lloyds world economic quarterly 2q2011

8/7/2019 Lloyds World Economic Quarterly 2Q2011

1/26

WORLD ECONOMIC QUARTERLY

SECOND QUARTER 2011


2/26

Lloyds Bank Corporate Markets WEQ - 14th

APRIL 20111

Mark MillerSenior Global Macroeconomist

T: +44 (0)20 7158 2141

E:[email protected]

Foreword 2

G10 Economic Outlook 3

E10 Economic Outlook 4

G10 country summaries:

US 5

Japan 6

Euro Area 7

Germany 8

France 9

Italy 10

Spain 11

Netherlands 12

Canada 13

Australia 14

E10 country summaries:

China 15

Brazil 16

India 17

Russia 18

Mexico 19

South Korea 20

Turkey 21

Poland 22

Indonesia 23

South Africa 24

Lloyds Bank Corporate Markets contacts

Jennifer Lee

Graphic Designer

T: +44 (0)20 7158 1744

E: [email protected]

Jeavon Lolay

Director of Global Economics

T: +44 (0)20 7158 1742


CONTENTSCONTENTS

Sian Fenner

Global Macroeconomist

T: +44 (0)20 7158 3975


EDITORIAL COMMENTS TO:

Trevor Wil liams

Chief Economist

Lloyds Bank Corporate Markets

Economic Research

10 Gresham Street

London, EC2V 7AE

T: +44 (0) 20 7158 1748

CONTRIBUTORS


3/26

CHART A: E10 GDP growth outperformance to continue...

CHART B: ...putting upward pressure on CPI inflation

WATCH OUT, INFLATIONS ABOUT...

Global output is now back above its pre-crisis peak. Driven

by robust expansion in world trade volumes, global GDP

growth this year is expected to remain strong at 4.3%,

following last years outturn of 4.7%. However, recent events

highlight that the ongoing recovery cannot be taken for

granted. Major uncertainties remain most notably the

sovereign debt crisis in the euro area, serious unrest in the

MENA region and soaring commodity prices - particularly

crude oil. Then there are the more predictable features that

follow a sharp slowdown the normalisation of policy

both fiscal and monetary. Here, the return of inflation has

put added pressure on central banks to raise interest rates.

In many countries, fiscal tightening will start in earnest during

2011, with the US and Japan important outliers holding back

on medium term consolidation plans. But conditions willbe most acute in the euro area periphery.

The continuing contrast in growth between the developed

and emerging economies is also creating new challenges.

Our G10 grouping is predicted to grow by 2.3% in 2011,

while our E10 grouping is forecast to expand by 7.1%. Output

gaps have either almost closed or become positive in many

emerging markets, while significant spare capacity remains

in the major developed economies. It is now soaring inflation

that dominates concerns in the emerging markets, not growth.

However, real interest rates are still close to historical lows

and we expect significant further monetary tightening. This is

likely to lead to further upward pressure on their exchangerates. However, any appreciation should be gradual as

policymakers also deal with the problem of continuing strong

capital inflows.

There is also a decent chance that global growth could prove stronger than we expect in 2011. Commodity price trends

will have a major say, particularly energy and food. Policymakers, especially in the emerging markets, could also keep

interest rates too low, encouraging domestic demand but risking medium-term prospects. In the developed economies,

the bounceback in Japan during the second half of 2011 could prove stronger than we currently expect. What is clear is

that ongoing volatility in currency, interest rates and asset markets is almost assured, reflecting the wide differentials in

economic performance and policy stance across countries.

Source: LBCM

Lloyds Bank Corporate Markets2

Source: Bloomberg Source: Bloomberg

FOREWORD

G10 E10 World

0

2

4

6

8

2010 2011 2012

Annual average change %

G10 E10 World

0

2

4

6

8

2010 2011 2012

Annual average change %

Key macroeconomic forecasts for our G10 & E10 groupings

2009 2010e 2011f 2012f 2009 2010 2011f 2012f 2009 2010e 2011f 2012f 2009 2010 2011f 2012f

World -0.8 4.7 4.3 4.6 2.2 3.4 3.0 2.1

G10 -3.5 2.6 2.3 2.7 0.0 1.4 2.4 1.9 E10 3.2 7.9 7.1 6.9 4.4 5.4 5.8 4.6

US -2.6 2.9 3.2 3.3 -0.3 1.6 2.7 2.3 China 9.2 10.3 9.3 8.8 -0.7 3.3 4.7 3.9

Japan -6.3 4.0 0.8 2.5 -1.4 -0.7 0.3 0.5 Brazil -0.7 7.5 5.0 4.6 5.7 4.9 5.0 5.6

Germany -4.7 3.5 2.4 2.0 0.3 1.1 2.4 1.9 India 7.0 8.6 8.1 8.3 8.3 12.0 7.9 4.8

UK -4.9 1.4 1.5 2.3 2.2 3.3 4.3 2.3 Russia -7.9 4.0 5.3 5.2 14.1 11.7 6.9 8.6

France -2.5 1.5 1.6 1.8 0.1 1.5 2.1 1.9 Mexico -6.1 5.5 4.6 4.9 5.1 5.3 4.2 4.1

Italy -5.1 1.1 1.1 1.2 0.8 1.5 1.8 2.2 South Korea 0.3 6.2 4.3 4.9 4.7 2.8 3.0 4.4

Spain -3.7 -0.1 0.6 1.1 -0.3 1.8 2.9 1.6 Turkey -4.8 8.9 6.5 4.7 9.8 4.8 5.1 6.7

Canada -2.5 3.1 3.2 3.0 0.3 1.8 2.4 2.0 Poland 1.7 3.8 4.0 4.4 4.3 3.8 2.7 3.8

Australia 1.3 2.7 3.2 4.3 1.8 2.8 3.2 3.0 Indonesia 4.6 6.1 6.4 6.0 9.8 4.8 5.1 6.7

Netherlands -3.9 1.7 1.7 1.9 1.2 1.3 2.1 1.8 South Africa -1.7 2.8 3.7 4.2 9.9 7.1 4.3 4.6

GDP growth % CPI inflation % GDP growth % CPI inflation %

WEQ - 14th

APRIL 2011

Source: LBCM

-6

-4

-2

0

2

4

6

8

10

2008 2009 2010 2011 2012

Forecast

E10

G10

% YoY

-6

-4

-2

0

2

4

6

8

10

2008 2009 2010 2011 2012

Forecast

E10

G10

% YoY


4/26


5/26

CHART B: Interest rates to head higher across the BRICsin 2011

CHART A: EMEA growth to strengthen but lag otherE10 regions

Source: Haver & LBCM



ACCELERATING INFLATION A MAJOR THREAT

The E10 recorded a 7.9% rise in GDP for 2010 and, with the

recovery firmly in place, attention has turned to removing the

very expansionary policy measures implemented during the

global financial crisis. In particular, a number of economies,

notably the BRICs and emerging Asia, are facing strong

inflationary pressures, driven by buoyant demand and rising

commodity prices. Inflation for the E10 as a whole is forecast

to rise by 5.8% this year, from 5.4% in 2010.

Chinas Premier Wen has noted that control ling inflation wil l

be important to sustaining households spending power. This

is the key challenge facing Chinese authorities this year with

consumer prices forecast to hover at or above 5% for the next

couple of months and to average 4.7% in 2011. In India,inflation has accelerated in recent months and is expected to

average 7.9% this year - our highest rate in the E10 grouping.

With consumer price inflation above target in most E10 countries,

we look for further monetary policy tightening this year. While

most countries have only begun to raise interest rates from their

emergency lows, Brazil and India have been aggressively raising

rates since early 2010, with more hikes forecast over the next 18-

months. In addition to rate hikes, other monetary policy tools,

such as raising bank reserve ratios, will continue to be used as

countries attempt to limit further appreciation in their currencies.

Brazil and Indonesia have also used taxes on foreign capitalinflows to stem the appreciation of their currency. But in the case

of Brazil, this has been met with limited success as USD/BRL has

recently fal len to a decade-low of below 1.57.

Although tighter fiscal and monetary policies within the E10

group are expected to see economic growth moderate to 7.1%

this year, if realized, it will be the second consecutive year of above trend growth. The BRICs are forecast to lead the way,

particularly China and India, which we predict to grow by 9.3% and 8.1% respectively. Indonesia and South Korea are also

expected to make strong contributions. Meanwhile, despite the improved economic outlook for Poland and South Africa, their

real GDP growth is forecast to lag the average performance of the Asian and Latin American countries.

