needed. We would see such a policy as prudent, offering moderate support for the ongoing recovery, which still faces potential fiscal shocks later this year as Congress and the President deal with tax and budget issues.
Q101
Q102
Q103
Q104
Q105
Q106
Q107
Q108
Q109
Q110
Shadow inventory (foreclosure or severely delinquent) Known inventory (new & existing)
Source: Census, NAR, Bloomberg
Inflation expectations anchored

2.8 2.6 2.4 2.2 2.0 1.8 1.6 1.4 Q107 Q108 Q109 Q110 Q111
Prof Forecasters: Median: YoY CPI Inflation rate over the next 5 years (%) Calculated 5 year forward inflation rate (%)
Source: FRB, FRB/PHIL
Policy uncertainty remains elevated

300 250
9/11 Debt Ceiling Debate Lehman Collapse Gulf War II
200 150 100 50
0 Jan-00 Sep-02 May-05 Jan-08 Sep-10 Economic policy uncertainty index (mean=100)
Source: Stanford University
Mike Carey
michael.carey@ca-cib.com +1 212 261 7134
Q111
14
Japan: Robust recovery followed by a soft landing

Although the Japanese economy contracted in 2011 with -0.7% real GDP growth, we maintain our view that a robust economic recovery based on reconstruction demand would result in strong +2.0% real GDP growth in 2012. Despite the recovery, inflationary pressure will remain subdued due to ongoing structural changes in the labour market. Real GDP growth projections (%)
2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0
Q111 Q211 Q311 Q411 Q112 Q212 Q312 Q412 Q113 Q213 Q313 Q413
Forecasts
Real GDP for the Oct-Dec quarter was revised up to -0.2% QoQ from -0.6% QoQ on the back of a much stronger recovery in capex than supply-side data was suggesting. That said, the Japanese economy contracted in 2011 with -0.7% real GDP growth due to the negative impact from the earthquake in March. However, while the implementation of fiscal stimulus packages for reconstruction has been much slower than we had originally anticipated, they are finally set to support growth in the coming quarters, and we maintain our view that, in addition to increased public demand brought in by the packages themselves, they will have positive repercussions for private sector capex and thus the economic recovery expected to start from the Jan-Mar quarter should result in +2.0% real GDP growth in 2012. The degree of recovery should be stronger in the first half of the year supported by the governments measures but we expect that the economy will manage to make a soft landing, with the growth engine handed over to the private sector from the public sector. It has been a year since the earthquake disaster last March. What has changed and what has not changed? One of the main unchanged elements is that inflationary pressure in the economy continues to be structurally weak. To be sure, the steady economic recovery going forward should at least ease the deflationary pressure by narrowing the output gap, especially with the pace of the recovery in its initial phase likely exceeding the economys potential growth rate. We are currently expecting that real GDP growth for Jan-Mar and Apr-Jun will be +0.7% QoQ (annualised +2.8%) and +0.6% QoQ (+2.4%), respectively, and these growth numbers are well above the economys potential growth rate of somewhere around +1%. However, we argue that underlying deflationary pressure in the economy should be persistent enough to offset, even if not completely, the inflationary pressure from the growth story, and one such factor is an ongoing structural change in the labour market. With Japans main manufacturing industries increasingly exposed to international competition especially from emerging Asian economies, the need to cut production costs has resulted in increased demand for part-time workers, whose cost of employment is less than full-time workers, and the share of part-time workers in the overall workforce now stands at a historical high of 35.7%. This should be consistent with the more theoretical framework of Phillips curve analysis, and the shape of the curve has progressively been becoming flat. While we admit that geopolitical risk would cast an upside risk to our inflation forecast through rising oil prices, we still expect that the CPI (excluding fresh food) inflation rate, on average, will be only +0.1% for 2012. On the other hand, one of the main changes is that the Bank of Japan has been increasingly proactive, with the Japanese central bank surprisingly deciding to ease in February, followed by the decision to enhance special lending facilities in March. We do not believe that the introduction of the price stability goal of a +1% inflation rate would have a material impact on the decision-making process given its similarity to price stability understanding, but the BoJs stance to support the economy is clearly seen by the fact that it decided the above measures despite upgrading its judgment on economic conditions. Although the BoJ appears increasingly confident that the economy will recover on the back of reconstruction demand, we still suspect that such confidence does not exclude the possibility of further monetary easing and the policy stance is actually still tilted to the dovish side. The BoJ currently sees the European debt crisis, commodity price developments, and uncertainty regarding the soft-landing scenario of emerging countries as possible risk factors, and we believe that the BoJ should respond by expanding the size of the asset purchase fund should there be increasing prospects of those risks materialising.
Source: Cabinet Office, Crdit Agricole CIB
Rising share of part-time workers

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Full-time worker
Source: Ministry of Internal Affairs and Communications, Crdit Agricole CIB
BoJ to expand further

180 160 140 120 100 80 60 40 97989900010203040506070809101112 BoJ's balance sheet JPY trn
Source: Bank of Japan
Yoshiro Sato
yoshiro.sato@ca-cib.com +81 3 45 80 53 37
84 89 94 99 01 03 04 05 06 08 09 10 11
Part-time worker
15
Eurozone: Standing the test of realism

Growth came to a sudden halt in late 2011 as unemployment surged. Economic conditions have deteriorated sharply in the Eurozone and our forecast now has to factor out the one item that could have injected a little breath of fresh air namely the slowdown in inflation. Fiscal orthodoxy will remain the rule but a few concessions could be granted to soften the adjustment regime in order to dig ourselves out of a recession that is likely to affect all or almost all member states. EMU : Activity and unemployment (Okun's law)
4
GDP growth (% YoY)
2 0 -2 -4 -6 y = -2.3047x + 1.5929
Outlook gloomier It looks as if 2012 will be a turning point in defining the right balance between fiscal orthodoxy to purge past excesses and reassure investors about the survival of the single currency on the one hand, and on the other a certain pragmatism to avoid choking both growth and public finances. In our projections, that room for manoeuvre is likely to be restricted to acceptance of a slight deviation from fiscal targets, without undermining austerity dogma. In this fragile balance the financing conditions for countries still present in the capital markets should continue unchanged, making life easier for governments and underpinning the step-by-small-step strategy of creating a unified Europe.
Januarys slight pick-up in Eurozone activity, following sharp falls in November and December, is the first confirmation of signs of improvement in survey indicators since the end of 2011. But the 0.2% uptick in industrial production is also not connected to incoming orders, which in view of their fall at year-end could herald a further halt to activity in Q112 (-0.3% QoQ according to our own forecasts). The deterioration in the labour market, with a fall in employment in the Eurozone for a second quarter in a row at year-end (-0.2% QoQ in Q411), spread from the peripheral countries to Italy and the Netherlands and marked a halt to job creations in France. This was because the pick-up in activity since 2010 did not drive major improvements in the economic and financial situation of businesses. With the foreseeable lifelessness of activity, the rapid rise in the unemployment rate (to 10.7% in February) is likely to continue and peak at 11.1% between end-2012 and early 2013. The increase will nevertheless be lower than that predicted in the activity/unemployment trade-off based on a standard Okuns law, as was already the case in 2009. The existence of schemes involving flexible working hours explains the relative resilience of employment given that, this time round, the tight fiscal margins are unlikely to allow the replication of large-scale sectoral support plans like car scrappage schemes for the automotive industry. Whereas the periphery is involved in a process of wage deflation, in the centre the good rule of respect for productivity gains is unlikely to be forgotten. This would mean that wages would not move much higher not even guaranteeing that purchasing power would be maintained, with the notable exception of Germany. The stickiness of inflation will therefore constitute an additional factor putting downward pressure on incomes. A return of inflation in its self-sustaining version (ie, a price-wage spiral) is not part of our central projection. Paradoxically, above and beyond our assumption that energy prices will stabilise, these upstream inflationary pressures carry a risk of concatenating a series of events that would in this base be deflationary (recession, asset price deflation, increased defaults, and a credit squeeze) notably in the peripheral countries. Although the risks (recession-inflation) connected with our projection have achieved a new balance relative to our previous forecast, there is still considerable lack of visibility. At the outer edge of our forecasting timeframe is a Eurozone growing at a slow rate, more people unemployed in particular more long-term unemployed, a capital stock that has seen little renewal since the start of the crisis, and a banking system that, while better capitalised, is less profitable and more dependent on ECB financing.
-1.5
-0.5 0.5 1.5 Unemployment rate (QoQ) Q196-Q407 Q108-Q411 Q112-Q413F (CASA)
2.5
Source: Eurostat, Crdit Agricole SA
EMU: Contribution to growth

2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 2010 2011 2012 2013 Change in inventories Domestic demand Net exports GDP % QoQ
Source: Datastream, Crdit Agricole SA
Frederik Ducrozet
frederik.ducrozet@ca-cib.com + 33 1 41 89 98 95
Paola Monperrus-Veroni
paola.monperrus-veroni@credit-agricole-sa.fr +33 1 43 23 67 55
16
ECB monetary operations only 17% of GDP

35% 30% 25% 20% 15% 10% 5% 07 08 09 10 11 Fed total balance sheet ECB total balance sheet ECB's OMO liquidity+SMP purchases 12 % of GDP
Source: ECB, Crdit Agricole CIB
Mario to the rescue of the EUR It was the ECB, in fact, which was behind the recent stabilisation in Europes financial markets. It is probably no exaggeration to state that the decisions taken by the Governing Council, chaired by Mario Draghi, helped to avoid a worst-case scenario at the end of last year. At the height of the financial storm, the ECB cut its main refinancing rate to 1%; but, more importantly, on 8 December it announced a series of spectacular measures designed to extend its support to bank liquidity, including two 3Y Longer-Term Refinancing Operations (which led to total demand of over EUR1trn), a broadening of eligible collateral and a cut in the banks required reserves ratio from 2% to 1%. It is no understatement to say that those measures contributed to reviving confidence in early 2012 in the shape of a reduction in banking stress and a sharp fall in Italian and Spanish sovereign yields, a trend that went alongside a stabilisation in the political situation in Italy and the announcement of large-scale structural reforms there (thanks to another Mario, also an Italian). As a result of these massive refinancing transactions, the ECBs balance sheet rocketed, and now stands 50% higher than in early July 2011, even if Mario Draghi rightly points out that the share of monetary transactions accounts for only 15% of the Eurozones GDP (or 17% if we include outright purchases of securities, see chart), compared with 19% in the US.
The ECBs mandate has not changed, but the bias of its monetary policy has shifted towards a clear objective of maintaining financial stability at all costs. In this respect, the ECBs non-conventional measures are not only aimed at gaining breathing space but have also, and most importantly, helped stave off systemic tail risks. Apart from the difference in style and an approach to monetary policy seen as being more pragmatic than his predecessors, Mario Draghi has pulled off the feat of stabilising the markets at the same time as he averted open conflict within the Council. While the majority of observers and many leading politicians were agreed that only direct market intervention by the ECB could put an end to the vicious circles operating between banks and governments in late 2011, the Italian, who had been at the helm of the ECB for only a month, opted for the roundabout route of indirect quantitative easing, which had already been used to a lesser degree in the Eurozone since 2009, and which consisted in ensuring bank refinancing beyond their real needs so that they themselves can refinance governments. From this point of view, the initial results probably exceeded the ECBs expectations, with a sharp increase in ownership of public debt securities on the part of Spanish and Italian banks in the first two months of the year, at over EUR50bn and EUR30bn, respectively. The ultimate stage in this strategy, which has been explicitly adopted by the ECB, is a potential support for bank lending to the private sector. The flow of new lending to households and businesses has been very subdued in recent months and, even if the ECB has noted the first timid signs of an improvement in some countries, it expects the improvement to be very gradual in the best of cases. Forthcoming data including money supply and credit aggregates, as well as the ECBs Bank Lending Survey of commercial banks, will be closely monitored, remembering that at best they could respond to ECB initiatives with a time-lag of one or two quarters. In view of this, policy rate levels have moved into the background, especially as the record levels of excess liquidity in the system are again pushing short-term interest rates to new lows. A rate cut would not make any great difference from this point of view, even if it remains, from our standpoint, justified for most countries (and the growing north-south divergence is even an additional supporting argument), despite the very short-term inflationary pressures. Consequently, our projection is again for a Refi rate of 0.75% in June and 0.50% in September 2012, but the probability of new conventional easing has clearly receded for the time being and the burden of proof has inverted. For the ECB to strengthen its easing bias, and then deliver a further rate cut, it would probably need to observe a further renewed economic weakness and a more rapid fall in inflation.
EMU: Confidence indicators

