barcap july8 global economics weekly signs of a partial turn

8/6/2019 BarCap July8 Global Economics Weekly Signs of a Partial Turn

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ECONOMICS RESEARCH 8 July 20

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 47

Global Forecasts

Global Synthesis

Global Rates and Inflation

Global Markets Watch

United States

Outlook

InFocus: Auto sector getting out ofreverse gear

Data Preview & Review

Euro Area

Outlook


United Kingdom

Outlook


Japan

Outlook


Emerging Asia

China Outlook

Asia Outlook

InFocus: Thailand A tactical long


EEMEA

Outlook


Latin America

Outlook


Country Snapshots

Global Weekly Calendar

GLOBAL ECONOMICS WEEKLY

Signs of a partial turn Economic data in Japan are improving as the economy is beginning to heal from

the contraction after the earthquake.

US manufacturing data are bottoming out as the temporary factors impedinggrowth are starting to fade.

We have downgraded our GDP forecast for the euro area, and look for apersistent slowing in growth, in part due to the effects of tighter fiscal policy.

In China, we believe that policy firming and tighter credit conditions are alsoyielding a more lasting slowing in growth than in the US or Japan.

Developed Economies

United States: A production turn - To everything there is a season 7

A V-shaped recovery appears to be taking hold in Japan, easing supply chain

disruptions to auto production and sales in the US.

Euro area: Austerity hurts and inflation bites 13

Following the strong growth in Q1 this year, and given what we believe was a weak Q2,

real GDP growth in H2 is set to be more modest than thought previously.

UK: Q1 wan, Q2 too 17

The available data suggest that growth in Q2 was even weaker than the disappointing

0.5% expansion in Q1, and we now expect growth to have been just 0.2% q/q.

Japan: An interim assessment 20

The BoJ will re-visit its GDP and CPI forecasts next week, likely projecting modest real

growth and core inflation for FY11. This will not reflect the CPI rebasing.

Emerging Markets

China: Rate hike cycle close to an end 23

The PBoC delivered an overdue benchmark interest rate hike on Wednesday, ahead of the

release of the June CPI data, which we expect to jump to 6.3% y/y from 5.5% in May.

Emerging Asia: Inflation pains linger on 25

Bank Negara Malaysia kept rates on hold due to moderation in external demand. We

expect the central bank to raise the policy rate 25bp in September.

EEMEA: Doves rule as inflation peaks and growth slows 31

Global commodity prices are moderating and prospects for local harvests are improving.

Latin America: A currency war again? Yes, but not for long. 36

As commodity price pressures dissipate and headline inflation moves south, the

crusade against currency appreciation is starting to re-emerge in the Latin region.


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Barclays Capital | Global Economics Weekly

8 July 2011 2

GLOBAL FORECASTS

1Q11 2Q11 3Q11 4Q11 1Q12 2010 2011 2012 1Q11 2Q11 3Q11 4Q11 2010 2011 2012

Global 4.2 3.2 3.9 4.2 4.4 4.9 4.0 4.3 3.4 4.0 4.0 3.7 2.6 3.8 3.0

Developed 1.6 1.2 2.4 2.9 2.8 2.5 1.8 2.7 2.1 2.8 2.9 2.8 1.4 2.7 1.9

Emerging 7.4 5.6 5.7 5.9 6.2 7.9 6.6 6.2 6.3 6.4 6.4 5.7 5.3 6.2 5.3

BRIC 7.6 6.8 7.1 6.8 7.5 8.9 7.6 7.4 6.6 6.9 6.7 5.4 5.0 6.4 5.1

America 3.0 2.7 3.1 3.6 3.7 3.7 3.1 3.6 3.4 4.3 4.5 4.3 2.8 4.1 3.5

United States 1.9 2.0 3.0 3.5 3.5 2.9 2.5 3.4 2.1 3.4 3.6 3.4 1.6 3.1 2.4

Canada 3.9 2.5 2.5 2.5 2.5 3.2 2.9 2.5 2.6 3.3 3.2 3.1 1.8 3.1 2.2

Latin America 5.7 4.6 3.3 4.3 4.4 6.2 4.7 4.1 8.3 7.9 8.2 8.2 7.5 8.1 7.9

Argentina 11.8 4.0 2.0 5.5 4.3 9.2 7.6 4.2 25.3 23.3 22.6 22.9 21.5 23.5 26.1

Brazil 5.4 2.9 3.4 4.5 4.5 7.5 3.8 4.2 6.1 6.6 7.1 6.6 5.0 6.6 5.7

Chile 5.4 5.0 5.0 5.0 4.5 5.2 6.4 4.5 2.9 3.2 3.5 4.0 1.4 3.4 3.0

Colombia 9.8 5.5 3.0 4.5 5.0 4.3 5.7 4.6 3.2 3.0 3.2 3.2 2.3 3.2 3.3

Mexico 2.1 6.5 3.0 3.0 4.0 5.4 3.9 3.7 3.5 3.3 3.7 3.6 4.2 3.5 4.0

Peru 6.6 5.7 4.6 5.4 4.0 8.8 6.4 5.2 2.3 2.9 3.0 3.6 1.5 2.9 3.1

Venezuela 6.9 4.4 5.0 4.6 5.6 -1.4 4.3 3.5 28.2 22.8 23.0 24.3 28.2 24.5 21.9

Asia/Pacific 6.3 4.7 6.4 6.9 6.9 8.1 6.0 6.5 3.4 3.8 3.6 2.8 2.3 3.4 2.7Japan -3.5 -2.3 3.7 5.0 4.4 4.0 -0.5 3.2 -0.2 0.5 0.5 0.0 -1.0 0.2 0.1