In 2012, E10 GDP growth is forecast to slip slightly to 6.9%. We see a further slowing in growth in China, as government policies

continue to focus on shifting economic growth away from the export sector and towards household consumption. But at 8.8%this will stil l remain above the latest 5-year government growth target of 7%. Solid growth in China is expected to continue to

support trade not only within the region but also with commodity-driven countries such as South Africa, which is benefiting from

Chinas increasing appetite for coal. Meanwhile, despite Indian interest rates rising to a peak of 8% next year, we expect

increased infrastructure investment in 2012 to support another solid year of above 8% GDP growth (8.3%). Strong investment

is also forecast to underpin 4.6% GDP growth in Brazil, while robust global demand for oil and gas is expected to drive growth

of 5.2% in Russia. In Poland, we look for growth to accelerate to 4.4% in 2012, from 4.0% this year, despite continued fiscal

consolidation. Turkish GDP is forecast to grow by a solid 6.5% this year, albeit the prospect that the current account could

breach 8%, represents a major vulnerability to the economic outlook.

Overall, the key challenge faced by the E10 this year is controlling inflation. As well as continued strong growth, adding further

pressure is the risk that oil prices remain at or rise above their current levels. In this event, we would expect inflation to be

significantly higher than forecast, potentially yielding a softer outlook for consumer spending and business investment.

E10 ECONOMIC OUTLOOK

0

2

4

6

8

10

12

14

16

Dec 06 Dec 07 Dec 08 Dec 09 Dec 10 Dec 11

%

forecastBrazil

RussiaIndia

China

%

0

2

4

6

8

10

12

14

16

Dec 06 Dec 07 Dec 08 Dec 09 Dec 10 Dec 11

%

forecastBrazil

RussiaIndia

China

%

0

1

2

3

4

5

6

7

8

9

10

2010 2011f 2012f

BRICSEMEAEmerging Asia

%

0

1

2

3

4

5

6

7

8

9

10

2010 2011f 2012f

BRICSEMEAEmerging Asia

%

WEQ - 14th

APRIL 2011


6/26


US

CHART: Labour market conditions are improving TABLE: Key US macroeconomic forecasts

Jeavon Lolay+44 (0)20 7158 1742

[email protected]

ENCOURAGING SIGNS OF SELF-SUSTAINING RECOVERY

The economy has responded well to the additional stimuli provided by the government and Federal Reserve in late 2010.

The manufacturing and non-manufacturing ISM surveys have both rallied sharply higher, signalling buoyant activity, whilejobs growth has picked up noticeably in recent months and the unemployment rate has fallen to a two-year low of 8.8%.

However, the twin global shocks of the serious unrest in the MENA region, which has pushed crude oil prices sharply higher,

and a catastrophic earthquake off the coast of Japan has dented momentum recently. This is most acutely reflected in a

sharp drop in US consumer confidence and a noticeable pull back in capital spending by firms. Housing market data have

significantly disappointed at the start of 2011, highlighting a key vulnerability to the economic outlook.

Annualised GDP growth in the first quarter of 2011 now looks likely to slow below the 3.1% pace in Q4 2010, leading to a

small downgrade to the general ly optimistic ful l year growth predictions at the start of the year. However, we believe the

recovery is more self sustaining this year and the growing realisation of this will bolster consumer and business confidence

over the coming months. We forecast average real GDP growth of 3.2% in 2011, up from 2.9% last year, as strengthening

private final demand more than makes up for a markedly reduced contribution from stockbuilding. Nevertheless, significant

downside risks to the outlook remain and recovery cannot as yet be taken for granted.

Household spending has been the main driver behind economic growth in recent quarters, rising at an annualised pace of4% in Q4 2010. A timely tax boost from the additional fiscal stimulus last year has partly shielded disposable incomes from

rising food and gasoline prices, but consumer confidence slumped to a three month low in March. Nevertheless, prospects

appear favourable for household spending, supported by continuing low interest rates, higher asset prices and an improving

labour market. The key concerns are the fragile housing market, with sales and construction activity back in the doldrums,

and the worrying uptrend in oil prices. We look for household spending to grow by 3.4% in 2011, up from 1.7% in 2010.

Corporate profitability has held up remarkably wel l during the downturn and should ultimately provide a key catalyst to

growth. Surveys show strong orders and buoyant production in both manufacturing and services, leading firms to become

more positive about capital spending and hiring. To date, business spending has been led by larger companies with access

to capital markets, but should broaden out as recovery progresses and access to funding improves. Although the recent

heightened global uncertainty appears to have weighed heavily on capital spending in the first quarter, we expect business

investment, particularly in equipment and software, to rebound strongly in the coming quarters.

While US exports should continue to benefit from robust global growth, strengthening domestic demand and high oil

prices will limit the contribution to GDP growth from net trade as imports rise. The contribution from stockbuilding is likely

to be modest this year. Government consumption is forecast to turn modestly negative in 2011, with fiscal consolidation

unlikely to start meaningfully until 2012 at the earliest. The deficit is large and likely to dominate headlines but pressure for

a medium-term resolution is not immediate. But some state governments face extremely difficult circumstances in 2011.

Looking at inflation, the underlying rate (core CPI) has edged above 1% and is forecast to trend higher. Our forecast shows

an average of 1.6% for this year and 1.9% in 2012. Headline CPI is seen at 2.7% and 2.3%, respectively. While the extent of

resource slack argues for monetary policy to remain stimulative for now, there is a strong case to say that emergency levels

may soon no longer be appropriate as the recovery becomes self sustaining. We look for the Fed to complete its QE2

programme by end-June 2011. The first hike in the fed funds rate is expected in Q4 2011, rising to 2.25% by end-2012.

WEQ - 14th

APRIL 2011

Source: Datastream

Monthly change, 000s

20012002200320042005200620072008 20092010-1000

-800

-600

-400

-200

0

200

400

Four-week ave, 000s

250

300

350

400

450

500

550

600

650

700

Private sectorpayrolls, LHS

Initialjobless claims, RHS

Monthly change, 000s

20012002200320042005200620072008 20092010-1000

-800

-600

-400

-200

0

200

400

Four-week ave, 000s

250

300

350

400

450

500

550

600

650

700

Private sectorpayrolls, LHS

Initialjobless claims, RHS

Real GDP -2.6 2.9 3.2 3.3

Household consumer spending -1.2 1.7 3.4 3.3

Gross investment -16.1 4.7 7.1 8.5

Government consumption 1.9 1.0 -0.7 -0.6

Exports -9.5 11.8 7.8 9.1

Imports -13.8 12.7 7.7 8.8

Industrial production -9.3 5.7 4.6 4.7

Unemployment rate (%, Q4) 10.0 9.6 8.2 7.8

CPI -0.3 1.6 2.7 2.3

Budget balance % GDP (cal yr) -10.4 -10.2 -9.0 -7.5

Current account % GDP -2.7 -3.2 -3.9 -3.9

US (Yr % chg unless stated) 2009 2010e 2011f 2012f


7/26

JAPAN


CHART: USD/JPY well below pre-crisis levels... TABLE: Key Japanese macroeconomic forecasts

BACK INTO RECESSION, UNCERTAIN OUTLOOK

With a sharp slowdown in economic growth already on the cards, a catastrophic earthquake and tsunami on the north eastern

coast of Japan in March has added a more worrying dimension to the outlook. At this still early stage, it is clear that there has beensignificant human cost, temporary infrastructure and power damage and potentially serious environmental consequences from the

ongoing nuclear fallout. The immediate focus has turned to the crippled nuclear power station in Fukushima, with the severity rating

now at the highest level and the same as Chernobyl in 1986. The final consequences are difficult to assess but are likely to be

substantial both for confidence, domestic and external demand. We expect the economy to contract in the first half of 2011,

followed by a rebound in the second half as government and private sector reconstruction activity take hold. On balance, the

economy is estimated to grow by 0.8% this year (0.3pp below our pre-quake forecast), then by 2.5% in 2012 (up from 2.3%).

Japanese economic growth averaged 4% in 2010 - the fastest rate since 1990, albeit following a sharp 6.3% contraction

in 2009. The rebound was underpinned by a marked recovery in global trade and stockbuilding, and supported by a series

of government initiatives to boost household consumption. However, the economy shrank by 0.3% in the final quarter of

2010, as consumer spending slumped and investment growth tailed off. The likely contraction in the first quarter of this year

will therefore mark a return to recession for Japan, with the fall in output projected to be much larger in the second quarter.

However, the policy response to the earthquake has also been sizeable, via fiscal, monetary and exchange rate support. The BoJ

was swift to provide emergency funding and has since adopted additional measures, including the purchase of JGBs. Already

facing a massive fiscal challenge, which saw Japans sovereign credit rating cut earlier this year, the government will announce its

first package to fund reconstruction later this month. This will be partly financed by rolling back spending and tax measures

announced previously but government borrowing is also likely to rise sharply. With regards to the exchange rate, for the first time

since 2000, the G7 sanctioned co-ordinated action in March to weaken the yen after it surged to a record high against the dollar.

After rebounding swiftly to pre-quake levels, the currency pair has since trended higher, recently breaking 85. However, this is still

significantly above pre-financial crisis levels (see chart). Although anecdotal evidence suggests external demand has improved.

The performance of the US and China, Japans main export markets, will be crucial for prospects in the year ahead.