65 60 55 50 45 40 35 30 130 120 110 100 90 80 70 60
03/00 03/02 03/04 03/06 03/08 03/10 03/12 Composite PMI EC Economic Sentiment Indicator (rhs)
Source: European Commission, Markit, Crdit Agricole CIB
Monthly flows of Eurozone MFI credit

200 150 100 50 0 -50 -100 05 06 07 08 09 10 11 12 to the public sector to the private sector EURbn
Source: ECB, Crdit Agricole CIB
17
France: Recession only just avoided

Instead of the forecast small technical recession at the turn of 2011 and 2012, the unexpectedly resilient growth rate at end-2011 should finally result in a short-lived Q112 fall of 0.3% QoQ, followed by a fragile, gradual recovery throughout the rest of the year. Overall, activity is forecast to remain relatively stable, at 0.2%, still undermined by weak domestic demand. France: GDP and its components
2.0 Contributions to quarterly growth, ppt 1.0 0.0 -1.0 -2.0 07 08 09 10 11 External balance Stockbuilding Dom. demand excl. stocks GDP
In Q411, French economic growth increased 0.2% QoQ a surprise at a time when activity receded in all the other big EU economies. This resilience can be partly attributed to temporary factors that have sustained business investment (up 1.4%). Businesses have, however, stopped their marked rebuilding of inventories, begun in early 2011, resulting in a negative contribution of 0.8 percentage point to quarterly growth. Reduced recourse to imports (down 0.7%) and continued strong exports (up 1.2% as in the previous quarter) allowed foreign trade to partly offset (+0.7ppt) the negative impact of inventories on growth. Nevertheless, this relatively strong performance is unlikely to be repeated in Q112. Activity should shrink by 0.3%, notably due to the forecast technical correction in business investment (-1.1%). Private consumption should see a slight fall of 0.2%, with notably a sharp fall in consumer spending on cars (down 7.6% MoM in January), due to the end of special promotions by carmakers. The contribution from foreign trade is also likely to be small, with a contribution of just 0.1 percentage point, since exports have been undermined by weaker demand from Frances main European trading partners.
Source: Insee, Crdit Agricole SA
France: Investment and stockbuilding

60 50 40 30 20 10 0 EURbn (vol) EURbn (vol) 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 00 01 02 03 04 05 06 07 08 09 10 11 Stockbuilding (rhs) Investment
Our growth profile therefore remains unchanged in 2012. A fragile, gradual recovery should supersede the dip at the start of the year. This scenario would be justified by a gradual easing of tensions in connection with the European sovereign debt crisis, which could drive a slight uptick in agent confidence, thereby limiting their wait-and-see behaviour. The forecast weakening of the EUR and the continuation of very low interest rates (with the ECBs key rate cut to 0.5% at the end of Q3) should also have a positive effect. But many negative factors should persist, leading to a sharp slowdown in spending and quasi-stable growth in 2012 (+0.2% over the full year). Firms financial situation remains a concern that will put downward pressure on their spending, with business investment quasi-stable by volume (+0.5%), and a slight downsizing of inventories amounting to around EUR3bn, for a negative contribution to annual growth of 0.8 percentage point. Profit levels should be almost unchanged due to weak activity, higher intermediate costs, and increased taxation (limitation on firms ability to defer taxes, increase in corporate income tax for big companies). Business spending will also be penalised by uncertainties in connection with the upcoming elections, the lack of pressure on production capacity, and a relative tightening of credit. Households will also find themselves in a tighter financial situation with the rate of increase in their nominal gross disposable income slowing markedly, to 1.8% in 2012 compared with last years 3.3%. This could be explained by a smaller increase in the overall wage bill, in line with a slight fall-off in employment and a deceleration in per-capita wages in an environment that encourages wage restraint: unemployment looks set to come out at an annual 9.7%, compared with 9.3% in 2011. The hoped-for drop in inflation, to 1.9% after 2.1%, would only have a slight offsetting effect and would enable purchasing power to stabilise (+0%). Households should limit the recourse to their savings, hence very slight growth in consumption (0.2%). The weakening in domestic demand is likely to have a negative impact on activity but should be partly offset by a positive contribution from foreign trade (+0.8ppt). Imports may fall slightly, by 0.7% after a 5% increase in 2011, due to lower domestic demand, while exports are likely to continue growing at a reduced pace (2.1% compared with 5%). Growth in exports should be sustained by the resilience of foreign demand in emerging and US markets and by a weaker EUR, given that the growth overhang for 2012 is already a positive 1.7% on the strength of a good performance in some export sectors in late 2011.
France: Forecast inflation and unemployment rate

% 3.5 YoY, % 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 2006 2007 2008 2009 2011 2012 Inflation 12.0 10.0 8.0 6.0 4.0 2.0 0.0
Unemployment rate (rhs)
Olivier Elure
olivier.eluere@credit-agricole-sa.fr + 33 1 43 23 65 57
Werner Perdrizet
wener.perdrizet@credit-agricole-sa.fr + 33 1 57 72 08 54
18
Germany: Caught up by the Union

The excellent recent performance of the German economy should not be allowed to hide the fact that the ties to a recession-hit Eurozone are closer than those to an emerging world that is seeing sustained, if slower, growth. However, the judicious share-out of past productivity and profitability gains should help Germany to limit the current slowdown to no more than a blip. Unit labour costs
25 20 15 10 5 0 -5 -10 2000 2002 2004 2006 2008 2010 Total economy Business sector Industry % YoY
While it is true that a growth rate of 3% takes the German economy closer to the growth trends in emerging countries than to those seen in Europe, which is struggling with a crisis in its economic model, the sharp Q4 GDP growth slowdown (-0.2%) saw the economy growing at a more European pace and leaves a growth overhang of just 0.2% for 2012. The low contribution of domestic demand to growth (0.1%) was more than offset by the negative contribution of foreign trade (-0.3%) driven by a fall in exports (-0.8%) that was more marked than in imports (-0.3%). Domestic demand was also driven by business investment (up 0.7%) and by construction investment (up 1.9%), but consumption declined by 0.2% as real disposable incomes stagnated. During 2011, therefore, Germany experienced a gradual decline in business investment as foreign demand began slowly to flag. The impact of sustained growth in employment and wages was also limited by rising inflation, which did not allow for an acceleration in real disposable incomes. The only shock absorber was a reduction in the savings ratio. The contribution from public spending (consumption and investment) was again slightly positive in 2011 at 0.3%. The rapid improvement in all the survey indicators (IFO until February, and ZEW in March) seemed to promise an unbroken recovery in the German economy and make the year-end blip seem no more than an accident. But the signal sent by the March PMI survey pointing to a further deterioration in the business climate in the manufacturing sector for a second month running counsels caution. Januarys 1.6% rebound in industrial production following a fall of 2.6% in Q411 was not enough to turn the -0.1% growth overhang in Q112 positive. And new orders, after falling by 1.5% at year-end, again fell in January, with a drop of 2.7%, signalling depressed downstream production. Simultaneously, however, demand from domestic businesses picked up by 0.9% against a backdrop of plummeting foreign orders, down 5.5%, clearly showing that growth in 2012 will above all be fuelled by domestic factors. Past gains in productivity and profitability will allow for a sustained wages trend (+2.5% in 2012 and +2.3% in 2013), benefiting from a catch-up in wages after years of restraint as a result of the financial crisis. Growth in employment is still positive and the unemployment rate merely stabilised in February (it is forecast to remain stable at 5.7% in 2012 and fall slightly, to 5.5%, in 2013). Both the government, for having generated enough fiscal room for manoeuvre, and the social partners have the means to continue financing the work-sharing agreements that have helped keep 1.5 million employees in work during the crisis. Working hours are now back at their 2007 levels and can therefore be used again as an adjustment variable in place of employment (+0.3% in 2012 and 2013). This should guarantee higher consumption (up 0.7% in 2012 and 1.2% in 2013), which should act as a rampart against flagging foreign demand and investment. Although a dip in growth is likely to be unavoidable in 2012 (+0.6% growth in 2012 and +1.6% in 2013), it should not involve the risk of a harmful combination of recession, asset price deflation, higher defaults and a credit squeeze, as experienced elsewhere in the Eurozone. This is because, while the banking sector is still highly exposed to European sovereign risk, this is largely down to Europes big commercial banks. The savings bank network is less exposed to this risk and can continue to play its role as financier to the Mittelstand. However, the big corporations have also benefited significantly from the sustained productivity cycle to improve their profitability and self-financing ratio and are now less dependent on bank lending to finance their activities.
Source: Destatis, Crdit Agricole SA
Contribution to growth
% QoQ 3
-1 2010 2011 2012 2013 Change in inventories Domestic demand Net exports GDP
Source: Destatis, Crdit Agricole SA
Activity indicators
70 65 60 55 50 45 40 35 points 120 115 110 105 100 95 90 85
30 80 Mar-06 Sep-07 Mar-09 Sep-10 Mar-12 PMI manufacturing IFO (rhs)
Source: Cesifo, Markit, Crdit Agricole SA
19
Italy: What is at the end of the tunnel?

With a negative growth overhang of 0.5% in late 2011, the Italian economy will undoubtedly see a recession, which could undermine the new Monti governments achievements of the past few months. The markets are keeping a particularly close watch on Italy, which will have to prove its ability to escape rapidly from its current economic predicament if it is to avoid endangering its prospects of debt sustainability, not to mention the added risk of political uncertainty in the run-up to elections in 2013. 10Y government bond yield
8 7 6 5 4 3 2 1 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Italy Germany %
Dr Montis prescription seems to have done the trick: the horse medicine he has applied, comprising a further turn of the fiscal screw, long-awaited pension reform and liberalisation of protected professions and services, has turned market expectations around. The corollary was the gradual easing of tensions on Italian sovereign debt, which can be seen in the reduction in the risk premium required by investors for holding Italian rather than German debt. Confidence has also been restored by a dissipation of fears about the fragility of the Italian banking system thanks to Dr Draghis miracle fix in the shape of an abundant dose of liquidity. The Italian state and its banking sector were thus able to cope relatively painlessly with the wall of repayments falling due in Q112. However, Italy is by no means out of the woods. In Q411, the 0.7% growth slowdown there was one of the most marked in the Eurozone. All domestic demand components were down: private consumption, (-0.7% QoQ), business investment (-4.9% QoQ) and (not a surprise for the past two years) public consumption (-0.7%). The stabilisation in construction investment is no more than a pause in the slow adjustment process experienced by the sector over the past four years, and which is almost certain to accelerate once more. The inventory downsizing seen this past summer has also continued, shaving four-tenths of a point from growth. The contribution from foreign trade was positive, however, due to a sharp, 2.5% drop in imports and comatose exports. The signs of weakening in this recessionary wave, via upticks in the index of Italian consumer confidence and the manufacturing sector PMI, look fragile. Februarys ISTAT survey of businesses was again down, a trend begun in November last year, and January industrial production was also sharply down, by 2.5% MoM. The Confindustria survey forecasts a further reduction in industrial production in February (-1.1%), which was largely confirmed by the fall-off in new orders in January (7.4% MoM). The Bank of Italys December quarterly survey pointed to increasingly tight liquidity constraints, with a third of businesses considering liquidity levels insufficient in Q112. This was because the economic situation of businesses deteriorated at year-end. The margin ratio fell because, despite modest growth in wages, productivity growth has slid into negative territory due to a greater fall in activity than in employment (-0.4% QoQ). The rapid increase in the unemployment rate (9.2% in January) and the first increase in short-time working in February, after falling steadily for over a year, testify to the growing difficulties encountered by businesses. This should keep downward pressure on wages, already marked by a wage freeze in the public sector. The reduction in the purchasing power of incomes, combined with higher taxes, implies a reduction in households real disposable incomes after zero growth in 2011. In view of this, private consumption and business investment are expected to fall this year. The rate at which the Italian economy will emerge from the recession (-1.4% in 2012) is likely to be sluggish and growth will not return to its (already low) potential rate before the end of our forecasting timeframe, with just 0.1% growth forecast for 2013. The growth hiccup will not jeopardise Italys return to a path of sustainable debt, but the increased uncertainty about achieving fiscal targets could lead to renewed tension on the sovereign debt market. The ECBs liquidity injections were partly recycled by the banks in purchases of Italian government paper. Such interdependency between sovereign and bank risk is a doubled-edged sword. It will benefit the banks in the event of a positive resolution to the debt crisis, but will harm them if not. Nor should we forget that there are general elections in 2013 heralding the big return of party politics...
Contribution to growth
2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 2010 2011 2012 2013 Domestic demand Change in inventories Net export GDP % QoQ
Source: Istat, Crdit Agricole SA
Public finances
130% 120% 110% 100% 90% 80% 70% 60%
20082009201020112012201320142015
as % of GDP
6% 5% 4% 3% 2% 1% 0%
Debt government net borrowing (rhs)
Source: Istat, Crdit Agricole SA
20
Greece: Overcoming its debt problem?