Australia -4.7 4.6 4.9 4.0 4.1 2.7 1.4 4.0 3.3 3.8 4.1 4.5 2.8 3.9 3.3

Emerging Asia 9.3 6.5 7.2 7.5 7.6 9.3 7.8 7.4 5.4 5.7 5.3 4.2 4.1 5.1 4.1

China 9.4 7.8 8.0 9.5 8.7 10.4 9.3 8.7 5.1 5.6 5.2 3.4 3.3 4.8 4.0

Hong Kong 11.9 -1.2 4.1 4.7 5.1 7.0 5.5 4.5 4.0 5.2 6.1 5.4 2.4 5.2 4.7

India 8.4 7.6 9.1 5.0 8.8 9.0 7.7 7.9 9.5 9.3 9.2 8.3 9.6 9.1 6.7

Indonesia 4.0 6.0 5.8 9.6 4.4 6.1 6.5 6.4 6.8 5.9 5.0 6.0 5.1 5.9 6.0

South Korea 5.4 4.5 6.2 6.3 3.6 6.2 4.4 4.1 4.5 3.9 3.3 2.8 3.0 3.6 2.1

Malaysia 7.0 4.9 2.5 4.1 5.8 7.3 5.0 5.5 2.8 3.5 3.7 3.9 1.7 3.5 2.2

Philippines 15.0 4.8 4.0 -0.1 10.3 7.6 5.0 5.3 4.0 4.6 5.1 5.0 3.8 4.7 3.8

Singapore 22.5 0.3 3.0 4.9 4.3 14.5 6.0 4.5 5.2 4.5 3.4 2.8 2.8 4.0 1.8

Taiwan 19.0 0.4 1.9 4.5 4.8 10.9 5.9 4.0 1.3 1.6 1.7 1.8 1.0 1.6 1.9

Thailand 8.4 0.8 2.0 5.1 5.0 7.8 3.6 4.7 3.0 3.6 4.1 4.5 3.3 3.8 2.7

Europe and Africa 3.0 1.8 1.7 1.6 2.1 2.5 2.5 2.4 3.3 3.6 3.8 3.8 2.6 3.6 2.6Euro area 3.4 1.1 1.2 1.6 1.5 1.7 1.9 1.6 2.5 2.7 2.8 2.9 1.6 2.7 1.8

Belgium 4.3 1.7 1.5 2.1 1.8 2.1 2.5 1.9 3.5 3.3 3.7 3.4 2.3 3.5 2.6

France 3.8 0.9 0.8 1.5 2.0 1.4 1.9 1.8 2.0 2.2 2.5 2.7 1.7 2.4 1.7

Germany 6.1 1.7 1.5 1.8 1.6 3.5 3.3 1.9 2.2 2.5 2.6 2.7 1.2 2.5 1.7

Greece 0.7 -2.2 -2.1 -1.0 -0.3 -4.4 -3.8 -0.5 4.5 3.3 3.2 4.2 4.7 3.8 3.0

Ireland 5.1 -1.4 2.4 1.1 1.8 -0.4 0.4 1.8 0.8 1.4 1.5 1.8 -1.6 1.4 1.4

Italy 0.5 1.1 1.7 1.9 0.6 1.2 1.0 1.1 2.3 2.9 2.7 2.9 1.6 2.7 1.6

Netherlands 3.6 2.1 1.7 1.7 1.9 1.6 2.3 1.9 2.0 2.4 2.8 2.9 0.9 2.5 2.6

Portugal -2.4 -2.6 -2.3 -1.7 -1.1 1.3 -1.7 -1.3 3.7 3.8 3.4 3.7 1.4 3.6 2.4

Spain 1.2 0.3 0.8 1.2 1.4 -0.1 0.7 1.5 3.2 3.3 3.3 3.1 2.0 3.2 2.0

United Kingdom 1.9 0.9 1.0 1.5 1.9 1.4 1.1 1.9 4.1 4.5 4.7 4.9 3.3 4.6 2.9

Switzerland 1.0 1.6 1.6 1.2 1.6 2.6 2.0 1.4 0.2 0.2 0.7 0.8 0.7 0.5 1.1

EM Europe & Africa 2.8 3.9 3.0 1.9 3.4 4.6 4.4 4.2 6.3 6.9 7.3 6.8 5.8 6.8 5.9

Czech Repub. 3.6 2.6 2.4 2.4 3.8 2.2 2.8 3.3 2.0 1.9 2.2 2.3 1.4 2.1 2.3Hungary 6.2 1.7 1.4 1.2 2.9 1.1 2.6 3.2 4.1 4.3 4.0 3.9 4.9 4.1 3.6

Poland 4.1 3.6 3.7 3.7 3.7 3.8 3.9 3.7 3.8 4.6 4.8 4.6 2.7 4.6 3.5

Russia 0.9 5.0 3.3 0.9 3.3 4.0 4.3 4.6 9.6 9.7 9.1 8.2 6.9 9.1 7.1

Turkey 3.7 2.3 1.7 1.2 2.9 9.0 5.8 4.1 4.3 6.5 9.0 8.5 8.6 7.1 7.1

Israel 4.7 4.0 4.0 4.0 4.8 4.9 5.0 4.2 3.9 3.8 3.8 3.7 2.6 3.9 3.2

South Africa 4.8 3.5 3.7 3.9 4.1 2.8 3.9 4.1 3.8 4.5 5.7 6.0 4.3 5.0 6.0

Consumer prices% annual chg

Real GDP% over previous period, saar

Consumer prices% over a year ago

Real GDP% annual chg

Note: Arrows appear next to numbers if current forecasts differ from that of the previous week by 0.5pp or more for quarterly annualized GDP, by 0.2pp or more forannual GDP and by 0.2pp or more for Inflation. Weights used for real GDP are based on IMF PPP-based GDP (2008-2010 average). Weights used for consumer pricesare based on IMF nominal GDP (2008-2010 average). Source: Barclays Capital


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8 July 2011 3

GLOBAL SYNTHESIS

Signs of a partial turn

We estimate that Q2 11 was the weakest quarter for real global GDP growth since the

recession, and that the slowdown has been widespread across economies. We look formoderately stronger Q3 11 growth, but that turn up is expected to be limited in scope.