The domestic economy looks increasingly fragile. Consumers front-loaded spending last year after a series of government

initiatives and face strong headwinds in 2011. We forecast consumer spending growth to slow to just 0.3%, after a 1.9% gain

last year, with the risks skewed to a softer outturn. The labour market is weak and we expect further downward pressure on

earnings. Annual real cash earnings turned negative in December and remain weak. There is also little chance of government

support, with the growing risk that some entitlements are cut to pay for the reconstruction effort. On the fixed investment side,

corporate profits have been bolstered by recovery but companies remain reluctant to invest. Excess capacity and an

uncertain out look are unlikely to foster a strong recovery in 2011. The Q1 Tankan survey painted a cautious picture, with

corporate sentiment suffering after the earthquake and the likely return to recession. While we believe corporate spending

has the potential to strengthen it is likely to do so only gradual ly.

The shadow of deflation also continues to loom large over the economy. Interest rates are set to remain at close to zero

for some time and further unorthodox monetary easing is more likely than not. Even before the earthquake, we predicted

Japan to be the last among major developed economies to raise official policy interest rates. This could potentially have

significant implications for the yen, particularly if interest rates start to normalise in other countries over the year ahead.

$/Y

2006 2007 2008 2009 2010

80

85

90

95

100

105

110

115

120

125

2011

$/Y

2006 2007 2008 2009 2010

80

85

90

95

100

105

110

115

120

125

2011

Jeavon Lolay+44 (0)20 7158 1742

[email protected]

WEQ - 14th

APRIL 2011

Source: Datastream

Japan (Yr % chg unless stated) 2009 2010e 2011f 2012f

Real GDP -6.3 4.0 0.8 2.5



Government consumption 3.0 2.2 1.7 1.2

Exports -24.2 24.2 2.0 12.1

Imports -15.4 9.8 6.3 9.4



CPI -1.4 -0.7 0.3 0.5


Current account % GDP 2.8 3.5 1.0 1.9


8/26


EURO AREA

CHART: The ECB has raised its CPI & GDP forecasts... TABLE: Key Euro zone macroeconomic forecasts

ECB TO CONTINUE TIGHTENING. BOND MARKETS TO REMAINVOLATILE

As widely expected the ECB sanctioned a quarter-point increase in its key refinancing rate, to 1.25%, at its 7 AprilGoverning Council meeting. Given ongoing volatility in peripheral euro area government bond markets, the ECB has

thus sent a strong signal that it is committed to preserving price stability over the medium term. In essence, the ECBs

hawkish stance can be attributed to the fact that when faced with a price shock (e.g. the commodity prices rises now

being seen) it is vital that second round effects into wages are avoided. In its March staff economic projections, the ECB

raised sharply the mid-point of its 2011 CPI forecast range to 2.3% from 1.8% in December. While Mr. Trichet notedin

March that there was no sense of a series of hikes, we expect modest additional interest rate increases over the

remainder of this year (in Q3 and Q4), with our end-2011 forecast standing at 1.75%.

Overall, euro area data remain encouraging. But tensions persist. Reflecting this, the ECB has extended its non-

standard policy measures (the 3m LTRO, for example, will continue with full allotment). In fact, the stability of euro

government bond markets remains a hot topic, with volatile conditions seen since our last Quarterly. Tensions were

particularly acute last year, leading to the 85bn bail-out of Ireland using the European Financial Stability Facility (EFSF).

Further difficulties emerged in early January, with peripheral government bond yield spreads over German bundswidening on concerns about sovereign funding. More recently, markets have pressured Portugal into applying for an EU

bailout under the EFSF fol lowing the rejection of further fiscal austerity measures in parliament.

Progress at the 11 March EU summit had only a limited beneficial impact on peripheral government yield spreads with

Greece - though not Ireland - accepting a deal to reduce by 100bp the rate payable on its bail-out package. As part of

the deal, the EFSF will be able to use its full 440bn capacity (from around 250bn previously) to support a bail-out,

while its successor from mid-2013, the ESM, can lend 500bn. Both the EFSF and ESM wil l be able to purchase sovereign

debt - but only in the primary market. The later EU summit (held on 24 & 25 March) promised a comprehensive final

package of measures. But it failed to deliver amid disagreement on how exactly higher capital guarantees associated

with a re-vamped EFSF would be financed. In any form, the new arrangement will disappoint the ECB, which had been

looking to wind down its Securities Market Programme, al lowing it to focus on other aspects of monetary policy. But

crucially, there is no formal channel to enforce fiscal discipline on profligate euro area countries - this remains the key issue.

An effective and permanent arrangement for solving potential future problems on euro sovereign debt is important

because lower long-term interest rates are needed to foster sustainable economic recovery. Long-term borrowing costs

impact significantly on spending decisions by both households and firms. As in our last Quarterly, the euro economy

continues to be driven by robust activity in Germany. Significantly, there are encouraging signs that the mix of economic

activity in Germany is shifting, with domestic demand playing an increasingly important role. Going forward, the

challenge will be to sustain this domestic momentum against a backdrop of weaker real pay growth, as inflation

pressures build during this year. Meanwhile, at the euro-wide level, forward-looking surveys continue to perform well.

March PMI manufacturing data indicated healthy expansion in the sector (57.5), not far off an 11-year high. A broadly

similar story holds true within services. Our euro area GDP forecasts stand at 1.5% and 1.7%, for this year and next.

0

0.5

1

1.5

2

2.5

CPI

March

GDP

March

2011

2012

%

December December

0

0.5

1

1.5

2

2.5

CPI

March

GDP

March

2011

2012

%

December December

Mark Miller+44 (0)20 7158 2141

[email protected]

WEQ - 14th

APRIL 2011

Source: ECB

Euro zone (Yr % chg unless stated) 2009 2010e 2011f 2012f

Real GDP -4.0 1.7 1.5 1.7


Gross investment -11.3 -0.8 1.5 3.0


Exports -13.1 10.6 6.2 4.1

Imports -11.8 8.7 4.6 3.6



CPI 0.3 1.6 2.5 1.8


Current account % GDP -0.6 -0.6 0.3 0.4


9/26


GERMANY

CHART: German business surveys augur well for industrial

activity...

TABLE: Key German macroeconomic forecasts

MIX OF GROWTH STARTING TO FAVOUR DOMESTIC DEMAND

The German economy continues to expand at a healthy pace, providing support for the euro area as a whole. In early

January, the Federal Statistics Office estimated that German GDP grew by 3.5% in 2010, the strongest outturn for around

20 years. Official data for Q4 released subsequently recorded an expansion of 0.4% quarter-on-quarter compared with

0.7% in Q3, although this deceleration likely reflects the impact of severe winter weather conditions. Going forward, we

look for 2011 GDP growth at a more sustainable pace compared with last year, as Germanys 80bn of government

spending cuts start to feed through. Our forecast stands at 2.4%, followed by growth of 2.0% in 2012.

Significantly, there have been signs in recent quarters that the mix of economic activity in Germany is shifting, with

domestic demand becoming an increasingly important driver of growth. Over the past three quarters, for example,

private consumption has contributed almost 0.25 percentage points (pp) on average to quarter-on-quarter GDP, while

fixed investment has added close to 0.4pp over the same period. Net trade, meanwhile, continue to perform well,

supported by a strong appetite for German exports in key markets such as emerging Asia (and China in particular). The

contribution of net trade to quarter-on-quarter GDP in 2010Q4 was 0.7pp, the same as in Q3.

Forward-looking business surveys suggest there is considerable momentum as we move further into 2011. At 111.1 inMarch, the latest Ifo business climate index, for example, hovered close to its al l-time high of 111.3. Indeed, the current

conditions index improved quite markedly, to 115.8 from 114.8 previously, likely reflecting continued optimism on the

part of exporters but also recent signs that the outlook for consumer spending has improved as joblessness has fallen

over a protracted period. Unemployment has fallen by around 825k since the start of the financial crisis in July 2007. The

Ifo expectations component, meanwhile, slowed to 106.5 in March from 107.9 in February perhaps reflecting the

looming fiscal consolidation over the next few years. Evidence from purchasing managers surveys in Germany has also

been encouraging, with the manufacturing index above the 60 level during the period December to March. The services

sector in Germany has performed strongly too, with Marchs reading of 60.1 consistent with robust activity.

But as in other many other countries, inflation pressures in Germany are now starting to build with more force. Preliminary

data for March revealed an annual rate of 2.2%, the highest since autumn 2008 (when oil prices were also very high).

With food and energy prices continuing their rise, German CPI looks set to move further above the ECBs target of below

but close, to 2%, particularly during the first half of this year. This is a potential drag on households real spending powerjust as consumer activity is beginning to show signs of life. Inflation is thus a notable downside risk for economic activity

in Germany going forward. For choice, however, we feel that lower real wage growth could be a price worth paying in

an environment of elevated price pressures. If German unions were to abandon their discipline on wage negotiations (in

fact, one of the key reforms implemented in Germany is that more wage-bargaining now occurs at the level of the firm),

then unemployment could potential ly rise fairly quickly, undermining the improved balance in overall economic activity.