The debt relief as a result of the PSI plan has given the country a chance to put the economy onto a more stable footing. Recession will continue to be deep (2012: -5.0%) making fiscal consolidation targets harder to achieve.
Greek banking system loans to and deposits from private sector (% ch YoY)
30 20 10 0 -10 -20 2008
With the successful completion of the PSI plan, Greece has been pulled back from the brink of default and has gained one more opportunity to address its macroeconomic imbalances. But the draconian austerity measures implemented so far need to be supplemented with new ones as agreed with the Troika in the context of the fresh bailout programme of EUR130bn to make up for divergences from the state budget targets consequent upon the deep recession. The new measures mainly focus on public sector spending cuts (-EUR3.2bn). Nevertheless, the general government deficit has been revised to -6.7% of GDP for 2012, up 1.3ppt from the initial target, as sharply declining economic activity is dragging down public revenues. As new measures (EUR11.5bn) will be needed in the 2013-14 period and probably more financial support thereafter, Greece needs to press on with the still-heavy structural reform agenda. Implementation setbacks would stall the economic recovery, which is very much needed in order to help debt fall towards the level targeted by the new programme: 120.5% of GDP by 2020. Recession last year was worse (-6.9%) than expected. In 2012 as well, real GDP will most likely fall more (-5.0%) than our projection made a couple of months ago given the tight new policy measures and the weakening external economic environment, which will restrict the positive contribution of the external sector to growth. Households' already faltering purchasing power will take another hit from further reductions in pensions and cuts to private sector wages the latter aimed at boosting job creation and enhancing competitiveness. The outlook for investment spending is altogether unfavourable. Apart from some promising interest in the energy sector, investors remain reluctant to pursue new projects in a distressed business environment. The drawdown rate from EU structural funds remains low, while the public investment budget has been cut drastically in the context of economising on public expenditure.
2009 2010 Loans
2011 2012 Deposits
Source: Bank of Greece
Labour cost index (% ch YoY)

16 8 0 -8 -16 Q108Q308Q109Q309Q110Q310Q111Q311 Total Wages Employees' social security contributions
Source: Hellenic Statistical Authority
General govt balance (% of GDP)

4
At the same time, bank financing of the private sector is receding further in 2012. Losses from participating in the PSI plan and the continuously shrinking deposit base in January 2012 deposits had fallen back to their mid-2006 level are aggravating banks' liquidity problems. Unemployment is soaring (December 2011 unemployment rate: 21%). With activity much weaker, we now see the unemployment rate averaging above 20% in 2012. Regarding prices, headline inflation (February 2012 HCPI: 1.7% YoY) is not coming down as fast as would be expected in deep recessionary conditions and while labour costs subside. Besides the impact of high energy prices, this makes it clear that rigidities still prevail in the product and services markets. In 2012 inflation is likely to be, on average, close to 1%. Risks to the overall outlook remain tilted to the downside. They mainly relate to the outcome of the upcoming general elections in April/May 2012. Should a stable government not be formed, the reform programme would be at risk of serious delay. On the other hand, social opposition may build up further in view of the new austerity measures.
-3
-10
-17
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012*
Overall balance Primary balance (ex. interest payments)
* revised budget Source: Hellenic Statistical Authority, Hellenic Ministry of Finance
Aikaterini Anagnostopoulou
anagnostopoulou.k@emporiki.gr + 30 210 3284608
21
Spain: Between austerity and pragmatism

The markets seem to have re-evaluated their risk perception regarding Spain after the government announced that it had revised its 2012 public deficit target. The announcement came only days after the European fiscal discipline pact was signed. The timing was poor, but Spain had little choice. The efforts needed to achieve the previous target seemed impossible at a time when the economy is falling back into recession (-1.8% in 2012) and unemployment is at record highs. Breakdown of public deficit by governmental body
2 0 -2 -4 -6 -8 -10 2010 2011 2012 (old) Regions 2012 (new) Other % GDP
In Q411, economic activity in Spain fell by 0.3% QoQ, but this was significantly less than in the other Southern European countries (-0.7% QoQ in Italy, -1.3% in Portugal). The limited drop in activity was, however, mainly due to a sharp fall in imports (down 6.5% QoQ) in line with the fall-off in domestic demand (-1.7%). On the basis of economic data from the start of the year, the economic situation seems to have worsened in Q112. Industrial production fell by 4.2% YoY in January after falling 3.5% in December. In February, the PMI index covering activity in both services and manufacturing fell by 3.2 points. The subindex representing expected orders saw a further decline, heralding a prolonged weakening in economic activity. Furthermore, higher input prices (notably for oil) continue to put pressure on firms margins. On the demand side, consumer confidence is depressed, falling 4.5 points in February. The unemployment rate continues to rise (reaching 23.3% in January), especially among young people (at 49.9%). With an industrial capacity utilisation rate at record lows, investment stands a good chance of seeing further stagnation. Overall, we are forecasting a 0.8% QoQ fall in Q112. In 2011, Spains deficit overshot the target negotiated with the European Commission by 2.5 points of GDP, coming out at 8.5% of GDP. The overshoot can be largely put down to budget overruns in the autonomous regions, with a deficit of 2.9% of GDP in 2011 (1.6 points of GDP higher than the target). In view of the higher starting point, and the deepening of the recession, the target of cutting the budget deficit to 4.4% in 2012 seemed unrealistic. The Spanish government aimed to re-set the target at 5.8% of GDP to avoid undermining growth further, but was constrained to agree to an additional effort, as the Commission was asking it not to exceed a deficit of 5.3% of GDP. The regions will need to accelerate their adjustment efforts, with a deficit reduced to 1.5% of GDP in 2012 (compared with 2.9% in 2011). The regions approved the reduction target on 7 March, which was an encouraging step, but this is still no guarantee of success. The Spanish authorities still lack a credible mechanism for effectively curbing regional spending. The ECBs 3Y refinancing operations were a success and restored a degree of calm to the financial markets by warding off the spectre of a systemic crisis. However, the restructuring of Spains banking system against a backdrop of balance sheet restructuring continues. Spanish banks will have to write additional provisions to absorb real estate risk (EUR50bn, according to the government) and cope with an increase in the ratio of non-performing loans as the recession bites even deeper. The Spanish economy, which continues to pay for the excesses of the housing bubble and purge past financial excesses, is still looking for a new growth driver to take up the slack. The government is currently placing the emphasis on structural reforms to return to more balanced growth. The priority is combating unemployment, with measures designed to streamline hiring and firing procedures and hence make the labour market more flexible by reducing wagebargaining powers and cutting redundancy payments. These reforms should also help to restore the countrys competitiveness, which has improved only slightly since 2009. However, before these reforms bear fruit, the process of adjustment underway in both the economy and public finances will plunge Spain back into another year of recession (-1.8% in 2012), before it can hope to see activity stabilise next year.
Central Govt
Source: GAE, Crdit Agricole SA
Banks: Non-performing loans by company

20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0%
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Total doubtful loans Agriculture, hunting Industry (excluding construction) Construction
Source: Crdit Agricole SA
Business climate
60 55 50 45 40 35 30 25 07 08 09 10 11 PMI index - manufacturing PMI index - services 12 <50 contraction of activity Points >50 expansion of activity
Source: Reuters, Crdit Agricole SA
Bndicte Kukla
benedicte.kukla@credit-agricole-sa.fr + 33 1 43 23 18 89
Dec-11
Jun-07
Jun-08
Jun-09
Jun-10
Jun-11
22
Portugal: Fighting off the stereotypes

Is Portugal the next Greece? No, every country is different and thus far the committed Portuguese government has maintained its fiscal adjustment programme. The question is how long Portugal will be able to continue such harsh fiscal adjustment in an ever-weakening economy. Planned financing sources
EURbn 60 50 40 30 20 10 0 19.6 22.4 12.9 1.7 Fin. Market MLT aid EU/IMF 13 19.2 20.1 38.1 25 IMF forecasts (Dec 2011) 0.5 0.9 4.1 1 10 13 9.3 15.9 14.5 5.1 13 13
Portuguese GDP plunged in Q411 (-1.3% QoQ). It was Portugals fifth consecutive quarter of negative growth, resulting in an annual contraction in GDP of -1.6% in 2011. Strong fiscal tightening combined with the ongoing deleveraging process in the private sector have led to a severe drop in investment (-11.4% in 2011) and consumption (-3.9%). The export performance has been relatively encouraging (+7.4% in 2011) but has slowed in recent months (-1.8% QoQ in Q411). Furthermore, external imbalances have improved, with the trade deficit falling by four percentage points of GDP in 2011 to -3.5%. The European Commission and the IMF have also praised Portugal for its large fiscal adjustment, having achieved the greatest budgetary corrections (equivalent to 3.9% of GDP) in the Eurozone in 2011. This adjustment was, however, in large part thanks to one-off revenues linked to a transfer from pension funds belonging to the banking sector. Therefore, in 2012 the macroeconomic impact of the targeted fiscal tightening will be more intense without any additional oneoff revenue. The 2012 budget includes ongoing reductions in public sector employment and pensions, wage freezes, an increase in VAT rates for certain sectors (notably restaurants, with an increase from 13% to 23%), and a 30minute unpaid extension to the workday in the private sector. The privatisation programme has also been enlarged, but contrary to the Greek situation privatisation proceeds have been more robust than initially anticipated. All in all, the situation of public finances in Portugal appears to be going in the right direction, but doubts remain as to how long Portugal will be able to continue this harsh fiscal policy in such a depressed economic environment, even with the majority governments strong commitment to reform. According to the latest IMF review, Portugal is expected to return to the bond markets in 2013 in order to raise over 70% of its funding needs. However, despite a recent fall in market tensions, Portuguese yields remain high (2Y bonds averaged 12.7% at the beginning of March, compared with 4.7% for Irish bonds), and funding needs could increase significantly if the deficitreduction programme is hampered by the slowdown in activity. Therefore, it looks increasingly likely that Portugal will need additional financing assistance from the EU/IMF before 2013. Therefore, with the risk of additional austerity measures being introduced in exchange for official funding, the outlook for the Portuguese economy remains grim. Unemployment is set to rise to over 15% in 2012, while wages will remain under pressure due to cuts to public sector pay. The Portuguese economy will undoubtedly be impacted by the slowdown in growth in neighbouring Spain and other Eurozone trading partners, especially at the beginning of 2012. Economic data points to a strong drop in activity in the first half of 2012 (-1.5% and -0.9% in Q1 and Q2, respectively), which will lessen in the second half as export prospects improve. We expect GDP to contract by 3.6% in 2012, with risks remaining skewed to the downside thanks to a negative feedback loop between growth and fiscal adjustment, as the experience in Greece cannot be ruled out. Nevertheless, we do not expect as severe a drop in activity given the weakness of Portuguese GDP growth over the last decade.
2009 2010 2011 2012 2013 2014 2015 Fin Markets ST Privatisation
Source: IMF review (December 2011)
Government deficit & forecasts