Some reasons for the growth slowdown are expected to be short-lived, notably, the effects

of the Japanese earthquake and the energy price surge earlier this year. However, other

factors, such as the effect of fiscal tightening in Europe and that of monetary tightening in

China, are likely to persist. As a result, we expect the Q3 11 growth improvement to be led

by Japan and the US, with little improvement in the euro area or China.

Japan beginning to recover

This weeks data showed some more signs of healing in Japan following the abrupt

weakening after the earthquake. The composite index of consumption, which helps in

forecasting GDP-based consumption, increased 0.3% in May after a 1.9% rise in April and

has now retraced more than half of its March drop (Figure 1). New auto sales gained 15.7%

m/m in June after a 29.6% climb in May, and have now reversed about 80% of the post-

earthquake decline. While we still expect a 2.3% annualized drop in real GDP growth in

Q2 11, the moves up in the consumption-related series suggest we are on track for a turn to

significantly positive GDP growth in Q3 11; we look for a 3.7% annualized gain.

US manufacturing growth appears to be bottoming out

We expect US economic growth to be weak again in Q2 11; our tracking estimate stands at

an annualized 1.5% pace, below our 2.0% forecast. However, the past week did bring some

tentative signals that the slowdown in the manufacturing sector and consumer spending

may be starting to ease. After three consecutive declines, the ISM manufacturing index rose

to 55.3 in June from 53.5 in May, suggesting that the worst of the manufacturing slowdownis over (Figure 2). The June employment report, however, showed no pickup from Mays

meager job growth; indeed, private sector job growth edged down to 57k from 73k. We

interpret the labor market weakness as a lagged response to the H1 11 slowdown in real

Dean Maki

+1 212 526 [email protected]

Figure 1: Japanese consumption indicators moving up Figure 2: US manufacturing is bottoming; employment is not

100

150

200

250

300350

400

450

500

Jan-09 Jul-09 Jan-10 Jul-10 Jan-11

104

105

106

107

108109

110

111

112

Japan auto salesReal consumption index, rhs

Thous Index 2000=100

-1000

-800

-600

-400

-200

0

200

400

Jan-09 Jul-09 Jan-10 Jul-10 Jan-11

10

20

30

40

50

60

70

Change in private payrollsUS ISM manufacturing, rhs

1m change, Thous Index

Source: Cabinet office, JAMA, JMVA, Haver Analytics, Barclays Capital Source: BLS, ISM, Haver Analytics

Japanese consumption data are

improving

Manufacturing data in the US

have started to modestly

improve


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8 July 2011 4

GDP growth, so the growth data need to turn stronger before the labor market improves.

While limited supply from Japan automakers continued to weigh on US auto sales in June,

chain store sales grew solidly in June as gasoline prices fell; next weeks reading on core

retail sales will give more information on this front. Overall, while the US data are mixed, we

read them as consistent with our forecast of a modest H2 11 pickup in growth.

No upturn is imminent in the Euro area or China

We look for no improvement in growth in Q3 11 in the euro area or in China, as we believe

their slowing is less driven by temporary factors than is that in Japan and the US. In line with

this view, the incoming data have remained soft in these regions. In the euro area, domestic

demand appears to be weakening; after a weak May retail sales report, our consumption

tracking indicator is pointing to a 0.2% contraction (not annualized) in real consumer

spending in Q2 11 (Figure 3). Euro area growth is being slowed, in large part, by factors that

are likely to be sustained, such as tighter fiscal policy across almost all countries, as well as

a slowdown in foreign demand for autos, particularly in Asia, that seems related mainly to

tighter monetary policy and credit conditions there. This week, we modestly downgraded

our euro area growth forecast and now look for growth of 1.9% (from 2.0%) in 2011 and

1.6% (from 1.8%) in 2012. Despite the modest growth outlook, inflation remains above theECBs target, and, this week, it delivered another 25bp rate hike, as expected. We continue

to look for the ECB to pause for several months before raising rates again in December.

In China, the persistent monetary firming and resulting tighter credit conditions continue to

yield moderation in growth. The NBS PMI index fell to a 28-month low in June, and the

slowdown in China is clearly having an effect on exporters reliant on Chinese growth. For

example, this week Taiwanese trade data showed that exports to China slowed to 8% y/y in

Q2 11, the weakest pace in nearly two years (Figure 4). The PBoC remains focused on

inflation as the main policy risk, and this week delivered the rate hike we had been

expecting. While we believe the rate hike cycle is nearing an end, we do not rule out another

rate hike in Q3 11, especially if inflation fails to moderate as we expect. Overall, we expect

the PBoC to succeed in moderating Chinese growth, and look for a further slowing to 8.7%in 2012 from 9.3% this year. Thus, unlike in Japan and the US, where we believe growth has

slowed for temporary reasons, policy tightening in the euro area and China seems likely to

yield a more persistent slowing in growth.

Tighter fiscal policy in the euro

area means growth will slow

more persistently

Figure 3: Euro area consumption weakening in Q2 11 Figure 4: China slowing shows in Taiwan exports

-1.0

-0.5

0.0

0.5

1.0

1.5

99 00 01 02 03 04 05 06 07 08 09 10 11

Euro area private consumption % q/q

BarCap priv. cons. tracking indicator

Q2 estimate: -0.2% q/q

-50

-30

-10

10

30

50

70

90

Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11

40

42

44

46

48

5052

54

56

58

60Taiwan exports to China

China PMI manufacturing, rhs

4Q % change Index

Source: Eurostat, Haver Analytics, Barclays Capital Source: MoF, CFLP/NBS, Haver Analytics

Tighter monetary policy in China

is slowing growth in a

lasting way


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8 July 2011 5

GLOBAL RATES AND INFLATION

Central Bank rates

Official rate Next move

% per annum (unless stated) Current date level Last move expected 3Q 11 4Q 11 1Q 12 2Q 12

Advanced

Fed funds rate 0-0.25 Easing: 17 Sep 07 5.25 Dec 08 (-75-100) Jul 12 (+25) 0-0.25 0-0.25 0-0.25 0-0.25