The desire to avoid a scenario where strong inflation pressures feed through into wages was behind the ECBs decision

to raise interest rates at April s Governing Council meeting. We expect modest additional interest rate increases over the

remainder of this year (in Q3 and Q4), with our end-2011 forecast standing at 1.75%.

Germany (Yr % unless stated) 2009 2010e 2011f 2012f

Real GDP -4.7 3.5 2.4 2.0




Exports -14.3 13.8 7.6 2.6

Imports -9.4 12.4 4.5 2.3



CPI 0.3 1.1 2.4 1.9

Budget balance % GDP (cal year) -4.3 -3.5 -2.9 -1.8


Mark Miller+44 (0)20 7158 2141

[email protected]

WEQ - 14th

APRIL 2011

Source: LBCM

-40

-30

-20

-10

0

10

20

30

40

Feb 01 Feb 03 Feb 05 Feb 07 Feb 09 Feb 11

% Yr

German factory orders

Germanindustrial

production

-40

-30

-20

-10

0

10

20

30

40

Feb 01 Feb 03 Feb 05 Feb 07 Feb 09 Feb 11

% Yr

German factory orders

Germanindustrial

production


10/26

FRANCEFRANCE NEEDS TO STRENGTHEN ITS DOMESTIC ECONOMY

The French economy continues to expand at a steady pace. Economic activity rose by 0.4% quarter-on-quarter during

Q4 last year, with final domestic demand leading the way. This was particularly evident in household consumption,which rose by 0.9% during the quarter against 0.5% in Q3. Importantly, forward-looking business surveys such as the

Bank of France business confidence report have been trending higher. We note that this survey has picked up

significantly early in 2011, with a reading of 110 in March versus 107 at the end of last year. The INSEE confidence index

has also been firm recently (109 in March against 106 in the previous month) - with net balances on components such

as new export orders, improving in March to -5 from -11 in February - perhaps underlining the firmness of economic

activity in key trading partners such as Germany.

While this is encouraging, France is not a particularly open economy which compared to countries like Germany - may

limit the upside potential for economic activity from robust (Asia-led) global economic recovery. Moreover, we expect

growth in Germany itself to slow this year and next, in part reflecting the significant fiscal tightening underway there. The

burden therefore falls squarely on domestic demand growth to accelerate the pace of economic expansion in 2011 and

beyond. The broad pattern seen in the Q4 GDP data wil l need to be sustained going forward.

In our view, this wil l not be easy to achieve. Employment growth in France has been trending higher for some time, but

a significant share of overall job creation has been accounted for by temporary positions. Besides, household

consumption is likely to face significant headwinds, notably in the form of weaker real disposable income growth.

Subdued wage growth in the public sector is a key element of this, given the large size of the public sector in France.

And as in many other countries, inflation pressures are mounting. French CPI registered 2.2% in the year to March

with a further pick-up looking likely over the near term. Our projections for consumer spending stand at 1.8% and

2.0% for this year and next.

Similarly, fixed investment cannot be relied upon to pick up sharply. Helpfully, long-term interest rates in France have

not risen by as much compared with some euro area members (e.g. the peripheral nations). On balance, this should

support capital spending decisions by firms. But capacity utilisation rates in France remain low in an historical context

and it may be that, for this year at least, fixed investment is confined to the replacement of existing capital stock. Our

GDP growth forecasts for France stand at 1.6% and 1.8% in 2011 and 2012.

Thus far, financial markets have not penalised France for the poor state of its public finances, which may reflect the

perception of a credible deficit reduction plan. Ten-year government bond yield spreads over Germany have been

quite stable relative to those of other euro area countries. The current spread (which has been steady despite recent

volatility in the periphery leading to a recent bailout application by Portugal) is around 30bp, compared with just

under 50bp towards the end of last year amid market concerns about Ireland. From a budget deficit in France of

around 7.7% of GDP at present, the governments target for 2011 remains at 6%. But needless to say, a healthy,

sustainable pace of economic growth is required to ensure meaningful progress towards the governments medium term

target of 3% by 2013.

CHART: Business surveys in France are trending higher... TABLE: Key French macroeconomic forecasts

France (Yr % unless stated) 2009 2010e 2011f 2012f

Real GDP -2.5 1.5 1.6 1.8

Household consumer spending 0.6 1.6 1.8 2.0


Government consumption 2.8 1.4 0.1 -0.1

Exports -12.2 9.9 4.7 2.8

Imports -10.6 7.7 2.8 1.9



CPI 0.1 1.5 2.1 1.9




Mark Miller+44 (0)20 7158 2141

[email protected]

WEQ - 14th

APRIL 2011

Source: LBCM

2002 2003 2004 2005 2006 2007 2008 2009 2010-4

-3

-2

-1

0

1

2

3

65

70

75

80

85

90

95

100

105

110

115

GDP (%Yr)

Bank of France business

sentiment (RH Scale)

2002 2003 2004 2005 2006 2007 2008 2009 2010-4

-3

-2

-1

0

1

2

3

65

70

75

80

85

90

95

100

105

110

115

GDP (%Yr)

Bank of France business

sentiment (RH Scale)


11/26


ITALY

CHART: Italian business confidence is trending higher... TABLE: Key Italian macroeconomic forecasts

FRAGILE BOND MARKET SENTIMENT THREATENS GROWTH

The Italian economy grew by just 0.1% quarter-on-quarter in 2010Q4, leaving it 1.5% higher than a year earlier. But more

timely forward-looking surveys suggest that net exports are performing wel l. The export orders component of Italys PMI

manufacturing survey averaged 60.4 during February and March while the latest ISAE survey has a broadly similar feel

(see chart). This is perhaps unsurprising given Italys export sector is essential ly geared towards the euro area where

core economies such as Germany are expanding strongly at present. But still fragile sentiment in euro government

bond markets is a downside risk to this source of growth. So like a number of Italys euro area peers, the challenge going

forward is to avoid over-reliance on net trade as the primary engine of growth. Domestic activity needs to provide more

meaningful support, while markets must be convinced that the government is pursuing a credible long-term fiscal

consolidation plan. Following a projected expansion of around 1.1% in 2010, our GDP growth forecasts for Italy are

broadly similar this year and next (1.1% and 1.2%).

The outlook for household consumption in Italy for this year and next is mixed. Labour market conditions, though stil l

weak, did not deteriorate rapidly at the height of the financial crisis thanks to flexibility which allowed some workers to

retain their jobs through shorter hours and reduced pay. Italys unemployment rate stood at 8.5% in February, comparedwith a euro average of close to 10%. But while this flexibility was welcome in a period of economic stress, the scope for

a meaningful rebound in employment seems limited. Consumer sentiment has weakened somewhat compared with the

position a year earlier - the ISAE survey registered a seven month low of 105.2 in March - and has been further impacted

by political uncertainty and scandals involving the Prime Minister, Silvio Berlusconi. As in other euro area countries, weak

real pay growth in Italy seems poised to drag on consumer spending, particularly in 2011, as inflation pressures

accelerate. We look for consumer spending to expand by just 0.7% this year, followed by growth of 1.2% in 2012.

Nor is it clear that fixed investment by firms will provide a significant boost to economic activity during this year and next.

Capacity utilisation, for example, is at historically low levels. Moreover, continued de-leveraging by small and medium-

sized enterprises also has the potential to limit firms appetite for new capital spending projects. Meanwhile, government

expenditure on infrastructure will be constrained by the need for fiscal consolidation. Our fixed investment growth

forecast stands at 1.9% this year followed by expansion of 2.7% in 2012.

Thus far, financial markets have given Italy the benefit of the doubt, though all that glitters may not be gold. The yieldspread of Italian 10-year government bond (BTP) yields over equivalent German bunds has narrowed since Portugals

application for an EU bailout and currently stands at 140bp compared with almost 200bp on 10 January, when concerns

about funding in peripheral euro area countries were particularly high. But the position is still fragile and progress

could potentially reverse, if, after the disappointing series of EU summits during March, there is another failure to agree

on the details of a permanent mechanism to address any future sovereign debt crises in the euro area. The crucial point

is that euro-wide issues cannot be allowed to distract from the central problem of the need for fiscal consolidation in

Italy. The government has approved austerity measures totalling 25bn during 2011 and 2012, equivalent to around

1.6% of GDP. But public debt in Italy remains worryingly high, at close to 130% of GDP.