% GDP 0 -2 -4 -6 -8 -10 -12 20062007200820092010201120122013 public deficit observed forecasts -4.7 -3.4
Source: Eurostat, source nationale
Economic sentiment
120 110 100 90 80 70 60 07 08 09 10 11 12 EMU Greece Ireland (rhs) Spain Portugal 80 60 40 20 0 points points 100
Source: ESI survey (GR, SP, EMU, PT), KBC survey (IR), Crdit Agricole SA
Bndicte Kukla
benedicte.kukla@credit-agricole-sa.fr + 33 1 43 23 18 89
23
UK: Oil prices cast a shadow over the economic outlook

Near-term indicators point to a stabilisation in activity and sentiment since the end of last year, but there are few signs of a sustained improvement as yet. Subdued growth in H1 followed by a strengthening in H2 remains our central-case scenario but increased price pressures from high oil prices represent a danger to the recovery in household consumption. Record-high petrol prices in GBP
600 500 400 300 200 100 0 02 03 04 05 06 07 08 09 10 11 12 Price of imported crude oil, GBP, SA HICP (rhs) GBP/tonne YoY, % 6 5 4 3 2 1 0
The strengthening in surveys since end-2011 has lowered the risk of a technical recession in the UK. The rebound in our in-house PMI composite index from an average of 51.9 in Q411 to 54.9 in Q112 points to an acceleration in growth in the current quarter, though its predictive power was distorted by oneoff factors last year. The improvement in the business climate seems to find its roots in the stabilisation of domestic and external demand and the fall in inflationary pressures on input prices since their peak in March last year. However, the increase in the PMI input price index in February (the largest since October 1992) broke the downward trend, not least because of a record in petrol prices in GBP. Stronger price pressures were reported on various commodities and PPI inflation also rose in February. This highlights the risk of a renewed downturn in business confidence should inflationary pressures persist. We expect GDP growth to remain uneven and subdued in 2012, strengthening in the second half of the year thanks to the pick-up in consumption and, further ahead, a rebound in business investment from its current depressed level. Household consumption has already registered positive growth in Q411, by expanding by 0.4% QoQ the first positive outcome after four quarters of contraction. This was consistent with the recovery in retail sales (1.1% QoQ in Q411). There have been tentative signs of a rebound in consumer confidence since the beginning of the year, although it remains at subdued levels. Financial expectations have improved slightly, likely in relation to the easing real income squeeze as inflation has moderated (from a peak of 5.2% YoY in September to 3.6% YoY in January). We expect inflation to continue to fall, approaching the 2% BoE target in Q4, which would be a key assumption for the recovery in household consumption and, hence, growth. However, the uncertainty over the employment outlook will likely continue to act as a drag on consumption. Declining public sector employment and the slowing pace of job creation in the private sector, associated with an expansion of the workforce, drove the ILO unemployment rate to 8.4% in Q411, a record high since 1994. 336,000 workers have been shed by the government over the period Q210-Q311. The fall in public sector employment is set to continue in the coming years as the OBR now expects 730,000 job losses over the period to the start of 2017. Private sector job creations are also likely to remain weak as long as uncertainty over demand is depressing hiring intentions. All in all, the unemployment rate is expected to continue to rise and reach 8.7% this year. Investment is unlikely to recover ahead of demand. We have to see an improvement in business confidence about the prospects for demand before we will see any sustainable rebound in capital expenditure. What is more, the business financial situation deteriorated in H211, as suggested by the sharp fall in the gross operating surplus. Lending to businesses has continued to contract with the latest BoE credit conditions surveys suggesting lenders are expecting a further marked widening in credit spreads to companies in the current quarter.
Source: ONS, Crdit Agricole CIB
UK recovery to remain patchy

1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 % QoQ % YoY 8 6 4 2 0 -2 forecasts -4 -6 -8 05 06 07 08 09 10 11 12 13 GDP, QoQ% GDP, YoY% (rhs)
Source: ONS, Crdit Agricole CIB
Public deficit in line with the OBR target for FY11/12

180 160 140 120 100 80 60 40 20 0 Apr Jun 2009-10 2011-12 Aug Oct Dec Feb 2010-11 OBR forecast GBPbn, cumuluative Ytd
Source: OBR, Crdit Agricole CIB
Slavena Nazarova
slavena.nazarova@ca-cib.com + 33 1 41 89 99 18
The BoE expanded its APF by GBP50bn in February to GP325bn and left its key policy rate at 0.5%. Consistent with easing downside risks from the Eurozone area, the February Inflation Report was less dovish than in November, with risks over the medium-term outlook for inflation judged as broadly balanced. Recent MPC communication suggests the committee sees the current policy settings as appropriate. Growing concerns about price pressures among MPC members also lead us to expect no further QE in May, when the current asset purchases are due to be completed. However, the BoEs monetary policy remains contingent on indicators for demand and, in the event of downside news, a further extension of the asset purchase programme remains a possibility.
24
Australia: Growth around trend

The economy is expected to grow by 3.1% and 3.2% in 2012 and 2013, respectively. Recovery in coal production after flood disruption, and relatively firm growth in China will help support the local economy. Easing inflation will allow the RBA to cut policy rates by another 25bp. AUD/USD is expected to reach 1.10 by end-2012. Once-in-a-century investment boom
800 700 600 500 400 300 200 100 0 2005=100 05 06 07 Mining Others 08 09 10 11 Manufacturing Private new capital expenditure
The Australian economy is expected to grow by 3.1% and 3.2% in 2012 and 2013, respectively. Overall, growth is expected at around trend over the coming two years. Recovery in coal production after the flood disruption, and relatively firm growth in China, will help support the local economy. The two-tier nature of economic growth remains a concern, however. An investment boom and the elevated exchange rate have benefited the mining sector significantly as the terms of trade have strengthened. However, the retailing and tourism sectors have suffered. In the labour market, a similar pattern has been observed, with employment growth skewed to the mining sector. Looking forward, investment will likely continue to play an important role in growth (with USD180bn of LNG projects in the pipeline) while exports are expected to remain buoyant. The twotier nature of growth will continue to make policymaking difficult in the months ahead. On the policy front, inflation pressures remain soft in part due to the elevated level of the AUD, providing the RBA with some scope for further monetary policy easing if needed. Indeed, the RBA has cut its policy rate twice consecutively. As the Eurozone crisis has eased and retail sales have rebounded, the easing cycle is almost done, with one more rate cut to 4.00% in Q2 likely. The market has priced in more aggressive rate cuts, with 50bp of easing in Q3 discounted. Despite the risk of a short-term correction lower, attraction to yield and improving risk appetite as well as central bank diversification will boost the AUD. We expect AUD/USD to appreciate to 1.10 by the end of 2012.
Source: Crdit Agricole CIB, CEIC
KinTai Cheung
kintai.cheung@ca-cib.com +852 28 26 10 33
New Zealand: Recovery to be delayed

New Zealands economy is expected to grow by 3.0% and 3.5% in 2012 and 2013, respectively. The main driver of growth will be investment but the process of deleveraging will likely put a drag on consumption growth. Meanwhile, the inflation outlook remains subdued due to the high exchange rate and spare capacity, probably delaying RBNZ rate hikes to Q312. Reconstruction-related growth to be delayed further
2.0 % 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 00 02 04 06 QoQ YoY (rhs) 08 New Zealand GDP % 8 forecasts 6 4 2 0 -2 -4 10 12 QoQ F YoY F (rhs)
New Zealands economy is expected to grow at a healthy pace over coming years, with 3.0% and 3.5% expected in 2012 and 2013, respectively. The main driver of growth will be investment on the back of rebuilding activity, which has been delayed. Retail sales were boosted largely by the Rugby World Cup last year. However, without a similar stimulus ahead, the lingering process of deleveraging by households will likely put a drag on consumption growth. On the production side, the primary sector is expected to strengthen over 2012 given favourable climatic conditions. With resilient demand from Asian countries and an improving global outlook, exports appear to remain supported. The inflation outlook remains subdued on the high exchange rate and spare capacity, as reflected by the high unemployment rate and negative output gap (ie, deflationary gap). Reconstruction could use up spare capacity, lifting inflationary pressures eventually, but it looks unlikely soon. The impact of the tobacco excise tax hike will be limited as well. We expect CPI inflation to stay within the 1-3% target band by 2013. With no urgency for rate hikes, the RBNZ is not expected to lift its rate until Q312. Indeed, the RBNZ has turned more dovish recently, noting less need to increase the OCR in the latest monetary policy statement. The NZD is expected to follow the path of the AUD, climbing to 0.84 in 2012 and then slipping to 0.79 in 2013. Over the short term, compared with the AUD, the smaller magnitude of yield attraction and RBNZs relatively dovish stance will likely leave the NZD vulnerable.
KinTai Cheung
kintai.cheung@ca-cib.com +852 28 26 10 33
25
Canada: Weaker external demand limits growth

Growth in the Canadian economy will likely remain below potential as favourable domestic conditions are dampened by a less favourable external environment. The Bank of Canada is expected to keep rates on hold in order to support economic growth. Canadian growth slowed in Q4 (%)
6 5 4 3 2 1 0 -1
Dec-10 Sept-11 Dec-11 Mar-10 Mar-11 Jun-10 Sep-10 Jun-11
Source: Bloomberg
Canadian growth slowed in Q411 due to slower inventory growth and weaker government spending. The 1.8% gain in Q4 GDP compares with 4.2% in Q3. However, the details in the Q4 report were better than the headline suggests. Personal expenditures grew at a 2.9% rate in Q4, an improvement from the lacklustre 1.8% growth in Q3. That supports the expectation that domestic demand will drive growth in coming quarters. Residential investment grew 3.3% in Q4 while business fixed investment posted a healthy 8.1% rate of growth. Government spending declined by 3.3% in Q4 compared with -1.0% in Q3. Net exports added 0.7 percentage points to growth in the fourth quarter. Imports rose +2.2% after falling 1.5% in Q3. Exports grew 4.6% after having surged 16% in Q3. The export slowdown underscores the adverse effects of a stronger CAD. Inventories subtracted 1 percentage point from growth in the fourth quarter. The monthly GDP figures for December showed 0.4% growth after the 0.1% decline in November. Strength was posted in manufacturing (+0.9%) and wholesale trade (+1.3%). This suggests that Q1 likely had a good start with growth estimated around 2.0% for the quarter. Weaker external demand will likely weigh on Canadian economic growth given the negative impact on confidence, trade and increased financial strains. Real GDP growth in 2012 is forecast to grow about 1.9% with private domestic demand driving growth. Domestic financial conditions have been quite accommodative with interest rates at historically low levels. Banks are ready to lend with a low cost of funding across the term structure. Residential investment spending is likely to remain strong, helped by low mortgage rates and favourable lending conditions. We expect weaker growth in the first half of the year as elevated uncertainty curbs business fixed investment. However, we expect that business investment will contribute to growth throughout the year and will become more solid in 2013. Overall, we anticipate that economic growth will strengthen in H212 as the European situation improves and economic activity in the US slowly strengthens. Canadas net exports will likely suffer from much weaker demand from many of its major trading partners as well as the dampening impact of the persistent strength in the CAD. The weakness in international growth reflects continued deleveraging by banks and households and more restrictive fiscal policies by governments. The stronger CAD has served to weaken the competitiveness of Canadian firms. Unit-labour costs have continued to increase relative to those in the US with a stronger CAD accounting for most of the loss of competitiveness. As a result, export growth is expected to be weak throughout 2012. Heightened geopolitical uncertainties and concerns about supply have led to a spike in commodity prices and will likely cause an increase in top-line inflation over the next few months. That said, we do not expect that inflation will exceed the Bank of Canadas 2.0% target throughout 2012 given the excess slack in the Canadian economy. Employment figures over the past two months have come in weaker than anticipated. The Bank of Canada does not expect to see the economy return to full capacity until Q313, and we anticipate that it will keep its overnight target rate on hold until next year.
Inflation within the BoCs target