BoJ overnight rate 0.10 Easing: 30 Oct 08 0.50 Oct 10 (0-10) Q1 13 (+20) 0-0.10 0-0.10 0-0.10 0-0.10

ECB main refinancing rate 1.50 Tightening: 7 Apr 11 1.00 Jul 11 (+25) Dec 11 (+25) 1.50 1.75 2.00 2.25

BOE bank rate 0.50 Easing: 6 Dec 07 5.75 Mar 09 (-50) May 12 (+25) 0.50 0.50 0.50 0.75

RBA cash rate 4.75 Tightening: 7 Dec 09 3.00 Nov 10 (+25) Q3 11 (+25) 5.00 5.25 5.25 6.25

Swiss National Bank 0.25 Easing: 8 Oct 08 2.75 Mar 09 (-25) Q3 12 (+25) 0.25 0.25 0.25 0.50

Norges Bank 2.25 Tightening: 29 Oct 09 1.25 May 11 (+25) Q3 11 (+25) 2.50 2.75 3.00 3.25

Riksbank 2.00 Tightening: 30 Jun 10 0.25 Jul 11 (+25) Q3 11 (+25) 2.25 2.50 2.75 3.00

Bank of Canada 1.00 Tightening: 1 Jun 10 0.25 Sep 10 (+25) Dec 11 (+25) 1.00 1.25 1.75 2.25

Emerging

China: Working capital rate 6.56 Tightening: 19 Oct 10 5.31 Jul 11 (+25) Q3 12 (+25) 6.56 6.56 6.56 6.56

Hong Kong: Base rate 0.50 Easing: 19 Sep 07 6.75 Dec 08 (-100) Beyond 2011 0.50 0.50 0.50 0.50

India: Repo rate 7.50 Tightening: 19 Mar 10 4.75 Jun 11 (+50) Q3 11 (+25) 7.75 7.75 7.75 7.75

Korea: Base Rate 3.25 Tightening: 9 Jul 10 2.25 Jun 11(+25) Sep 11 (+25) 3.75 3.75 3.75 3.75

Poland: 2w repo rate 4.50 Tightening: 19 Jan 11 3.50 Jun 11 (+25) Sep 11 (+25) 4.75 4.75 4.75 4.75

Russia: Refi rate 8.25 Tightening: 25 Feb 11 7.75 Apr 11 (+25) June 12 (-25) 8.25 8.25 8.25 8.00

South Africa: Repo rate 5.50 Easing: 11 Dec 08 12.00 Nov 10 (-50) Jan 12 (+50) 5.50 5.50 6.50 7.00

Turkey: 1wk repo rate 6.25 Easing: 20 Nov 08 16.75 Jan 11 (-25) Oct 11 (+25) 6.25 7.00 8.00 8.00

Brazil: SELIC rate 12.25 Tightening: 19 Jan 11 10.75 Jun 11 (+25) Jul 11 (+25) 12.75 12.75 12.75 12.75

Chile: Monetary policy rate 5.25 Tightening: 15 June 10 0.50 Jun 11 (+25) Jul 11 (+25) 5.50 5.50 5.50 5.50

Mexico: Overnight rate 4.50 Easing: 16 Jan 09 8.25 Jul 09 (-25) Apr 12 (+25) 4.50 4.50 4.50 5.00