Italy (Yr % unless stated) 2009 2010e 2011f 2012f

Real GDP -5.1 1.1 1.1 1.2



Government consumption 0.6 -0.6 0.1 1.0

Exports -19.1 8.7 6.8 4.6

Imports -14.6 8.9 6.8 4.3



CPI 0.8 1.5 1.8 2.2



Mark Miller+44 (0)20 7158 2141

[email protected]

WEQ - 14th

APRIL 2011

Source: LBCM

0

20

40

60

80

100

120

140

1999

Q4

2001

Q1

2002

Q2

2003

Q3

2004

Q4

2006

Q1

2007

Q2

2008

Q3

2009

Q4

2011

Q1

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

ISAE Business

confidence

GDP (%Yr) (RH

Scale)

0

20

40

60

80

100

120

140

1999

Q4

2001

Q1

2002

Q2

2003

Q3

2004

Q4

2006

Q1

2007

Q2

2008

Q3

2009

Q4

2011

Q1

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

ISAE Business

confidence

GDP (%Yr) (RH

Scale)


12/26


SPAIN

CHART: Spains PMI surveys barely signal expansion TABLE: Key Spanish macroeconomic forecasts

PORTUGAL BAILOUT APPLICATION PUTS SPOTLIGHT ON SPAIN

Economic activity in Spain rose by a modest 0.2% quarter-on-quarter in 2010Q4. But this weak pace of growth

characterised by a declining construction sector is clearly not a new story. Financial markets are focused on bigger

picture issues such as progress on fiscal consolidation and the strength of Spains domestic banking sector. The yield

spread of 10-year Spanish government bonds over equivalent German bunds has fal len back since concerns about

sovereign funding in peripheral euro area countries became elevated earlier this year. It currently stands at 190bp,

compared with around 268bp back on 10 January. In part, this reflects significant efforts in tightening fiscal policy,

where Spain has received praise from northern European countries such as Germany. We note that the Spanish yield

spread has not widened after Portugal s recent bailout application. But markets will be watching Spain closely - there is

no room for complacency.

Specifically, Spain has announced a fiscal austerity package incorporating measures such as income tax increase for

those earning over 120,000, along with cuts in public sector salaries and a suspension of automatic increases in

pensions. This comes on top of a 50bn austerity plan implemented in January last year. More recently, Prime Minister

Zapatero has urged Spains seventeen autonomous regions to curtail their spending in a drive to achieve this years target

for the public sector deficit of 6% of GDP agreed in Septembers budget - en route to 3% by 2013.

Meanwhile, the health of Spains domestic banking sector remains a concern - but remedial action is in the pipeline. In mid-

January, Prime Minister Zapatero announced a second round of restructuring for the cajas, or regional savings banks,

through an additional re-capitalisation over and above the 15bn spent to date. This, taken together with fiscal consolidation,

represents an attempt by Spain to ensure that its ability to raise funding in the government bond markets will not be called

into question again. But success is by no means guaranteed (indeed, Moodys downgraded Spains credit rating by one

notch, to Aa2, in early March). Despite a trend improvement in retail deposit-taking by Spanish banks, the sector still relies

heavily on wholesale market funding. A further complication is that if the first three quarters of 2010 were anything to go

by impairments and provisions have been rather sticky amid stil l weak economic conditions. This potentially compromises

earnings growth and risks dragging on their capital base. In short, there is no room for complacency.

It is encouraging that Spain is attempting to address its structural fragilities. But from a cyclical perspective, significant

headwinds remain. Forward-looking business surveys, such as the PMI reports, are the weakest among the larger euroarea economies. Marchs PMI manufacturing survey showed only a modest pace of expansion at 51.6 (compared with

60.9, 56.6 and 56.2 in Germany, France and Italy). High unemployment remains a key challenge. The unemployment rate

currently stands at some 20.4% of the workforce and we look for the jobless rate to remain above 20% until at least next

spring. Weak labour market conditions - and as in other euro area countries - a pull-back in households real pay

growth, is likely to mean that consumer spending struggles to make headway this year. Our 2011 household spending

forecast stands at 0.4% prior to expansion of 0.7% next year. Meanwhile, the outlook for fixed investment spending by

firms remains downbeat against a backdrop of an ongoing reduction of capacity in the construction sector and sizeable

cuts in public expenditure as part of Spains fiscal consolidation. Our overall GDP growth forecasts stand at 0.6% this

year accelerating slightly to 1.1% in 2012.

Spain (Yr % unless stated) 2009 2010e 2011f 2012f

Real GDP -3.7 -0.1 0.6 1.1


Gross investment -16.0 -7.6 -2.8 1.5

Government consumption 3.2 -0.7 -1.1 -0.9

Exports -11.6 10.3 6.7 6.9

Imports -17.8 5.4 1.5 4.8



CPI -0.3 1.8 2.9 1.6



Mark Miller+44 (0)20 7158 2141

[email protected]

WEQ - 14th

APRIL 2011

Source: LBCM

20

25

30

35

40

45

50

55

60

65

Mar 01 Mar 03 Mar 05 Mar 07 Mar 09 Mar 11

50 denotesstability

Services

Manufacturing

20

25

30

35

40

45

50

55

60

65

Mar 01 Mar 03 Mar 05 Mar 07 Mar 09 Mar 11

50 denotesstability

Services

Manufacturing


13/26

NETHERLANDS


OPEN NATURE OF ECONOMY SUPPORTS GROWTH PROSPECTS

The Netherlands economy expanded at a stronger-than-expected pace in 2010Q4. Growth registered 0.6% quarter-on-quarter, to yield an annual rate of 2.4% - the best outturn since autumn 2008. Within this, exports performed strongly,

rising by some 11.3% in the year to Q4. This underlines the Netherlands as a particularly open economy benefiting from

stronger global growth and healthy expansion in key euro area trading partners such as Germany. Usefully, major

exports such as agricultural produce, chemicals & energy have general ly held up wel l, affording the Netherlands an

opportunity to increase its share in world trade in these areas.

But looking forward, export growth could slow this year and next relative to 2010, as the pace of global economic

expansion tails off modestly. We look for export growth in the Netherlands to average around 6% over both years, versus

10.9% in 2010. Interestingly, notwithstanding the open nature of the economy, there have been tentative signs (e.g. from

the middle of last year) that domestic demand is playing an increasingly important role as a driver of activity. This applies

in particular to fixed investment by non-financial corporations, although we caution that the upturn seen towards end-

2010 was largely confined to replacement of existing capital stock rather than new capital expenditure. This is entirely

natural in a climate of demand uncertainty fol lowing an economic and financial crisis. But we note that if new investmentis to come on-stream, long-term rates in the euro region will need to fal l from their historically high rates to prevent the

cost of raising capital in bond markets from becoming prohibitively high. Failure to agree on the details of a permanent

mechanism to address any future sovereign debt crises in the euro area at the 24-25 March EU summit is unhelpful for

the capital spending outlook. Our fixed investment growth forecasts stand at 1.0% and 3.5% for this year and next.

In terms of the public sectors contribution to overall domestic demand, as in other euro area countries, the Netherlands

is now embarking on a substantial fiscal tightening programme, unwinding the stimulus implemented in response to the

economic and financial crisis. Previously, in 2009, government spending was the only component making a meaningful

contribution to GDP. The current fiscal consolidation essential ly focuses on reducing public administration costs and

subsidies. Spending cuts announced in the 2011 Budget delivered by the caretaker government last September amounted

to 3.2bn, with a deficit target of 3.9% of GDP in 2011.

Encouragingly, consumer confidence in the Netherlands has been trending upwards for around 18 months now. Marchs

European Commission consumer confidence survey registered 8.1 close to its strongest since November 2007 and

compares with a 10-year average of -1.3. This may reflect relatively healthy labour market conditions in the Netherlands.

The unemployment rate stood at just 5.1% in February against a euro region average of almost 10%. A large part of this

resilience can be attributed to labour hoarding by firms at the height of the crisis, to prevent potential difficulties in re-

hiring skilled and qualified staff during a subsequent upturn (the labour market was tight in the lead-up to the financial

crisis). In addition, the Netherlands has a high proportion of self-employed and part-time workers. Given this flexible

labour market structure, it seems unlikely that employment will recover rapidly going forward. We think the outlook for

consumer spending growth is correspondingly subdued, with our projections at just 1.0% in 2011, prior to a modest

acceleration to 1.5% next year. Following overall GDP growth of around 1.7% in 2010, we look for the economy to

register a broadly similar rate of expansion this year, prior to 1.9% growth in 2012.