4 3 2 1 0 -1 Mar-08
Mar-09 CPI YoY %
Mar-10
Mar-11
Mar-12
Core CPI YoY %
Source: Bloomberg
BoC to keep rates on hold

6.0 5.0 4.0 3.0 2.0 1.0 0.0
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Federal Open Market Committee: Fed Funds Target Rate (%) Canada: Bank of Canada Rate (Avg, %)
Source: FRB, BOC
Sireen Harajli
sireen.harajli@ca-cib.com +1 212 261 7139
Jan-12
26
Emerging markets: Landing softlybut watch oil prices

Two sources of uncertainty have grown in EMs. There have been signs of a stronger-than-expected slowdown in China, and the threat of high oil prices is looming. Our view: China will land softly. EM momentum has strengthened recently, as suggested by the PMI surveys, but would be vulnerable should oil prices rise strongly from current levels. China: retail sales (YoY)
26% 24% 22% 20% 18% 16% 14% 12% 10% 8% 6% 05 06 07 08 09 10 11 Retail sales YoY 12
Crossed trajectories?
The global backdrop has definitely improved over the past few weeks, with progress on the institutional front in Europe, progress in the resolution of Greek liquidity problems, positive surprises about US economic momentum and improvements on the job market in particular and, on top of that, the ECB providing banks with liquidity.
Chinas economic landing: less soft than expected

However, it is precisely when the developed world seems to get better that warning signs are switched on in emerging markets. There are two kinds of signal. First of all, there have been signs that China may slow more strongly than initially expected. Retail sales and industrial production have decelerated in February. It is always difficult to analyse Chinese data for the first two months of the year because of the Chinese New Year effect. However, the picture remains unchanged when looking jointly at the first two months of the year. Retail sales decelerated from more than 17% YoY in H211 to 14.7% YoY YTD. One could argue this is still strong. However, this slowdown is unfortunate, as it may delay the rebalancing of economic growth from investment to consumer demand. In our view, the central bank will react by easing monetary policy, in order to make sure that domestic demand does not weaken too strongly before the handover to the next generation of leaders that will be initiated at the 18th National Congress of the CCP in November.
Source: Datastream, Crdit Agricole CIB
Brazil: GDP YoY growth

10% 8% 6% 4% 2% 0% -2% -4% 00 02 04 06 08 10 GDP YoY growth 12
Oil price a possible hurdle

There have been signs of deceleration in other large EMs, like Brazil for instance. However, it is also worth noting that most EMs have significant monetary and fiscal leeway to buffer possible soft patches. This leads us to the second warning sign. Oil prices have reached their highest level since 2008. Some economies could suffer from such prices oil-intensive Asian economies in particular. Moreover, uncertainty remains strong in the Middle East, and at some point this could fuel further the political premium that is incorporated in oil prices. One reason why oil prices can make the difference is because inflation in EMs stands at a crossroads. EM inflation has been decreasing over the past few months, but more in Asia than in other EMs, and there have already been signs recently that disinflation could soon come to an end. The correlation between EM inflation and the yearly change in global oil prices makes the oil price an important factor for the EM inflation outlook. Should the political premium decrease and oil prices (Brent) come back towards USD105/bl in H212, disinflation could continue in coming months and then inflation could stabilise close to its 2004-06 average level. By contrast, a further spike in oil prices (say to USD150/bl) could send average EM inflation much higher. This would create uncertainty for the market: either rate hikes would make it difficult for stock markets to grow further, or the reluctance of central banks to hike could erode their credibility and fuel some investors reluctance to invest in EMs and exert some negative pressure on EMs external financing and possibly some EM currencies. The price of oil is definitely one of the main numbers to watch in Q2 to gauge the EM outlook.
Source: Datastream, Crdit Agricole CIB
EM inflation and oil prices

10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 03 04 05 06 07 08 09 10 11 12 CPI YoY Change (EM23 - LHS) Oil Prices YoY change (RHS) Oil prices CA-CIB assumption (RHS) Oil prices at 150 USD/b YoY (RHS) 150% 100% 50% 0% -50% -100%
Bottom line
That said, if oil prices come down as we expect in our base-case scenario, EM economic growth should remain fairly strong in 2012. The rebound in many PMI indices over the past two months already suggests that the soft patch has come to an end. Overall, we still expect emerging markets to grow by 5.4% in 2012 (compared with 6.2% in 2011).
Source: Bloomberg, Datastream, Crdit Agricole CIB
Sbastien Barb
sebastien.barbe@ca-cib.com + 33 1 57 87 17 23
27
Central Europe: On the back foot

Despite the latest positive figures, economic activity within the region will remain subdued in 2012. Bank deleveraging, though easing, will continue to hurt domestic demand over the coming months. Inflation is increasingly becoming a concern and should prevent central banks from cutting rates soon. Given the impressive rally, FX has the potential to depreciate. Inflation threat
10 %YoY 9 8 7 6 5 4 3 2 1 0 Mar-07 Mar-09 Mar-11 Czech Rep Hungary Poland
The latest Q4 GDP figures across Central Europe have confirmed the ongoing economic slowdown, spurred by Eurozone debt worries and bank deleveraging. The PMIs released over the past two months point to a mild recovery, though growth should remain anaemic through 2012. The bank deleveraging continues to weigh on domestic demand but some rays of hope are breaking through. Indeed, the Vienna 2.0 initiative seems to be underway and even the Austrian authorities, which were highly hawkish about bank deleveraging in CEE countries late last year, are turning more lax on regulation for Austrian banks involved in the region. In addition, the feeling that the worst is over in Europe breathes some fresh air into Central European countries, and the bank deleveraging could be smaller than originally feared. However, central banks remain in an uncomfortable position with the rising inflation threat. Past FX weakness coupled with tax hikes and austerity measures have pushed consumer prices higher, and the still-high commodity prices will likely delay the expected decline in inflation through the remainder of the year. Unlike Romania, which still benefits from room to manoeuvre, CE3s central banks should remain on the sidelines until the summer at least. Despite the easing of European worries, FX should remain on the back foot given the pending threats and the impressive rally in Q1, which will lead to some short-term weakness. Given this backdrop, the HUF is likely the most vulnerable as the talks with the IMF have not yet started and the markets fatigue and disappointment could lead to some weakness at some point in the short term.
Guillaume Tresca
guillaume.tresca@ca-cib.com +33 1 41 89 18 47
Russia: Stability for now

As presidential elections have passed and oil is above USD120/bl, there is some kind of stability in Russia at least for the next quarter. The low interest rate environment continues to stimulate lending, while the tight labour market has resulted in accelerating wage growth. For now, the resulting strong internal demand is satisfied with growing imports and is not leading to higher inflation, but we expect that as early as Q2 the CPI trend will reverse, showing more need for policy tightening. Russia : unique situation of strong demand and low CPI
20% 15% 10% 5% 0% -5% -10% Jan-10 Aug-10 Mar-11 Oct-11 Retal sales, YoY, % Investments, YoY, % CPI, YoY, % (rhs) 10% 9% 8% 7% 6% 5% 4% 3%
Russian presidential elections have passed: Mr Putin won in the first round and according to the current legislation will serve a six-year term. Political tensions have faded away but not disappeared completely: any prolonged economic crisis (which may be triggered by lower oil prices) will bring the political story back to the stage. But as long as oil prices are strong we see no negative political surprise in Russia (as major elections have passed). With less political risk, attention returns to the economy. Here, we see a tight labour market, which is fuelling wage growth (real wages are up 13.3% YoY in February). Strong income and a low savings ratio (on the back of a low interest rate environment) are pushing retail sales and (combined with high utilisation levels) investment growth close to multi-year highs. As a result, according to our estimates, the economy is already running slightly above potential: in this case further strong internal demand growth will result in the economy overheating and a worsening of external balances. CPI, which hit an alltime low of 3.7% YoY in February, was driven mainly by temporary factors like postponed tariff hikes or high base effect in food prices. Already in April this trend will reverse, pointing to the necessity of further monetary policy tightening, which will slow down internal demand growth by the end of the year. If no tightening is delivered, the risks of a hard landing for the economy will increase.
Maxim Oreshkin
maxim.oreshkin@ca-cib.com +7 495 937 0581
28
South Africa: Current account deficit widens

The deterioration in the balance of payments observed in 2011 is unlikely to improve in 2012, unless gold or platinoids start to rise again (which we are not expecting). The ZAR should, nevertheless, appreciate slightly in H212.
Precious metals and the ZAR

5 6 7 8 9 10 11 12 00 02 04 06 08 10 12 ZAR/USD (inv) Gold price (USD/oz, rhs) Platinum price (USD/oz, rhs) 2000 = 100 800 700 600 500 400 300 200 100 0
South Africas trade balance deteriorated sharply in late 2011. The Q4 balance of payment figures are not yet available, but the current balance should come in at around -USD15bn for 2011 as a whole, or 3.8% of GDP. The deficit is still easily financed, and currency reserves stood at USD51.4bn (4.6 months of imports of goods and services) in late January. However, the reserves have grown only slightly since March 2011. The deterioration in the balance of payments is partly due to the end of the virtually continuous rise in the gold price and to a lesser degree in that of platinum (which had experienced a severe correction in late 2008). Precious metals account for around a quarter of South Africas exports, and have contributed significantly to the improvement in the countrys terms of trade (+25% since 2005). Their price prospects will therefore influence the outlook for the balance of payments and for ZAR. In 2012, against a backdrop of slightly higher growth (3.5% after 3.2% in 2011) on the strength of sustained domestic demand in H112 and driven by a rebound in external demand in H2, the balance of payments deficit will widen a little more to 4.0% of GDP. ZAR should nevertheless be strengthened by sustained investor interest in the big emerging markets.
Source: Reuters, LBM, Engelhard
Jean-Louis Martin
jean-louis.martin@credit-agricole-sa.fr +33 1 43 23 65 58
Turkey: Market sentiment rules

Turkey enjoys international liquidity but its funding requirements are very high. Although growth is slowing, the current account deficit is proving very sticky. For the time being, there is no shortage of confidence but the scenario depends a lot on market sentiment. Turkey: substantial funding requirements
200 160 120 80 40 0 -40 2000 USDm -200 -160 -120 -80 -40 0 40 2003 2006 2009 2012 Foreign reserves Current account balance (rhs) Financing requirements* (rhs)
The economys tendency to slow is gathering momentum. In February, the industrial capacity utilisation rate was at its lowest level since 2010, at 72.9%, and the growth rate for consumer credit stood at 22.5%, compared with 36% in April 2011. Most importantly, industrial production is slowing sharply. However, flagging domestic demand is good news: the current account deficit will shrink, especially as exports are proving resilient thanks to the currency depreciation of 2011 and to the geographic diversification of export sales. We should remain cautious, however, because Januarys current account deficit figure was disappointing at 9.9% of GDP over 12 months, and it raises fears that the contraction is too slow. Turkey seems likely, therefore, to live for some time with considerable amounts to finance, giving rise to both currency and liquidity risks. In addition, regardless of the structural improvements (falling unemployment), the country is at the mercy of market sentiment. In the short run, Ankara is taking advantage of increased international liquidity. It is finding it easy to roll over its debt, and foreign direct investment is on the rise, financing 14% of the current account deficit in January. The errors and omissions item finances 15% of the deficit, fed by informal receipts from exports or tourism. Clearly, Turkey has benefited from the Arab Spring. All these trends should continue in 2012, provided that inflation does not go any higher (10.6% in January), which would have an adverse effect on confidence levels.
* Current account balance + ST debt + amortisation of M- to LT debt foreign direct investment Source: EIU, IMF
Tania Sollogoub
tania.sollogoub@credit-agricole-sa.fr +33 1 43 23 49 27
29
India: Close to bottom?