Start of cycle Forecasts as at end of

Note: Rates as of COB 7 July 2011. Source: Barclays Capital

Key CPI projections

HICP

nsa y/y nsa y/y y/y nsa y/y y/y nsa y/y nsa y/y nsa y/y

Aug 10 218.3 1.1 224.5 4.7 3.1 109.54 1.53 1.6 119.97 1.32 302.06 0.9 99.1 -1.0

Sep 10 218.4 1.1 225.3 4.6 3.1 109.76 1.71 1.9 119.88 1.49 304.60 1.4 99.1 -1.1

Oct 10 218.7 1.2 225.8 4.5 3.2 110.16 1.84 1.9 120.03 1.52 305.57 1.5 99.5 -0.6

Nov 10 218.8 1.1 226.8 4.7 3.3 110.27 1.84 1.9 120.09 1.50 306.58 1.8 99.4 -0.5

Dec 10 219.2 1.5 228.4 4.8 3.7 110.93 2.14 2.2 120.61 1.69 308.73 2.3 99.4 -0.4

Jan 11 220.2 1.6 229.0 5.1 4.0 110.11 2.19 2.3 120.32 1.69 306.15 2.5 99.0 -0.2

Feb 11 221.3 2.1 231.3 5.5 4.4 110.57 2.28 2.4 120.90 1.61 308.02 2.5 98.9 -0.3

Mar 11 223.5 2.7 232.5 5.3 4.0 112.11 2.77 2.7 121.90 1.94 310.11 2.9 99.4 -0.1

Apr 11 224.9 3.2 234.4 5.2 4.5 112.75 2.89 2.8 122.32 2.02 311.44 3.3 99.8 0.6

May 11 226.0 3.6 235.2 5.2 4.5 112.74 2.76 2.7 122.40 1.97 312.44 3.5 99.9 0.6

Jun 11 225.6 3.5 236.0 5.3 4.5 112.67 2.71 2.7 122.45 2.02 312.36 3.4 99.7 0.4

Jul 11 225.6 3.5 235.9 5.5 4.6 112.17 2.62 2.7 122.27 2.16 312.05 3.7 99.6 0.6

Aug 11 226.2 3.6 237.1 5.6 4.5 112.51 2.71 2.8 122.71 2.28 312.27 3.7 99.7 0.6

Sep 11 226.7 3.8 238.8 6.0 5.0 113.02 2.97 2.9 122.82 2.45 314.69 3.6 99.4 0.3

Oct 11 226.4 3.5 240.0 6.3 5.1 113.43 2.97 3.0 123.18 2.62 316.20 3.8 99.5 0.0

Nov 11 226.3 3.4 241.2 6.3 5.1 113.47 2.90 2.9 123.19 2.58 316.39 3.5 99.4 0.0

Dec 11 226.4 3.3 241.3 5.6 4.5 113.89 2.67 2.7 123.61 2.49 317.29 3.1 99.5 0.1

Jan 12 227.0 3.1 240.4 5.0 3.8 112.75 2.40 2.5 123.03 2.25 316.45 3.4 99.1 0.1

Feb 12 227.8 2.9 241.9 4.6 3.4 113.03 2.22 2.3 123.35 2.03 318.01 3.2 99.1 0.2

Mar 12 228.6 2.3 243.4 4.7 3.5 114.17 1.84 1.9 124.02 1.74 319.39 3.0 99.6 0.2

2010 1.6 4.6 3.3 1.5 1.6 1.5 1.2 -1.0

2011 3.1 5.6 4.6 2.7 2.7 2.2 3.3 0.4

2012 2.4 4.3 2.9 1.7 1.8 1.6 3.1 0.2

US UK Euro area France

CPI HICPxRPI CPI

Sweden

CPI ex tobacco

Japan

CPI CPI ex perishibles

Note: Shaded values indicate actual data. R indicates revision to front-month forecast. Source: Barclays Capital


6/49


8 July 2011 6

GLOBAL MARKETS WATCH

Global Equities

Rates, Credit and Commodities Global FX

1-week

Index (% chng) Local Curr USD

Global Weighted Avg. 0.7 5.2 3.5

Developed Weighted Avg. 0.7 0.0 1.9

Emerging Weighted Avg. 0.7 7.9 5.7

BRIC Weighted Avg. 0.2 -7.6 0.2

United States S&P 500 2.5 21.4 21.4

Euro area FTSE Euro 100 1.1 4.3 4.5

Japan Nikkei 225 2.6 -4.5 8.6

UK FTSE 100 1.8 11.9 10.5

Emerging Asia Weighted Avg. 1.2 3.8 1.3

China Shanghai Comp. 1.2 -14.7 -10.0

India NIFTY 1.4 10.1 9.8

Korea KOSPI 3.8 29.6 41.8

EMEA Weighted Avg. 1.3 20.6 16.6

Russia MICEX 4.4 27.0 36.7

Turkey ISE 1.3 21.3 12.4

South Africa JALSH 1.4 16.7 29.4

Latin America Weighted Avg. 0.1 3.1 0.6

Brazil Bovespa -0.3 -9.3 1.7

Mexico IPC 0.1 13.9 12.4

% chng from 12/31/2009

Note: Updated as of COB 7 July 2011. Weighted averages calculated using IMFshare of world GDP. EM Asia includes China, India, HK, Indonesia, Korea,Malaysia, Singapore, Taiwan, Thailand and Vietnam. EMEA includes Russia,Czech Republic, Hungary, Poland, Romania, Turkey, Ukraine and South Africa.LatAm includes Brazil, Argentina, Chile, Colombia, Mexico, Peru and Venezuela.Source: Bloomberg, Barclays Capital

Key USD Exchange Rates

80

85

90

95

100

105

Jul-10 Oct-10 Jan-11 Apr-11 Jul-11

Index: July 7 2010 =100

USD/JPY

USD/EUR

USD/GBP

US Treasury Yields

0

2

4

6

%

3m 2yr 5yr 10yr 30yr

Jul 1, 2007

Jan 1, 2008

July 7, 2011

Source: Bloomberg, Barclays Capital

1 week 3 months 12 months

Latest ago ago ago

Rates

2 year Treasury 0.47 0.46 0.78 0.63

10 year Treasury 3.14 3.16 3.55 2.98

30 year Treasury 4.37 4.37 4.62 3.96

Overnight LIBOR 0.12 0.13 0.16 0.29

3-month LIBOR 0.25 0.25 0.29 0.53

Spread 3M LIBOR over 3M OIS 0.14 0.13 0.17 0.34

Credit

Barclays Global Aggregate 68.8 67.5 56.3 63.0

Barclays US Aggregate 56.1 56.1 49.2 56.6

Barclays EM Aggregate 297.3 301.1 266.0 360.9

Barclays US Credit 138.7 141.5 127.7 178.7

Barclays US Corporate IG 150.9 154.6 137.5 192.2

Commodities

CRB/Reuters Commodities Index 553.4 550.3 578.1 419.9

WTI 98.67 95.42 110.30 74.07

Gold 1532.4 1500.4 1458.1 1202.8

Barclays Metals Total Return Index 170.1 166.0 169.0 121.8

Barclays Agri. Total Return Index 173.7 170.4 188.9 120.3

Note: Updated as of COB 7 July 2011. Barclays indices expressed in option-adjusted spreads. Source: Bloomberg, Barclays Capital

1-week 3-month 12-month

Spot % Chg. % Chg. % Chg.

G7 Rates

DXY Dollar Index 74.96 0.9 -0.8 -10.6

EUR/USD 1.44 -1.0 0.4 13.7

USD/JPY 81.25 0.9 -4.3 -7.4

GBP/USD 1.60 -0.5 -2.1 5.2

USD/CHF 0.84 0.5 -7.9 -19.7

USD/CAD 0.96 -0.5 0.1 -8.4

USD/AUD 0.84 0.5 -7.9 -19.7

USD/NZD 1.20 -0.5 -6.6 -15.6

Selected EM Rates

USD/KRW 1064 -0.3 -2.2 -13.0

USD/CNY 6.47 0.0 -1.2 -4.6

USD/BRL 1.55 -0.6 -2.0 -12.1

USD/RUB 27.91 0.2 -1.1 -10.1

USD/INR 44 -0.6 0.5 -5.6

USD/TRY 1.62 -0.4 7.0 4.2

USD/MXN 11.54 -1.5 -2.0 -10.1

Note: Updated as of COB 7 July 2011. DXY Dollar Index consists of EUR (57.6%),JPY (13.6%), GBP (11.9%), CAD (9.1%), SEK (4.2%) and CHF (3.6%).Source: Bloomberg, Barclays Capital


7/49


8 July 2011 7

OUTLOOK: UNITED STATES

A production turn: To everything there is a season

A V-shaped recovery appears to be taking hold in Japan, easing supply chaindisruptions to auto production and sales in the US.