CHART: Confidence in the Netherlands continues to rise... TABLE: Key Netherlands macroeconomic forecasts

Netherlands (Yr % unless stated) 2009 2010e 2011f 2012f

Real GDP -3.9 1.7 1.7 1.9




Exports -7.9 10.9 6.3 5.5

Imports -8.5 10.6 5.1 6.0



CPI 1.2 1.3 2.1 1.8



Mark Miller / Kathryn McGeough+44 (0)20 7158 2141

[email protected]

WEQ - 14th

APRIL 2011

Source: European Commission

-30

-20

-10

0

10

20

30

2005 2006 2007 2008 2009 2010 2011

% Net balance

Consumer confidence

Industrial confidence

-30

-20

-10

0

10

20

30

2005 2006 2007 2008 2009 2010 2011

% Net balance

Consumer confidence

Industrial confidence


14/26


CANADAHOUSING MARKET TO UNWIND IN AN ORDERLY MANNER

The Canadian economy grew by an annualised 3.3% in Q4, up from 1.8% in the previous quarter. The increase in GDP

growth was led by the external sector, where despite a strong CAD, export volumes surged 17.2%, driven by a recoveryin the US and stronger petroleum exports. Meanwhile, imports were broadly flat, resulting in net exports adding 5.2

percentage points to GDP growth. This was partly offset by a large fal l in inventories. Economic growth was 3.1% for

2010 as a whole.

Domestically, household consumption was a key driver of growth, accelerating by 1.2% in Q4 from 0.5% in Q3. And it

appears that consumer spending has started the year wel l. Retail sales volumes increased 3.4% year-on-year in January.

Moreover, employment has returned to pre-recession levels,with the unemployment rate having fallen from its peak of

8.5% in 2009 to 7.7% in March. However, while robust labour market conditions are expected to support consumption

this year, growth is likely to be tempered by a reduced wealth effect from a softening in the housing market. Moreover,

with recent GDP outcomes being stronger than anticipated by the Bank of Canada (GDP rose 0.5% m/m in January),

and inflation currently runnng above the official 2% target, we expect it to resume interest rate increases as early as

mid-2011 to 2.5% by the end of this year. With further hikes anticipated in 2012, this will become an increasing headwind

faced by households.

The current low interest rate enviroment has contributed to the household debt-servicing ratio falling in recent quarters.

However, the household debt to income ratio has increased to 140% of disposable income in Q3 the highest level on

record. Moreover, there is evidence that the proportion of households with debt servicing ratios above the generally

regarded vulnerable 40% level has risen. This means that a larger percentage of households are more sensitive to

shocks to employment or the housing market, as wel l as significantly higher interest rates.

After supporting the early stages of the recovery, residential investment is expected to slow substantially this year. Annual

growth in dwelling starts remains negative, falling 4.7% year-on-year in March, down for the fourth consecutive month.

Moreover, demand appears to be softening, with both mortgage approvals and house price growth slowing.

Despite these headwinds facing the economy, the outlook remains favourable. In particular, businesses have been taking

advantage of the strong currency, firm commodity prices and government incentives to invest in machinery and equipment.

And while investment growth is expected to remain below the double-digit rate recorded in mid-2010, improvingcorporate balance sheets are expected to support non-residential investment and drive economic growth this year.

Stronger US economic growth (the US accounts for nearly 75% of total good exports) and robust demand for Canadas

commodity exports are expected to support firm growth in exports this year. And consistent with an easing in household

spending, growth in consumer imports is expected to see net trade make a positive contribution to GDP growth in 2011.

In 2011, we see a rebalancing of growth away from households and government spending, to business investment and

exports with the economy expected to grow by 3.2% and 3% in 2012. However, a key risk to our economic outlook

concerns exports. Both a strong CAD and higher oil prices may see export growth softer than currently anticipated. A

high CAD damages the competitiveness of Canadian exports, while higher oil prices could impinge on US and global

GDP growth prospects.

CHART: Continued recovery in corporate profits tosupport strong business investment going forward

TABLE: Key Canadian macroeconomic forecasts

Sian Fenner+44 (0)20 7158 3975

[email protected]

WEQ - 14th

APRIL 2011


-27

-18

-9

0

9

18

2006 2008 2010 20127

9

11

13

15

17

%, y-o-y % of GDP

Corporate profits(RHS)

Business investment (LHS)

forecast

-27

-18

-9

0

9

18

2006 2008 2010 20127

9

11

13

15

17

%, y-o-y % of GDP

Corporate profits(RHS)

Business investment (LHS)

forecast

Canada (Yr % chg unless stated) 2009 2010e 2011f 2012f

Real GDP -2.5 3.1 3.2 3.0




Exports -14.2 6.4 8.7 6.1

Imports -13.9 13.4 4.4 4.9



CPI 0.3 1.8 2.4 2.0




15/26

AUSTRALIA


UNEVEN RIDE AHEAD

After nearly stal ling in Q3, the Australian economy expanded by 0.7% quarter-on-quarter in Q4, bringing 2010 GDP

growth to 2.7% . Growth in Q4 was underpinned by a strong rise in exports (despite the drag on coal exports fromheavy rain), government spending and a rebuilding of inventories. And while Q4 GDP once again expanded below the

0.9% trend rate,if the RBA estimates are correct and the impact of the floods on activity subtracted 0.5 percentage

points from growth, then the outcome could still be considered encouraging.

While household spending and business investment both showed subdued growth in Q4, we continue to expect a

rebalancing of growth from the public sector towards private sector demand. Fiscal spending has slowed significantly

over H2 2010 and with the exception of a temporary boost from flood and disaster assistance, we expect government

expenditure to make a smaller contribution to GDP growth over 2011.

Although our economic outlook remains favourable, quarterly GDP growth in 2011 is expected to be uneven. Damage to

agriculture and mining production caused by the floods, combined with disruptions to business operations is likely to have a

large impact on Q1 GDP growth. Furthermore, the recent natural disaster in Japan, a key trading partner, is likely to negatively

impact exports in the short-term, although on balance, our model shows no change to our GDP growth forecast.

Household spending is also unlikely to lead to GDP growth returning to trend in H1. Retail sales continue to disappoint,

increasing 0.5% month-on-month in February, while passenger vehicle sales fell 2.5% quarter-on-quarter in Q1. The

subdued spending trend reflects the cautious nature of households, despite strong income growth. However, with the

unemployment rate forecast to fall to 4.6% by end-2011 and wages set to accelerate, improved confidence and higher

real disposable income are expected to encourage an increase in spending in H2. And, despite debt-servicing ratios

remaining high, an improving net wealth position is expected to support household consumption firming to 4.3% next

year, following a projected 3.2% rise in 2011.

Latest national accounts data confirmed the dilemma facing Australian policy makers. Although inflation has been

subdued recently, the economy is awash with income from the terms of trade boom. Real net disposable income

surged 7.7% year-on-year in Q4. This is boosting both household disposable incomes and corporate balance sheets.

Accordingly, the latest CAPEX survey suggests that business investment is set to soar in 2011-12, led by the mining

sector. In particular, investment in buildings and structures is estimated to be over A$91mil lion, up 18.1% from the2010-11 estimate.

Private sector investment is also expected to be a key driver of growth over the next two years but it will further tighten

already limited spare capacity, raising the risks to the medium-term inflation outlook. This will be reinforced by the

recent floods in the form of both higher food prices (a short-term phenomenon) and costs for labour and materials.

We have a first interest rate hike pencil led in for mid-2011 and expect rates to end-2011 at 5.75%, before peaking at

6.25% in 2012.

On balance, while the natural disasters are likely to impact GDP growth in H1, a rebound in exports combined with

stronger household spending and private investment are expected to underpin GDP growth of 3.2% this year prior to

4.3% growth in 2012.

CHART: Capital spending survey suggests mininginvestment will soar in 2011-12

TABLE: Key Australian macroeconomic forecasts

Sian Fenner+44 (0)20 7158 3975

[email protected]

WEQ - 14th

APRIL 2011

Source: ABS & LBCM

0

1

2

3

4

5

6

1991-92 1995-96 1999-00 2003-04 2007-08 2011-12

% of GDP

Forecast

TotalBuildingsMachinery and Equipment

0

1

2

3

4

5

6

1991-92 1995-96 1999-00 2003-04 2007-08 2011-12

% of GDP

Forecast

TotalBuildingsMachinery and Equipment

Australia(Yr % chg unless stated) 2009 2010e 2011f 2012f

Real GDP 1.3 2.7 3.2 4.3




Exports 2.8 5.3 6.7 6.6

Imports -9.0 13.2 7.2 8.1


Unemployment rate 5.6 5.2 4.6 4.2

CPI 1.8 2.8 3.0 2.8

Budget balance % GDP -3.4 -2.0 -1.7 -0.6



16/26


CHINA

CHART: Accelerating inflationary pressures a key

challenge for authorities

TABLE: Key Chinese macroeconomic forecasts

FOOT FIRMLY ON THE POLICY BRAKES

The Chinese authorities have applied the policy brakes, and we believe that economic growth will moderate in 2011 to 9.3%

from 10.3% in 2010. We expect to see more evidence of a rebalancing of growth away from the housing market and heavyindustry towards the services sector in 2011. Q1 GDP is forecast to have grown 9.3% year-on-year, down from 9.8% in Q4.