Growth slowed fairly sharply at the end of last year. Without a clear recovery in global demand and a marked easing in interest rates, it could remain below the Indian economys potential in the short term. But economic activity should pick up in 2012/13, despite a political environment that is likely to remain difficult. India: domestic demand and interest rates
25 20 15 10 5 0 -5 -10 3/07 3/08 3/09 3/10 3/11 Private consumption Investment Key rate (%, rhs) YoY %, sa % 10 9 8 7 6 5 4 3/12
The first half of 2012 should remain fairly difficult for the Indian economy. There is unlikely to be any significant improvement in export markets, and no marked monetary easing is on the cards either. Indias central bank (RBI) once again opted for the status quo and hence for caution at its March Monetary Policy Committee meeting. The RBI should nevertheless concede a first cut in interest rates in Q2. At least, the markets have priced one in. The cut could come in April, with the trajectory of food prices, oil, INR and economic activity between now and then playing a decisive role in the decision. However, the longer the RBI puts it off, the smaller its window of opportunity, especially as fiscal policy should remain fairly expansionary this year. That said, the rebound in private consumption in the last quarter of 2011, together with the smaller fall in investment, could signal that Indian growth (which fell to 6.1% YoY in the last three months of 2011 its lowest rate since Q109) has bottomed, or is close to doing so. Economic activity should become stronger in 2012/13, although one unknown quantity nevertheless persists in the scale of the trend. This will partly depend on changes in the international environment and on the governments ability to relaunch its reforms and win back investor trust two points on which there is a lack of visibility. The latest setback for the Congress Party in the last regional elections raises fears that the government of Manmohan Singh will be even more hesitant between now and the general elections in 2014 to take reforms forward and will opt instead for a series of populist measures these fears have been partly borne out by the 2012/13 budget presented in mid-March. In the meantime, we are currently forecasting growth of 7.3% during the fiscal year (April-March) that has just begun.
Source: CSO, Reserve Bank of India
Sylvain Laclias
sylvain.laclias@credit-agricole-sa.fr +33 1 43 23 65 55
China: Hard-landing fears will pass

The output slowdown has triggered hard-landing fears, but they should pass as domestic demand and monetary easing revive growth. We maintain our calls for 2012: 200bp in RRR cuts, 50bp in policy rate cuts, 8% GDP growth. Industrial output and private domestic demand
30 25 20 15 10 5 0 Jan-11
6.7%
%, s.a. MoM annualised
2012 growth if January February data is extrapolated 17.4% 16.6%
China had a disappointingly soft January and February. Annualised MoM gains in industrial output averaged 6.7%, less than half the 2011 level, stoking hardlanding fears. We believe the slowdown is temporary and still expect a soft landing. Firstly, weaker output was driven by a reduction of the inventory overhang. The recent pick-up in new orders and decline in stockpiles should trigger a recovery in production. Secondly, private domestic demand remains buoyant. Annualised MoM gains in nominal retail sales and fixed asset investment were 16.6% and 17.4%, above targets and enough to revive output. Thirdly, the acceleration in government spending will boost aggregate demand. Finally, sharp disinflation and downside risks prompted policymakers to send strong signals that monetary policy will be eased. Moreover, the CNY was weakened versus the USD to prevent appreciation in trade-weighted terms. We see 200bp in required reserve ratio cuts and 50bp in main policy rate cuts later this year. These measures should stimulate growth, and we keep our 8.0% forecast for 2012. USD/CNY should end the year at 6.20.
Jul-11
Jan-12
Jul-12
Retail Sales
Ind. output Fixed asset invest.
Source: CEIC, Crdit Agricole CIB
Dariusz Kowalczyk
dariusz.kowalczyk@ca-cib.com +852 28 26 15 19
30
Mexico: Riding the improved US momentum

Mexican growth prospects are still at acceptable levels and remain well supported by improved US momentum. The transmission channel continues to be the export sector, with manufacturing in the drivers seat.
Mexico and US cycle synchronisation

65 60 55 50 45 40 35 30 07 08 09 US PMI 10 11 Mexico PMI 12
Mexico will likely continue to have growth rates in 2012 oscillating around 3.03.5%, keeping the momentum seen in 2011 supported by the improved US momentum (external pull) and domestic factors such as private consumption and, to a lesser extent, investment. The chart illustrates how US and Mexico PMI indices continue to show synchronised moves and thus are a source of support for Mexican manufactured products automobiles and auto parts in particular. On the inflation front, in spite of seeing volatile patterns in headline inflation in recent months, prices seem to be normalising, and core inflation, although accelerating, is still under control thus leaving no room for central bank action in the remainder of the year. The political scene is just about to gain attention as presidential campaigns will start on 31 March ahead of a 1 July election day. The latest polls still show the PRI leading the preferences, followed by the PAN (President Calderons party) and then the PRD. Our base-case scenario continues to be that a win by either PRI or PAN would have a muted impact on markets. In the event of seeing the PRD gaining popularity, bouts of volatility cannot be ruled out.
Source: Bloomberg
Mario Robles
mario.robles@ca-cib.com +1 212 261 7736
Brazil: The BCB surprises again

Although the economy is improving, the pace of recovery has been slightly disappointing so far this year. On the other hand, inflation continues to fall as expected. The BCB surprised the markets again by accelerating the pace of easing to 75bp at its March meeting. We believe that the current cycle is not yet over. The massive monetary stimulus is likely to cause a strong rebound in H2, but it may also cause a deterioration in inflation and inflation expectations. Brazil : IPCA (CPI), IPCA-Core and Services
10 9 8 7 6 5 4 3 2 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 IPCA IPCA-Core Services
Most economic indicators released in Brazil have been positive, although somewhat disappointing. The highlight has been industrial production, which back in 2011 was negatively impacted by the inventory cycle, the strong BRL, rising labour costs and the lagged effects from the tightening cycle. At the same time, inflation has continued to fall, roughly in line with expectations. In spite of this, some inflationary risks remain, as services inflation continues to run at a very high level, the decrease in core measures has been much milder and medium- to long-term inflation expectations are starting to deteriorate. At its March meeting, the BCB surprised the market once again by cutting its policy rate by 75bp. The BCB also signalled that the easing cycle was not yet over. The monetary stimulus that is being given to the economy comes on top of a tight labour market and ongoing credit expansion. Thus, we continue to believe that this policy will lead to a strong rebound in the economy in the second half of the year, led by domestic demand. Our optimism towards economic activity, however, is tempered by a growing concern regarding inflation in the medium to long term and the damage that monetary policy credibility has suffered as a result of the erratic communication from the BCB and its dovish and unconventional approach to the inflation targeting regime.
Source: IBGE
Vladimir Vale
vladimir.vale@ca-cib.com +55 11 38966418
31
Saudi Arabia: Sustained public spending

Saudi Arabia is taking full advantage of higher oil output. Its current account and fiscal surpluses are up despite a sharp increase in spending. In 2012, economic growth in excess of 4% is being forecast, and this will be supported by the non-oil sector household consumption and the construction sector and by investment in the oil sector. Further sustained growth
20% 15% 10% 5% 0% -5% -10% 00 01 02 03 04 05 06 07 11e 12f Real GDP growth Oil output growth Non-oil growth %, YoY
The Saudi economy saw GDP growth of 6.7% in 2011. Obviously, oil underpinned that performance: the average price of a barrel of Brent rose from USD76 to USD111 in 2011 and production rose from 8.2mbd to 9.3mbd. Saudi Arabias current account balance is thought to have seen a USD140bn surplus, taking its foreign currency reserves to USD545bn, or 100% of GDP. The second factor to explain the growth is a near-30% increase in public spending between 2010 and 2011. Saudi Arabia, which has already undertaken a USD400bn investment programme, 60% of which is earmarked for building homes, has, in parallel, injected over USD100bn more into the economy in spending on wages and investment following the Arab Spring. Economic growth should remain relatively high once more this year, but should slow relative to 2011. Oil output levels are expected to remain relatively stable, except in the event of a sharp drop in Iranian crude oil exports. Non-oil growth should remain sustained, however, fuelled by higher public spending, where a 10% increase is forecast for 2012. Wage increases agreed in 2011 will, for their part, continue to drive strong growth in household consumption, facilitated by bank lending, which was back at a more sustained pace, up 7% in the first half of 2011 compared with an increase of 3.7% a year earlier.
Source: IIF, Crdit Agricole SA
Riadh El-Hafdhi
riadh.el-hafdhi@credit-agricole-sa.fr +33 1 57 72 33 35
Egypt: Positive economic signals

One swallow may not make a summer but we can nevertheless see a number of positive economic signals coming out of Egypt. There is still a lot of uncertainty, but it would seem that the IMF plan designed to bring down public spending in exchange for an injection of USD3.2bn could restore investor confidence. Egypt: fall in foreign currency reserves slowed in March
3 2 1 0 -1 -2 -3 -4 -5 -6 -7 USDbn USDbn 40 35 30 25 20 15 10 5 0
Feb-12 Q104 Q105 Q106 Q107 Q108 Q109 Q110 Q111
Current account balance Balance of payments Official reserves (rhs)
Source: Egyptian Central Bank
Riadh El-Hafdhi
riadh.el-hafdhi@credit-agricole-sa.fr +33 1 57 72 33 35
Egypt is engaged in a transitional process that should take it to presidential elections on 23 and 24 May 2012. Against that backdrop, the country is facing an external funding requirement estimated at close to USD12bn this year. Its foreign currency reserves have had to be deployed massively in an attempt to stave off a devaluation of the EGP, plummeting from USD36bn to USD15bn in the space of 14 months. If the fall were to continue at that pace, Egypt would face the threat of a disorderly devaluation of its currency. Right now, investors are looking for any sign pointing to a stabilisation of the economy, and such signs are indeed on the increase in February and March. As seems to be shown by the success of the latest issue of sovereign bonds, the markets have responded positively to the announcement that the fall in foreign currency reserves has been limited to USD600m in March, compared with USD2bn in previous months. The markets are also expecting the release of USD3bn from the IMF in the near future, a loan that would lead to the release of other credit lines from the EU, the World Bank, and so on, which would significantly reduce the need for external financing. In March, the International Islamic Trade Finance Corporation also granted a loan of USD1.2bn. We can, therefore, expect to see a fairly limited fall in Egypts foreign currency reserves in March (the data will be published in April), and the effect of this on confidence levels could, here again, be very positive. If the country does not experience any new political shocks, March 2012 could perhaps mark the end of the deterioration in Egypts macroeconomic balances.
32
Exchange rate forecasts