However, the US private sector is behaving cautiously; nominal consumer spendinggrowth has held up, but labor market conditions took another step back in June.

The outcome of the debt ceiling negotiations and the potential for a cautiousconsumer remain the most pressing risks to a second-half recovery.

Given the link between supply constraints in Japan and the slowdown in US growth, it is

worth monitoring developments in Japan that may foreshadow a turn in US production.

Incoming data in Japan suggest that a recovery from the steep earthquake-induced

slowdown in March and April is underway. New auto sales rose a seasonally adjusted 29.5%

and 15.7% in May and June, respectively, and core private-sector machinery orders rose

3.0% in May after falling 3.3% in April. These data come on the heels of last weeksindustrial production report, which indicates that Japanese output is now close to pre-

earthquake levels. Although uncertainties remain, our Japan economists continue to expect

a V-shaped recovery to take hold in the second half of this year and extend into Q1 12.

A time to rebuild

If the incoming data in Japan are indicative of a turning point, then the constraints on US

growth from supply chain disruptions should begin to ease. As we write this week in Auto

sector getting out of reverse gear, supply chain disruptions have had a significant effect on US

vehicle output. Figure 1, for example, shows that the main source of weakness in the April

report on industrial production was autos; we expect the disruption to persist in the May and

June data as automakers return to pre-earthquake production levels. Altogether, we estimate

that the decline in auto production, largely confined to US-based Japanese automakers,

shaved 0.5-1.0pp off Q2 GDP growth. However, we expect the recovery in auto production to

accelerate in July, potentially boosting Q3 GDP growth as much as 1.0-1.5pp.

Michael Gapen


Figure 1: Supply chain disruptions on auto production

should peak in the second quarter

Figure 2: Comparable chain store sales suggest nominal

spending growth has held up

-0.4

-0.2

0.0

0.2

0.4

0.60.8

1.0

1.2

Jun-10 Sep-10 Dec-10 Mar-11 Jun-11

Manufacturing

Manufacturing ex autos

% m/m

f/c

-10

-8

-6

-4

-2

0

24

6

8

10

05 06 07 08 09 10 11

Chain store sales (ex-Walmart)

Core retail sales6m/6m % chg, saar

Source: Federal Reserve, Haver Analytics Source: ICSC, Census Bureau, Haver Analytics

A V-shaped recovery

appears underway in Japan

Auto production is

set to rebound in July


8/49


8 July 2011 8

A time for resilience, a time for caution

A rebound in auto production is only one part of an expected turn in activity. As we have

frequently written, soft goods production often follows soft goods consumption: the slow

start to goods production in Q2 was also related to the surge in headline inflation that

caused a moderation in real goods consumption in Q1. After rising only 0.4% in April and

declining 2.5% in May, comparable chain store sales rose 1.8% m/m in June (7.0% y/y). As

shown in Figure 2, comparable chain store sales are often a good indicator for the trend in

core retail sales and suggest nominal consumer spending has remained resilient. The

expected rebound in auto sales and the moderation in headline inflation suggest stronger

real consumption in the months ahead. As shown in Figure 3, both ISM indexes remain in

expansionary territory, suggesting that manufacturers see the slowdown as short-lived.

However, the corporate sector has clearly turned much more cautious. The June

employment report, in which private payrolls expanded only 57k, and the May reading,

which was revised lower, to 75k, provide further indication that labor market conditions

have weakened. In addition to tepid payroll growth, the report suggests that growth in

nominal income may have slowed (Figure 4). The softer trend in the payroll proxy for labor

income (hours worked times average hourly earnings) and worsened employment

prospects, if persistent, may cause households to follow the corporate sector and become

more cautious in regards to their spending plans.

A time to agree (its not too late)

Altogether, while the data at home and abroad points toward a rebound in production, several

risks to a broader H2 recovery remain. An important near-term one is the debt ceiling

negotiations, which have likely become more difficult in the face of a weaker job market, as the

administration will be less likely to accept an outcome that threatens the recovery. A failure to

reach an agreement to raise the debt ceiling would certainly curtail growth in H2 11. If an

agreement is reached, the risk to growth in 2012 from fiscal consolidation is still uncertain,

since the details of the composition and timing of the re-profiling of revenues and

expenditures remain in flux. A second risk, highlighted above, is that consumers turn cautiousand push the saving rate higher while reducing expenditures on durables. We will continue to

monitor these risks and look for better real GDP growth in H2 11 as the most likely outcome.

Consumers remain resilient, but

labor market conditions

worsened further

Figure 3: Both ISM indexes remain in expansion territory Figure 4: Growth in labor income may have softened in June

30

35

40

45

50

55

60

65

05 06 07 08 09 10 11

ISM manufacturing indexISM nonmanufacturing index

Diffusion index

-15

-10

-5

0

5

10

15

05 07 09 11

Wage and salary incomePayroll proxy (agg hours * avg hourly earnings)

3m/3m % chg, saar

Note: Shading indicates recession. Source: Institute of Supply Management,Haver Analytics

Note: Shading indicates recession. Source: BLS, Haver Analytics

and the corporate sector

has turned cautious

The pendulum has swung in the

direction of fiscal consolidation


9/49


8 July 2011 9

IN FOCUS: UNITED STATES

Auto sector getting out of reverse gear

The auto sector will be a sizable drag on Q2 GDP growth, but output started to rebound

at the end of June and is set to rise further in July, suggesting a significant boost to Q3GDP growth.

Supply chain disruptions in the aftermath of the Japan earthquake have had a significant

effect on US vehicle output. Auto production declined 9.3% m/m in April and a further 1.5%

in May. Another drop is expected in June. This is likely to translate into a sizable drag on Q2

GDP growth and has had broader implications, too: auto inventories have fallen sharply

among Japanese producers, imports from Japan were down a record $3.0bn (nsa) in April,

and auto sales fell in May and June. However, disruptions have begun to ease and

production should bounce back during Q3, providing a boost to Q3 GDP growth.