Industrial production has been surprisingly firm in the first two months of the year given the recent deterioration in the PMI

manufacturing survey. Moreover, despite a moderation in new loans, fixed urban investment continues to record solid

growth, up 24.9% year-on-year for the first two months of 2011. Dwellings investment has remained strong despite efforts

to cool the property market. In contrast, government investment has slowed sharply. Household spending also appears to

have moderated, with retail sales easing to 11.6% year-on-year in February, its slowest rate of growth for two years.

In our view, accelerating consumer prices and low deposit interest rates have seen real disposable income growth ease

recently, despite average monthly minimum wages increasing by around 23% in 2010. And while wages are set to rise

further this year, managing higher inflation is a key challenge for the authorities. There are a number of significant price

pressures in the pipeline. In particular, producer prices are currently growing at rates experienced in late 2008 reflecting the

rise in USD-denominated commodities. And while government price controls may successfully restrain growth in consumer

goods prices, the latest data shows that services sector prices, which are generally more sticky than goods, have accelerated

recently. We expect consumer prices to hover at or above 5% for the next couple of months, reflecting high commodity

prices. Adding to these cost-push pressures is the current threat of drought pushing up locally-sourced food prices.

Consumer inflation is forecast to average 4.7% in 2011, above the governments target of 4%.

To date, the Peoples Bank of China (PBoC) has used quantitative measures aggressively, increasing bank reserve ratios nine

times since January 2010 to an all time high of 20% for large banks. But despite raising the prime lending and deposit

interest rates by 25bp on the 5th April the fourth rate hike since October 2010 they remain below their pre-crisis peaks.

Going forward, we expect the PBoC to tighten interest rates further, with the prime lending rate increasing to 6.61% by end-

2011 and 7.11% by end-2012. However, we do not anticipate reserve ratios being raised much further.

With household earnings and interest returns set to rise, we expect household spending to pick up after Q1 and support the

services sector. In contrast, caps on mortgages and rising interest rates wil l result in residential investment moderating in the

coming quarters. That said, given the strength of demand outside the major cities such as Beijing and Shanghai, we believethat the slowdown in investment will be milder than previously projected.

Recently, Chinas trade surplus has narrowed significantly, recording its first deficit in Q1 since 2004. However, we expect

import growth to move back broadly in line with exports, reflecting more moderate growth in fixed investment this year.

Moreover, at present we do not think that the recent natural disaster in Japan will have a significant effect on Chinese

exports. In fact, disruptions to Japanese steel production may actually benefit Chinas steel industry.

In conclusion, despite a projected slowing in investment over the next two years, we expect economic activity to remain

strong, albeit more geared towards service sectors compared with the past couple of years. Real GDP growth is expected

to ease to 9.3% this year and 8.8% in 2012. Moreover, we expect growth to average around 8% over the next five years,

above the latest 5-year government growth target of 7%, featuring a gradual shift towards consumption.

Sian Fenner+44 (0)20 7158 3975

[email protected]

WEQ - 14th

APRIL 2011

Source: ABS & LBCM

-10

-5

0

5

10

15

Mar 07 Mar 08 Mar 09 Mar 10 Mar 11

20

30

40

50

60

70

80% YoY

Input prices (RHS)

CPI

PPI

DI

-10

-5

0

5

10

15

Mar 07 Mar 08 Mar 09 Mar 10 Mar 11

20

30

40

50

60

70

80% YoY

Input prices (RHS)

CPI

PPI

DIChina (Yr % chg unless stated) 2009 2010e 2011f 2012f

Real GDP 9.2 10.3 9.3 8.8


Gross investment 23.7 14.2 9.4 7.4


Exports -11.2 26.5 11.7 11.0

Imports 5.3 17.1 9.1 10.8

Industrial production 9.9 12.2 9.5 8.3


CPI -0.7 3.3 4.7 3.9

Budget balance % GDP (cal yr) -1.2 -0.4 0.4 0.5



17/26

BRAZIL


MACROPOLICIES TO DAMPEN OVERHEATING ECONOMY

The Brazilian economy expanded by 0.7% quarter-on-quarter in Q4, up from 0.5% in Q3. Although slightly weaker than

expected, this saw GDP growth for 2010 at 7.5% - the fastest rate in 24-years. Domestic demand remained the key driverof growth in Q4, with household spending increasing 2.5% in the quarter and fixed investment growing by 0.7%. However,

robust demand led to import volumes increasing strongly, up 3.9%, outpacing growth in exports, up 3.6%.

In 2011, a second year of above trend economic growth will continue to support employment growth. The unemployment

rate is expected to fal l from 6.4% in February to 4.5% by end-Q4. Moreover, anecdotal evidence suggests that firms are

facing increasing difficulties in sourcing raw materials and labour. As such, we expect wages to increase, supporting real

earnings growth. However, while this bodes well for household spending, we anticipate growth wil l ease back this year on

the back of further monetary policy tightening to combat inflation. The Brazilian central bank has lifted interest rates by

300bp since March 2010. And while the latest COPOM minutes stated that that there was no bias in their current monetary

policy stance, we believe that the risks to the medium-term outlook warrant further rate hikes this year. Consistent with

consumer inflation to average 5.6% this year, up from 5.0% in 2010, we expect rates to end 2011 at 12.75%. The use of other

macroprudential instruments, such as the recent increase in consumer lending tax, are expected to play a bigger role in

monetary policy. However, there is a risk that the secondary impact of higher wages wil l add further fuel to both demand-pull and cost-push inflationary pressures.

While the outlook for households is favourable, we note that the surge in household debt has left a greater proportion

of households vulnerable to interest rate changes. Moreover, as households are able to purchase a wide range of goods

and services using an instal lment plan, we believe that a sizeable number of households are spending excessively. As

such, any change in circumstances could mean a sharp pull back in spending. While we have assigned a small

probability to this particular scenario, higher inflation and an increased debt burden are expected to result in household

consumption moderating to 5.9% in 2011, compared with 7.0% in 2010.

While the annual expansion in investment expenditure is expected to slow to 11% after the 22% surge seen in 2010, the

level remains high, particularly in the mining and government sector. Government investment is forecast to be strong,

reflecting spending ahead of the footbal l World Cup in 2014 and Olympics in 2016 to support infrastructure improvements

and building works. We believe that the cuts to federal expenditure, worth BRL50bn are unlikely to impact these

investment plans. However, there is a chance that other non-event related investment wil l be postponed.

A key risk to the economic outlook is strength of the real may further reduce the competitiveness of Brazilian exports. The

Brazilian authorities have actively been trying to limit the real s appreciation against the USD, imposing capital controls

and increasing foreign reserves holdings. However, it has appreciated by nearly 10% against the USD over the past year,

and over 36% in the past two years. We expect the authorities to remain active this year, nonetheless we are looking for

only a modest rise in USD/BRL to 1.69 by end-2011.

Our central forecast is for GDP growth to slow to 5.0% in 2011 as tighter fiscal and monetary policies dampen the

overheating economy. With demand for Brazilian exports expected to remain strong, GDP growth is projected to

increase 4.6% next year.

CHART: Strong labour market conditions have supportedrobust growth in household spending

TABLE: Key Brazilian macroeconomic forecasts

Sian Fenner+44 (0)20 7158 3975

[email protected]

WEQ - 14th

APRIL 2011


0

1

2

3

4

5

6

7

8

Feb 07 Feb 08 Feb 09 Feb 10 Feb 11

6

7

8

9

10

11

12

13

14%, YoY %

Retail sales, 3mma

Unemployment rate,3mma (RHS)

0

1

2

3

4

5

6

7

8

Feb 07 Feb 08 Feb 09 Feb 10 Feb 11

6

7

8

9

10

11

12

13

14%, YoY %

Retail sales, 3mma

Unemployment rate,3mma (RHS)

Brazil (Yr % chg unless stated) 2009 2010e 2011f 2012f

Real GDP -0.7 7.5 5.0 4.6


Gross fixed investment -10.4 22.0 11.0 10.2


Exports -10.1 11.5 9.5 10.2

Imports -11.2 36.0 19.6 -0.8



CPI 4.9 5.0 5.6 4.7




18/26


INDIA

CHART: Official interest rates have further to rise TABLE: Key Indian macroeconomic forecasts

TIGHTER POLICY STANCE TO HIT GROWTH

The resilience shown by the Indian economy, both during and after the global financial crisis has been commendable. Real

GDP rose 8.6% in 2010, up from 7.0% in 2009, with the slowest pace of growth posted in the final quarter (8.2% year-on-

year). The 2010 rebound was driven by robust domestic demand, with fixed investment growth surging 16.5% and private

consumption up 6.9%. However, stubborn and elevated inflation has led the central bank to tighten monetary policy

significantly in the past year, with the prospect of further interest rate hikes to come. Taken together with a tighter fiscal stance

announced in the March Budget, the pace of economic growth looks set to moderate this year, albeit remaining robust at

8.1%. Indias medium-term prospects are favourable, with the potential growth rate estimated at slightly above 8%. Barring

a major policy mistake or global financial dislocation, we expect to see India post sustained high growth in the next decade.