29-Mar Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13
USD Exchange rate

Industrialised countries Euro Japan United Kingdom Switzerland Canada Australia New Zealand Asia China Hong Kong India Indonesia Malaysia Philippines Singapore South Korea Taiwan Thailand Vietnam Latin America Argentina Brazil Mexico Africa South Africa EUR/USD USD/JPY GBP/USD USD/CHF USD/CAD AUD/USD NZD/USD 1.33 82 1.59 0.90 1.00 1.04 0.82 1.28 85 1.54 0.97 1.00 1.07 0.83 1.27 87 1.55 0.99 0.99 1.09 0.84 1.26 90 1.58 1.02 0.96 1.10 0.84 1.26 92 1.56 1.03 0.94 1.08 0.82 1.25 94 1.54 1.06 0.93 1.06 0.80 1.25 97 1.52 1.06 0.95 1.05 0.81 1.25 100 1.52 1.06 0.96 1.04 0.79
USD/CNY USD/HKD USD/INR USD/IDR USD/MYR USD/PHP USD/SGD USD/KRW USD/TWD USD/THB USD/VND
6.31 7.76 51.12 9189 3.07 43.0 1.26 1137 29.6 30.9 20835
6.25 7.77 48.40 8830 2.97 42.2 1.24 1100 29.4 30.4 21800
6.23 7.77 48.00 8760 2.96 42.1 1.24 1090 29.3 30.2 22400
6.20 7.77 47.50 8700 2.95 42.0 1.24 1080 29.2 30.0 22400
6.16 7.77 48.13 8600 2.96 42.1 1.24 1083 29.3 30.1 22900
6.13 7.77 47.25 8500 2.93 41.8 1.23 1065 29.0 29.8 22900
6.09 7.77 46.38 8400 2.89 41.4 1.21 1048 28.8 29.6 23400
6.05 7.77 45.50 8300 2.85 41.0 1.20 1030 28.5 29.3 23400
USD/ARS USD/BRL USD/MXN
4.37 1.83 12.75
4.60 1.75 12.80
4.60 1.75 12.30
4.50 1.80 12.20
4.40 1.80 12.40
4.30 1.80 12.20
4.30 1.75 12.50
4.30 1.75 12.40
USD/ZAR TRY/ZAR
7.67 4.31
7.80 4.46
7.60 4.34
7.50 4.41
7.40 4.48
7.40 4.63
7.40 4.63
7.40 4.63
Emerging Europe Poland Russia Turkey
USD/PLN USD/RUB Basket/RUB USD/TRY
3.11 29.27 33.66 1.78
3.34 30.37 34.20 1.75
3.35 32.55 36.50 1.75
3.29 33.35 37.25 1.70
3.33 32.68 36.50 1.65
3.32 33.71 37.50 1.60
3.28 33.71 37.50 1.60
3.20 34.16 38.00 1.60
Euro Cross rates

Industrialised countries Japan United Kingdom Switzerland Sweden Norway Central Europe Czech Rep. Hungary Poland Romania EUR/JPY EUR/GBP EUR/CHF EUR/SEK EUR/NOK 110 0.837 1.21 8.84 7.63 109 0.830 1.24 9.10 7.50 110 0.820 1.26 9.20 7.45 113 0.800 1.28 9.30 7.40 116 0.810 1.30 9.40 7.35 118 0.810 1.33 9.35 7.30 121 0.820 1.33 9.32 7.25 125 0.820 1.33 9.30 7.20
EUR/CZK EUR/HUF EUR/PLN EUR/RON
24.68 293 4.15 4.38
25.00 305 4.28 4.35
25.00 300 4.25 4.33
24.60 300 4.15 4.30
24.50 290 4.20 4.30
24.60 290 4.15 4.30
24.40 290 4.10 4.20
24.00 290 4.00 4.20
33
Interest rate forecasts developed countries

29-Mar USA Fed funds 3M 2Y 10Y Japan Call 3M 2Y 10Y Eurozone Repo 3M 2Y (Ger) 10Y (Ger) United Kingdom Base rate 3M 2Y 10Y Sweden Repo Norway Deposit Canada Overnight Target Australia Cash Target 0.25 0.47 0.34 2.21 Jun-12 0-0.25 0.40 0.60 2.80 Sep-12 0-0.25 0.40 0.90 3.40 Dec-12 0-0.25 0.40 1.20 3.60 Mar-13 0-0.25 0.40 1.60 3.80 Jun-13 0-0.25 0.40 2.10 4.00 Sep-13 0-0.25 0.55 2.40 4.15 Dec-13 0-0.25 0.60 2.50 4.25
0.08 0.20 0.12 1.00
0-0.10 0.20 0.15 1.10
0-0.10 0.20 0.15 1.15
0-0.10 0.20 0.20 1.25
0-0.10 0.20 0.20 1.35
0-0.10 0.20 0.25 1.45
0-0.10 0.20 0.25 1.50
0-0.10 0.20 0.30 1.60
1.00 0.69 0.22 1.85
0.75 0.85 0.75 2.50
0.50 0.60 1.10 2.60
0.50 0.60 1.25 2.75
0.50 0.70 1.50 3.00
0.50 0.75 1.70 3.20
0.50 0.80 1.90 3.40
0.50 0.90 2.00 3.50
0.50 1.03 0.45 2.22
0.50 0.80 1.00 2.75
0.50 0.80 1.20 3.00
0.50 0.75 1.30 3.20
0.50 0.75 1.50 3.50
0.50 1.00 1.80 3.70
0.50 1.25 2.25 3.85
0.50 1.50 2.50 4.00
1.50
1.50
1.50
1.50
1.50
1.50
1.75
2.00
1.50
1.50
1.50
1.50
1.75
2.00
2.25
2.50
1.00
1.00
1.00
1.00
1.00
1.00
1.25
1.75
4.25
4.00
4.00
4.00
4.00
4.25
4.25
4.50
New Zealand Official Cash Rate 2.50 2.50 2.75 3.00 Note: 3M rates are interbank, 2Y and 10Y rates are government bond yields
3.25
3.25
3.50
3.50
34
Interest rate forecasts emerging countries

29-Mar USA Fed funds 3M 2Y 10Y Japan Call 3M 2Y 10Y Eurozone Repo 3M 2Y (Ger) 10Y (Ger) Asia China Hong Kong India Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand Vietnam Latin America Argentina Brazil Mexico Emerging Europe Czech Rep. Hungary Poland Romania Russia 14D repo 2W repo 7D repo 2W repo O/N Deposit rate O/N repo rate Turkey 1W repo rate 0.75 7.00 4.50 5.50 4.00 5.25 5.75 0.75 7.00 4.50 5.00 4.50 5.50 5.75 0.75 7.00 4.50 5.00 5.50 6.50 5.75 0.75 6.75 4.25 5.00 6.00 7.00 6.25 0.75 6.50 4.00 5.00 6.00 7.00 6.50 1.00 6.25 4.00 5.00 6.00 7.00 7.00 1.25 6.00 4.00 5.00 6.00 7.00 7.00 1.25 6.00 4.00 5.00 6.00 7.00 7.00 3M deposit Overnight/Selic Overnight rate 13.54 9.75 4.50 15.00 9.00 4.50 16.00 9.00 4.50 17.00 9.00 4.50 17.00 9.00 4.75 16.00 9.00 5.00 16.00 9.50 5.25 16.00 10.00 5.50 1Y lending rate Base rate Repo rate BI rate Call rate OPR Repo rate 6M SOR Redisc Repo Refinancing rate 6.56 0.50 8.50 5.75 3.25 3.00 4.00 0.54 1.88 3.00 14.00 6.31 0.50 8.25 5.75 3.00 2.75 4.00 0.49 1.75 2.75 13.00 6.06 0.50 8.00 5.75 2.75 2.50 4.00 0.59 1.63 2.75 12.00 6.06 0.50 7.75 5.75 2.75 2.50 4.00 0.63 1.63 2.75 11.00 6.06 0.50 7.75 5.75 2.75 2.75 4.00 0.76 1.63 2.75 11.00 6.31 0.50 7.75 6.00 3.00 2.75 4.25 0.99 1.63 3.00 11.00 6.31 1.00 7.75 6.00 3.25 3.00 4.25 1.09 1.75 3.25 11.50 6.56 1.50 8.00 6.00 3.50 3.00 4.50 1.20 1.88 3.50 12.00 1.00 0.69 0.22 1.85 0.75 0.85 0.75 2.50 0.50 0.60 1.10 2.60 0.50 0.60 1.25 2.75 0.50 0.70 1.50 3.00 0.50 0.75 1.70 3.20 0.50 0.80 1.90 3.40 0.50 0.90 2.00 3.50 0.08 0.20 0.12 1.00 0-0.10 0.20 0.15 1.10 0-0.10 0.20 0.15 1.15 0-0.10 0.20 0.20 1.25 0-0.10 0.20 0.20 1.35 0-0.10 0.20 0.25 1.45 0-0.10 0.20 0.25 1.50 0-0.10 0.20 0.30 1.60 0.25 0.47 0.34 2.21 0-0.25 0.40 0.60 2.80 0-0.25 0.40 0.90 3.40 0-0.25 0.40 1.20 3.60 0-0.25 0.40 1.60 3.80 0-0.25 0.40 2.10 4.00 0-0.25 0.55 2.40 4.15 0-0.25 0.60 2.50 4.25 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13
Africa & Middle East South Africa UAE Saudi Arabia Repo Repo Repo 5.50 1.00 2.00 5.50 1.00 2.00 5.50 1.00 2.00 5.75 1.00 2.00 6.00 1.00 2.00 6.25 1.00 2.00 6.50 1.50 2.50 7.00 2.00 3.00
35
Economic forecasts
USA JAPAN EUROZONE Germany France Italy Spain Greece Other developed countries United Kingdom 0.7 0.5 1.5 4.5 2.7 2.0 -3.0 Norway 1.7 2.2 2.7 1.3 1.5 1.9 13.2 Sweden 4.0 0.8 2.3 3.0 1.6 2.0 6.7 Switzerland 1.8 0.2 1.5 0.2 -0.4 1.0 12.5 Canada 2.2 1.9 2.2 2.9 1.9 2.0 -3.2 Australia 2.0 3.1 3.2 3.4 3.3 2.8 -2.2 New Zealand 2.0 3.0 3.5 4.0 2.8 2.9 -2.9 Asia 7.3 6.8 7.4 5.9 4.1 4.7 2.0 China 9.2 8.0 8.5 5.4 3.4 4.0 2.7 Hong Kong 5.0 3.8 5.0 5.6 3.2 4.0 6.6 India 6.9 7.3 7.7 8.7 6.2 7.2 -3.6 Indonesia 6.5 5.9 6.0 5.4 4.6 5.0 0.2 Korea 3.6 3.6 5.0 4.0 3.5 4.2 2.4 Malaysia 5.1 3.2 4.0 3.2 2.5 2.8 11.5 Philippines 3.7 3.5 4.5 4.8 3.5 4.3 3.8 Singapore 4.9 3.4 5.5 5.3 3.6 4.5 21.8 Taiwan 4.0 3.4 5.0 1.4 1.2 1.5 8.8 Thailand 0.1 4.5 4.5 3.8 3.2 3.3 4.9 Vietnam 5.9 4.9 6.3 18.7 13.0 10.5 -5.7 Latin America 4.1 3.5 3.8 5.9 5.8 5.8 -1.7 Argentina 8.5 3.7 3.7 11.0 12.0 14.0 -0.5 Brazil 3.1 3.5 3.9 6.3 5.5 5.2 -2.7 Mexico 3.9 3.3 3.8 3.4 3.8 3.4 -0.8 Emerging Europe 4.8 2.7 3.4 5.6 6.6 5.4 -0.3 Czech Republic 1.6 0.1 1.9 2.1 3.0 2.0 -3.7 Hungary 1.7 -0.5 1.6 4.0 4.3 4.0 1.9 Poland 4.4 2.7 2.8 4.3 4.0 3.0 -5.4 Russia 4.3 3.0 3.3 6.1 7.2 6.5 5.7 Romania 2.4 1.5 3.3 5.8 4.0 3.3 -4.1 Turkey 8.4 3.5 5.0 6.5 9.4 6.5 -9.0 Africa & Middle East 4.4 3.6 4.2 5.2 5.0 4.4 7.7 Algeria 3.9 3.5 4.0 4.5 3.5 2.1 9.8 Egypt 1.2 3.0 5.0 10.2 9.1 8.6 -1.9 Kuwait 4.4 3.1 4.0 3.7 4.3 4.2 21.8 Lebanon 1.5 2.8 4.0 2.6 3.2 4.3 -30.6 Morocco 4.3 2.8 3.5 1.3 1.5 2.4 -8.4 Qatar 17.8 6.0 4.5 2.9 3.7 3.9 29.3 Saudi Arabia 6.7 4.5 4.9 4.9 4.3 3.1 25.5 South Africa 3.2 3.5 3.5 5.0 6.0 5.0 -3.6 United Arab Emirates 4.0 3.0 3.5 1.6 2.1 1.6 7.6 Tunisia -0.7 2.5 3.3 3.7 3.5 3.6 -7.5 Total 3.6 3.2 3.7 4.1 3.3 3.2 0.0 Industrialised countries 1.4 1.2 1.7 2.6 2.0 1.8 -1.4 Emerging countries 6.2 5.4 6.0 5.8 4.8 4.9 1.6 Notes: (1) CPI for UK: HICP; for India: wholesale prices; for China, retail price index; for Brazil: IPCA; for South Africa: CPI-X (2) India fiscal year ending in March Real GDP (YoY. %) 11 12 13 1.7 2.1 2.2 -0.7 2.0 1.5 1.6 -0.4 1.0 3.1 0.6 1.6 1.7 0.2 1.2 0.5 -1.4 0.1 0.7 -1.8 0.0 -6.9 -5.0 -1.0 11 3.1 -0.2 2.7 2.5 2.3 2.9 3.1 3.1 CPI (YoY. %) 12 2.4 0.1 2.1 2.0 2.0 2.6 1.6 0.9 13 2.2 0.3 1.7 2.0 1.8 1.6 1.2 1.0 Current Account (% GDP) 11 12 13 -3.2 -3.3 -3.2 2.1 2.1 2.3 -0.6 -0.3 0.0 4.8 4.7 5.0 -2.2 -1.8 -2.3 -4.3 -3.5 -2.5 -3.8 -3.4 -3.0 -9.8 -7.3 -6.5 -3.0 16.0 6.9 11.0 -3.1 -3.1 -3.3 1.0 1.3 6.0 -3.5 0.5 1.9 11.8 3.0 18.0 5.8 2.5 -5.0 -2.0 -1.1 -3.0 -1.1 -1.2 -3.0 3.2 -4.1 2.5 -5.0 -7.0 4.8 4.3 -2.7 16.8 -21.2 -4.0 30.9 16.6 -4.0 2.5 -6.6 -0.4 -1.3 0.6 -2.5 15.5 6.7 11.0 -2.9 -2.6 -2.5 1.1 1.1 8.0 -3.4 0.7 2.8 11.2 3.5 20.0 6.5 3.8 -4.5 -2.1 -0.8 -3.2 -1.0 -2.0 -3.5 3.8 -3.9 1.0 -5.3 -7.5 4.5 6.4 -1.6 20.0 -20.2 -4.3 28.5 12.5 -3.5 3.3 -5.0 -0.4 -1.1 0.5
36
Economic forecasts quarterly breakdown