A rebound in auto production should become clear in July

The cut in production has been centered in the US-based plants of Japanese producers (thethree largest Toyota, Honda and Nissan account for about 40% of car output and 20%

of truck output). Weekly production data compiled by Automotive News show that Honda,

for example, cut output sharply during April, and Toyota halted production altogether for

the first week of June. As disruptions have eased, Toyotas production has rebounded,

although Honda remains at about half of pre-disruption levels (Figure 1). The effect on

domestic producers, meanwhile, has been much smaller (Figure 2).

Monthly production schedule data from Wards suggest a more significant increase is likely

among the Japanese producers in July. Allowing for seasonal factors and differences

between the two data sources, the Wards production schedules point to about a 15-20%

m/m (sa) increase in auto output in July, although they suggest that another small decline is

likely in June (Figure 3).

providing a boost to Q3 GDP growth

All in all, schedule data point to a solid recovery by the end of Q3, consistent with a rebound

of about 65% q/q (saar), following a decline of about 27% in Q2.

Peter Newland


Supply chain disruptions have hit

auto output

specifically among the US-based Japanese producers

Production schedules point to a

strong rebound in July

Figure 1: Honda and Toyota cut output sharply Figure 2: but US producers have been largely unaffected

0

4

8

12

16

20

24

Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11

Honda Toyota000s, nsa

0

20

40

60

80

100

120

Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11

US makes

Japanese makes

000s, nsa

Source: Automotive News, Barclays Capital Source: Automotive News, Barclays Capital

which should boost Q3

GDP growth


10/49


8 July 2011 10

What does this mean for GDP?

Auto production has accounted for about 2.5% of GDP in recent quarters, so the pattern

suggested above points to a drag on growth of 0.5-1.0pp (annualized) in Q2 and a boost

of 1.0-1.5pp in Q3 (allowing for the fact that the monthly measures of output and

production schedules do not map one-for-one to the series in the GDP report and tend to

be more volatile).

While significant, this is far from unprecedented the auto sector may be relatively small,

but volatility in production and inventory levels have dominated the growth picture in

several quarters in the past. Indeed, the sector contributed more than 1pp to the 1.8% GDP

growth recorded in Q1 this year. Looking further back, vehicle production was a large drag

on growth at the height of the recession in late 2008 and early 2009, reflecting the closure

of GM and Chrysler plants which were both forced to file for bankruptcy protection on the

back of a sharp and sudden drop off in demand. However, aided by government support

and the boost to sales from the cash for clunkers program, output rebounded sharply in

the second half of 2009, a key factor behind the emergence of the economy from recession

(Figure 4).

The expenditure side of the national accounts paints a similar picture

Looking at GDP from the expenditure side (as we do with our tracking estimate) the drop in

auto sales in May and June will materially hit real consumer spending in Q2. Sales fell to

11.8m (saar) units in May and 11.5m in June from 13.1m in April. Again it was the US-based

Japanese producers who were hit hardest. For example, sales at Honda and Toyota were

down about 20% y/y in June, compared with gains of 5-10% at GM and Ford. This suggests

that supply constraints played a significant role. In addition, press reports have highlighted a

cut in incentives and a rise in prices in response to the supply effect as hitting sales more

broadly. Our equity analysts expect a rebound during Q3, driven by the Japanese producers.

Meanwhile, auto inventory accumulation looks set to be a drag on Q2 growth, although this

is likely to be partially offset by a stronger trade picture in part reflecting the drop in

imports from Japan. All in all, our GDP tracking estimate currently suggests that the risks to

our 2.0% forecast for Q2 growth are tilted to the downside, but an auto-driven rebound in

Q3 looks increasingly likely.

The auto sector has distorted

GDP growth in the past

The associated drop in auto

sales will hit Q2 consumption

Figure 3: Auto output and production schedules Figure 4: Motor vehicle contribution to GDP growth

70

75

80

85

90

95

100

Ja n-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr -11 Jul-11

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0IP auto production (lhs)

Ward's production schedule (rhs)

Units, mil (saar)Index (sa), 2007=100

-2

-1

0

1

2

Q198 Q100 Q102 Q104 Q106 Q108 Q110

pp

Forecasts

Source: Federal Reserve, Wards, Barclays Capital Source: BEA, Barclays Capital

but should also rebound in Q3


11/49


8 July 2011 11

DATA REVIEW & PREVIEW: UNITED STATES

Dean Maki, Michael Gapen, Troy Davig, Peter Newland

Review of last weeks data releases

Main indicators Period Previous Barclays Actual Comments

Factory orders, %m/m May -0.9 R 0.9 0.8 Factory orders improved significantly, as we expected

ISM non-manufacturing index Jun 54.6 54.5 53.3 Mixed signals: lower headline, but solid employment

ADP private employment, chg, thous Jun 38 157 Strong, but a misleading signal for the BLS report

Initial jobless claims, thous (4wma) 1-Jul 429 (426) 425 418 Jobless claims declined by more than expected

Nonfarm payrolls, chg, thous Jun 25 R 75 18 Very weak employment report

Private nonfarm payrolls, chg, thous Jun 73 R 100 57 Declines in construction and finance payrolls

Unemployment rate, % Jun 9.1 9.1 9.2 Fully reflected weakness in employment

Average hourly earnings, % m/m (y/y) Jun 0.3 (1.9) R 0.1 (1.9) 0.0 (1.9) Payroll proxy of labor income rose 4.6% in Q2

Average weekly hours Jun 34.4 34.4 34.3 Aggregate hours rose 2.8% in Q2

Preview of the next week

Monday 11 July

No significant events or data releases scheduled

Tuesday 12 July Period Prev 2 Prev 1 Latest Forecast Consensus

8:30 Trade balance, $bn May -46.0 -46.8 -43.7 -43.5 -44.1

14:00 Fed releases minutes from June 21-22 FOMC meeting

Trade balance: The ISM imports index suggests modest real import growth in May. And given that import prices rose that

month, we also expect a rise in nominal imports. The ISM export index still points to steady export growth, though it was slightly

softer in May relative to its much stronger readings earlier in the year. Export prices slightly outpaced import prices in May,

leading us to forecast a modest narrowing of the trade deficit, from $43.7 to $43.5bn.