Although the pace of real GDP growth is set to slow to 8.1% in 2011, domestic demand growth is predicted to accelerate

as personal consumption firms on the back of rising employment, soaring incomes and robust bank lending growth. The

main risk is that inflation remains elevated for longer than expected, constraining growth in real incomes. We look for

consumer spending growth to accelerate to 8.4% in 2011. However, fixed investment growth looks set to slow markedly as

higher interest rates, soaring oil prices and supply-side bottlenecks weigh on confidence. We forecast growth of just 7.8%,

albeit coming after last years brisk 16.5% rate. Nevertheless, given Indias growth trajectory and the pressing need for

increased infrastructure spending, investment spending should return to double-digit pace in 2012 and 2013.

The external trade deficit narrowed sharply in the final quarter of 2010, however the outlook is less favourable, particularly

given high global commodity prices and continuing buoyant domestic demand. We look for the trade deficit to widen

significantly in the coming years, registering around $180bn in 2012 from around $130bn in 2010. The current account

deficit already represents a key concern, averaging above $50bn in the last four quarters, equivalent to over 3% of GDP.

However, although it is set to widen to 3.5% of GDP in 2011, it should moderate in the coming years. We do not see financing

as a major problem, but Indias rising external vulnerability is a concern. Portfolio flows have provided the majority of the

coverage and net FDI is relatively small. This could lead to heightened volatility in the rupee in the year ahead.

The government has announced plans to significantly reduce the fiscal deficit in the coming years, largely through expenditure

restraint. The target for the fiscal year ending March 2012 is at 5% of GDP, from 6.7% in the current fiscal year. We believe

the main risks to this forecast come from higher oil prices and state elections later this year. However, the need for increasedfiscal restraint has been widely acknowledged and we expect the deficit to be on a declining trend in the coming years.

Inflation represents Indias main challenge at this time. It has been accentuated by the sharp rise in global commodity prices

and the soaring price of basic domestic foodstuffs, while surveys highlight that capacity constraints are also increasing.

After accelerating in the first two months of this year, to 8.31% in February, we expect favourable base effects to lead to a

significant slowing in the benchmark wholesale prices series in the coming months. However, underlying price pressures,

reflected in elevated inflation expectations, remain strong and inflation could accelerate in the second half of 2011. With

inflation set to exceed the RBIs 4-4.5% comfort range for some time, further monetary tightening seems inevitable. We look

for the benchmark repo rate to rise to 7.5% by end-2011, from 6.75% currently. The risk is that more tightening is required,

putting downward pressure on growth prospects this year and next.

Jeavon Lolay+44 (0)20 7158 1742

[email protected]

%

2006 2007 2008 2009 2010-2

0

2

4

6

8

10

12

2011

WPI inflation

Repurchaserate

%

2006 2007 2008 2009 2010-2

0

2

4

6

8

10

12

2011

WPI inflation

Repurchaserate

WEQ - 14th

APRIL 2011

Source: Datastream

India (Yr % chg unless stated) 2009 2010e 2011f 2012f

Real GDP (cal yr) 7.0 8.6 8.1 8.3


Fixed investment 2.9 16.5 7.8 13.0


Exports -7.4 14.6 10.0 13.4

Imports -7.0 3.5 11.8 15.9

Industrial production 6.6 10.4 6.7 10.1

CPI 1.8 2.8 3.0 2.8

Budget balance % GDP (fiscal yr) -3.4 -2.0 -1.7 -0.6



19/26

RUSSIA


INFLATION FEARS ABOUND DESPITE DISAPPOINTING GROWTH

Although Russia has failed to match the growth performance of the other major emerging markets, such as Brazil, India

and China, its battle with inflation has been no less challenging. Sparked by a severe drought and heatwave last summer,

annual consumer price inflation was 9.5% in March, up from a low of 5.5% in July 2010. We expect inflation to remain

elevated on high oil prices, limited spare capacity and underlying structural bottlenecks. However, lower food price

inflation wil l be an offsetting factor. Stubborn inflation has intensified pressure on the central bank to tighten monetary

policy to reduce the risk of second round effects threatening the nascent economic recovery. The refinancing rate was

raised to 8% in February (from a record low 7.75%) and we predict it could be hiked a further 75bp this year. The

exchange rate will also provide an important safety valve to subdue price pressures. The trading band against the dollar-

euro basket was widened in March as rising oil prices saw the rouble appreciate sharply at the start of 2011. However,

the authorities have also started to intervene directly in the foreign exchange market to slow the pace of appreciation.

The Federal Statistics Service estimated that the economy expanded by 4% in 2010, which is very disappointing considering

that output contracted by 7.9% in 2009. However, the drought had a significant impact on agriculture and industry in the

second half of 2010 and latest data show a much improved performance in the final quarter, with GDP growth accelerating

to 4.5% y/y, from 3.1% in Q3. Monthly indicators show considerable momentum in the first quarter of 2011, in large part

supported by a sharp rise in crude oil prices. Official estimates suggest Russian GDP growth increases by close to 0.5pp

for every $10 increase in oil prices. We look for GDP growth to average 5.3% in 2011, although with upside risks should

crude oil prices rise further. We have a relatively aggressive interest rate profile for this year and a less restrictive policy

stance could also see growth exceed our expectations, albeit raising concerns about medium-term prospects.

Domestic demand should be supported by stronger consumer spending growth and fixed investment spending. Real

wages are increasing and the unemployment rate should trend downward. Consumer confidence has improved, while

low interest rates are underpinning particularly strong growth in retail lending. We forecast consumer spending to rise

by 4.9% in 2011, up from 3.0% in 2010. Pre-election government transfers to households and pensioners could further

bolster consumer spending this year (the presidential election is due in 2012). The main downside risk is that inflation

remains stubbornly high, hitting household real incomes and potentially leading to more aggressive monetary tightening.

Fixed investment growth was subdued last year, up by just 6.1% after fal ling 15.7% in 2009, but business confidence

should improve as the recovery consolidates. We look for fixed investment growth in the region of 8% in 2011 and 2012.

However, the importance of the oil and gas sector to Russias prospects should not be underestimated, being equivalent

to around 15% of GDP and 65% of export earnings. The rise in crude oil prices has significantly improved economic

prospects in the year ahead. The current account is expected to post a surplus of around 4% of GDP, while the

government budget deficit should narrow to 3.1% of GDP on higher revenues. Russia posted its first fiscal deficit for a

decade in 2009. However, it is worth highlighting that the non-oil deficit is close to 13% of GDP, while the oil reserve fund

has been depleted. The need to improve fiscal sustainability is crucial to reducing Russias vulnerability to external

shocks. The severity of the economic contraction in 2009 also highlights the need for increased investment in the non-

oil sector and enacting structural reforms to put economic growth on a more sustainable footing. This is critical if Russia

hopes to match the growth exploits of its major emerging market peers.

CHART: Pipeline pressures suggest CPI inflation set to rise TABLE: Key Russian macroeconomic forecasts

Russia (Yr % unless stated) 2009 2010e 2011f 2012f

Real GDP -7.9 4.0 5.3 5.2




Exports -4.7 8.3 6.3 6.5

Imports -30.4 21.2 14.1 8.3



CPI 11.7 6.9 8.6 7.0



Jeavon Lolay+44 (0)20 7158 1742

[email protected]

%

2006 2007 2008 2009 2010

5

6

7

8

9

10

11

12

13

14

15

16

-20

-10

0

10

20

30

40

CPI inflation,

LHS

PPI inflation,

RHS

%

2011

%

2006 2007 2008 2009 2010

5

6

7

8

9

10

11

12

13

14

15

16

-20

-10

0

10

20

30

40

CPI inflation,

LHS

PPI inflation,

RHS

%

2011

WEQ - 14th

APRIL 2011

Source: Datastream


20/26


MEXICO

CHART: Unemployment is expected to fall gradually over

2011

TABLE: Key Mexican macroeconomic forecasts

Mexico (Yr % unless stated) 2009 2010e 2011f 2012f

Real GDP -6.1 5.5 4.7 4.9




Exports -14.0 21.7 9.2 8.0

Imports -19.0 23.1 11.0 10.2



CPI 5.3 4.2 4.1 3.7



Sian Fenner+44 (0)20 7158 3975

[email protected]

BENIGN INFLATIONARY PRESSURES TO KEEP RATES ON HOLD

Mexican real GDP grew an annualised 1.3% quarter-on-quarter in Q4, up from 0.8% in Q3. This yielded a ful l year

expansion of 5.5% in 2010. Although not offsetting the annual contraction of 6.1% recorded in 2009, it does represent

a strong recovery, especially considering the relatively sluggish import demand from the US Mexicos largest trading

partner.

Domestic demand remained robust in Q4, increasing by 1.3% quarter-on-quarter. Encouragingly, the rebalancing in

growth from the public to the private sector appears to be on track, with household spending and investm

lloyds world economic quarterly 2q2011

Documents