2011 Q1 Real GDP growth, QoQ % USA (annualised) JAPAN EUROZONE Germany France Italy Spain United Kingdom Consumer prices, YoY % USA JAPAN EUROZONE Germany France Italy Spain United Kingdom Unemployment rate, % USA JAPAN EUROZONE Germany France Italy Spain United Kingdom 9.0 4.7 9.9 6.3 9.6 8.1 20.7 7.7 9.0 4.6 9.9 6.0 9.6 8.2 20.9 7.9 9.1 4.4 10.2 5.8 9.7 8.4 22.0 8.3 8.7 4.5 10.5 5.7 9.8 8.7 23.0 8.4 8.3 4.5 10.7 5.7 10.1 9.2 23.6 8.5 8.3 4.4 10.9 5.6 10.3 9.4 24.2 8.7 8.0 4.3 11.1 5.7 10.3 9.7 24.6 8.7 7.9 4.3 11.1 5.6 10.3 9.7 24.9 8.7 7.9 4.2 11.1 5.6 10.3 9.6 25.0 8.6 7.8 4.2 11.1 5.6 10.3 9.5 25.2 8.6 7.7 4.2 11.1 5.5 10.2 9.5 25.2 8.6 7.7 4.2 11.0 5.5 10.2 9.4 25.1 8.4 2.2 -0.8 2.5 2.2 2.0 2.3 3.2 4.1 3.3 -0.2 2.8 2.5 2.2 2.9 3.3 4.4 3.8 0.2 2.7 2.6 2.3 2.7 2.9 4.7 3.3 -0.1 2.9 2.6 2.6 3.7 2.7 4.7 2.8 -0.2 2.6 2.3 2.3 3.3 1.9 3.3 2.4 0.0 2.2 2.1 2.0 2.8 1.6 2.7 2.1 0.1 2.0 2.0 1.9 2.4 1.7 2.5 2.3 0.2 1.7 1.8 1.7 1.7 1.3 2.1 2.3 0.2 1.7 1.9 1.7 1.6 1.3 1.9 2.1 0.2 1.5 1.8 1.7 1.2 0.9 2.0 2.2 0.4 1.7 2.0 1.8 1.7 1.3 2.1 2.2 0.4 1.8 2.1 1.8 1.7 1.4 2.1 0.4 -1.8 0.8 1.3 0.9 0.1 0.4 0.3 1.3 -0.3 0.1 0.3 -0.1 0.3 0.2 0.0 1.8 1.7 0.2 0.6 0.3 -0.2 0.0 0.5 3.0 -0.2 -0.3 -0.2 0.2 -0.7 -0.3 -0.3 2.0 0.7 -0.3 0.0 -0.3 -0.6 -0.8 0.2 1.9 0.6 -0.1 0.2 0.1 -0.4 -0.8 0.0 2.0 0.3 0.2 0.3 0.2 -0.1 -0.4 0.6 2.2 0.4 0.3 0.4 0.3 0.0 -0.2 0.2 1.8 0.5 0.2 0.4 0.3 0.0 0.0 0.3 2.5 0.2 0.3 0.4 0.4 0.1 0.1 0.4 2.6 0.4 0.4 0.5 0.5 0.2 0.6 0.6 2.7 0.3 0.4 0.5 0.4 0.2 0.6 0.5 Q2 Q3 Q4 Q1 Q2 2012 Q3 Q4 Q1 Q2 2013 Q3 Q4
37
Economic forecasts
USA JAPAN EUROZONE Germany France Italy Spain Netherlands Belgium Greece Ireland Portugal United Kingdom Government balance 11 12 13 -8.7 -7.5 -5.6 -11.9 -4.0 -1.0 -5.5 -3.9 -8.5 -4.3 -3.5 -9.0 -10.2 -5.9 -8.5 -9.8 -3.1 -0.9 -4.5 -2.6 -5.8 -3.2 -3.5 -6.7 -8.6 -4.7 -6.9 -9.2 -2.2 -0.7 -3.0 -1.8 -4.0 -2.5 -2.6 -5.2 -7.5 -3.4 -6.7 11 67.3 204.7 88.0 81.8 85.3 119.0 68.0 64.5 95.7 165.3 112.2 107.1 87.6 Public debt 12 71.3 213.8 89.3 81.4 88.3 120.0 71.2 64.9 97.7 159.7 117.9 114.3 93.7 13 74.4 220.7 89.6 80.1 88.8 119.7 75.2 66.0 97.6 164.0 120.0 117.0 97.8
Commodities forecasts
Oil price forecasts
End quarter prices Brent USD/bl 29-Mar 125 Q2 120 2012 Q3 115 2013 Q4 110 Q1 110 Q2 112 Q3 112 Q4 114
Metals forecasts
Precious metals Gold USD/oz 29-Mar 1,663 Q2 1,680 2012 Q3 1,660 Q4 1,635 Year 1,670 Q1 1,565 2013 Q2 Q3 1,500 1,420 Q4 1,350 Year 1,500
Publication Manager: Jean-Paul BETBEZE Chief Edition: Herv GOULLETQUER, Isabelle JOB Production and Sub-Editor: Fabienne Pesty Contact : publication.eco@credit-agricole-sa.fr Crdit Agricole S.A. Economic Research Department 75710 PARIS Cedex 15 Fax : +33 143 23 58 60 This publication reflects the opinion of Crdit Agricole S.A. on the date of publication, unless otherwise specified (in the case of outside contributors). Such opinion is subject to change without notice. This publication is provided for informational purposes only. The information and analyses contained herein are not to be construed as an offer to sell or as a solicitation whatsoever. Crdit Agricole S.A. and its affiliates shall not be responsible in any manner for direct, indirect, special or consequential damages, however caused, arising therefrom. Crdit Agricole does not warrant the accuracy or completeness of such opinions, nor of the sources of information upon which they are based, although such sources of information are considered reliable. Crdit Agricole S.A. or its affiliates therefore shall not be responsible in any manner for direct, indirect, special or consequential damages, however caused, arising from the disclosure or use of the information contained in this publication. www.credit-agricole.com - Economic Research Subscribe to our free online publications
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Quarterly - no.

Markets still looking for meaning

The world is changing: Far-sightedness is everything!

Source: Bloomberg, Crdit Agricole CIB

Current account in the Eurozone

Source: Bloomberg, Crdit Agricole CIB

Macro Prospects no. 136 2nd quarter 2012

Savings ratios in the Eurozone

5% 00 01 02 03 04 05 06 07 08 09 10 11 12 EZ Germany France Italy Spain

Source: Eurostat, Crdit Agricole CIB

Basel III impact on capital ratios: higher !

Source: Crdit Agricole CIB

China: change in exports and private consumption

Source: Bloomberg, Datastream, Crdit Agricole CIB

Macro Prospects no. 136 2nd quarter 2012

Public accounts in developed countries

Source: Bloomberg, Crdit Agricole CIB

Macro Prospects no. 136 2nd quarter 2012

Monetary policy: New frontiers, new challenges

Source: Bloomberg, Crdit Agricole SA

Fed: short-term interest rates

Source: Bloomberg, Crdit Agricole SA

Macro Prospects no. 136 2nd quarter 2012

BRIC: FX reserves (USDbn)

Source: Central banks, Crdit Agricole SA

Fed/ECB: balance sheet size in % of GDP

The dangers of omnipotence

25% 20% 15% 10% 5% ECB Fed

Source: Fed, BCE, Crdit Agricole SA

Macro Prospects no. 136 2nd quarter 2012

Fed: composition of assets

Source: Fed, Crdit Agricole SA

ECB: composition of assets

08 09 10 11 LTRO OMO Claims on residents Other Assets Claims on non-residents Gold

Source: BCE, Crdit Agricole SA

Macro Prospects no. 136 2nd quarter 2012

US Interest Rates: Markets begin to think for themselves

Source: Crdit Agricole CIB

US 2Y & 3Y UST yields

Primary dealer positions (USTs)

Source: Federal Reserve

Macro Prospects no. 136 2nd quarter 2012

Eurozone Interest Rates: Indirect bid for core bonds to wane

Yields should catch up with economic surprises

Source: CESI, Crdit Agricole CIB.

Risk aversion is less extreme, thanks to the ECB

10Y periph. ASW

Source: Bloomberg, Crdit Agricole CIB.

Low starting point for rates conditional to risk aversion

Source: Crdit Agricole CIB.

Macro Prospects no. 136 2nd quarter 2012

Exchange Rates: Increasing influence of yield

Source: Crdit Agricole CIB, Bloomberg

Commodity currencies offer the best G10 FX returns

Source Crdit Agricole CIB, Bloomberg

Most currencies set to strengthen versus EUR

% 12M Carry-adjusted Return (vs EUR)

Source: Crdit Agricole CIB, Bloomberg

Macro Prospects no. 136 2nd quarter 2012

Gold: Gradual fall

Source: Bloomberg, Crdit Agricole CIB

Macro Prospects no. 136 2nd quarter 2012