FOMC minutes: We look for the minutes of the June FOMC meeting to provide additional insight into the committees view that

much of the slowing in recent months stemmed from the temporary impact of higher commodity prices and supply-chaindisruptions from the earthquake in Japan. Given the chairmans heavy focus on commodity prices in his June 7 speech in Atlanta

and the dropping of a reference to core or underlying inflation in the statement, we look for the minutes to provide additional

context on the determinants of commodity price pressures, the relative advantage of focusing on core versus headline inflation,

and the recent behavior of actual and expected inflation. Finally, we look for the minutes to suggest that the trade-off for further

stimulus has worsened and that the bar for additional asset purchases remains high.

Wednesday 13 July Period Prev 2 Prev 1 Latest Forecast Consensus

8:30 Import prices, % m/m (y/y) Jun 3.0 (10.3) 2.1 (11.4) 0.2 (12.5) -0.4 (13.3) -0.7 (13.3)

9:10 Boston Fed President Rosengren (FOMC non-voter) speaks on economic outlook in Worcester

10:00 Fed Chairman Bernanke delivers semi-annual monetary policy report to house

13:20 Dallas Fed Fisher (FOMC voter) speaks on economy in Dallas

14:00 Treasury budget balance, $bn Jun 33.5 (08) -94.3 (09) -68.4 (10) -66.0 (11) -65.0 (11)

Import prices:We expect a 0.4% decline in import prices in June. This largely reflects a decline in petroleum prices, partly offsetby our expectation of a 0.3% rise in ex-petroleum prices, reflecting a softer dollar and rising cost pressures abroad.

Treasury budget balance: We forecast the June federal deficit to be $66bn, bringing it to $993bn for the first nine months of the

current fiscal year.

Thursday 14 July Period Prev 2 Prev 1 Latest Forecast Consensus

8:30 PPI, % m/m (y/y) Jun 0.7 (5.8) 0.8 (6.8) 0.2 (7.3) 0.0 (7.4) -0.2 (7.4)


12/49


8 July 2011 12

8:30 Core PPI, % m/m (y/y) Jun 0.3 (1.9) 0.3 (2.1) 0.2 (2.1) 0.2 (2.1) 0.2 (2.2)

8:30 Retail sales, % m/m Jun 0.8 0.3 -0.2 -0.2 0.0

8:30 Retail sales excluding autos, % m/m Jun 1.2 0.5 0.3 -0.1 0.1

8:30 Core retail sales, % m/m Jun 0.6 0.3 0.2 0.3 0.4

8:30 Initial jobless claims, thous (4wma) 8-Jul 429 (426) 432 (428) 418 (425) 415 (424)

10:00 Fed Chairman Bernanke delivers semi-annual monetary policy report to Senate

10:00 Business inventories, % m/m May 0.7 1.3 0.8 0.8 0.6

PPI:We expect a 0.0% reading on the headline PPI in June, and a 0.2% rise in the core PPI. Within non-core items, a sizeable dropin gasoline prices during the month should be partly tempered by the rebound we expect in food prices (following a 1.4% decline

in May). Within the core, our 0.2% forecast is consistent with our view that pipeline price pressures are gradually building across

most consumer-related components.

Retail sales:We expect retail sales to fall 0.2% in June, reflecting declines in auto and gasoline sales. On the former, reports showthat sales were down sharply among US-based Japanese producers during the month, suggesting that supply constraints in the

aftermath of the earthquake in Japan were again a factor. On the latter, the decline in gasoline prices is likely to be reflected in

nominal sales, too. Excluding autos, gasoline and building materials, we are looking for a solid 0.3% increase in the core retail

sales measure, consistent with the rebound in weekly chain store sales during June.

Friday 15 July Period Prev 2 Prev 1 Latest Forecast Consensus

8:30 CPI, % m/m (y/y) Jun 0.5 (2.7) 0.4 (3.2) 0.2 (3.6) -0.3 (3.5) -0.1 (3.6)

8:30 Core CPI, % m/m (y/y) Jun 0.1 (1.2) 0.2 (1.3) 0.3 (1.5) 0.2 (1.5) 0.2 (1.6)

8:30 CPI, NSA index Jun 223.467 224.906 225.964 225.6

8:30 Empire State mfg index Jul 21.70 11.88 -7.79 10.00 4.00

9:15 Industrial production, % m/m Jun 0.6 0.0 0.1 0.3 0.4

9:15 Capacity utilization, % Jun 76.8 76.7 76.7 77.0 77.0

9:55 U. Michigan consumer sentiment index Jul p 69.8 74.3 71.5 73.0 72.5

CPI:We expect a 0.3% decline in the CPI and a 0.2% increase in the core CPI in June, consistent with an NSA CPI index print of225.6, down from 225.964 in May. Within non-core components, we expect a significant negative contribution from gasoline

prices, with the decline during the month likely to be amplified by a negative seasonal factor. We expect this to be only partly

offset by a small positive contribution from food prices. Within the core, we expect the recent trend of small increases in the

heavily weighted Owners Equivalent Rent (OER) index to continue, boosting core services prices. Meanwhile, core goods inflation

is likely to come in softer than May, when prices were boosted by sharp gains in the volatile apparel and vehicle components.

Empire State manufacturing:We expect the Empire State manufacturing index to rebound to 10.0 in July after falling to -7.8 in June. Growth in manufacturing activity slowed sharply during Q2, but we think this stemmed largely from transient factors,

including supply disruptions in the auto sector. We expect a rebound in Q3.

Industrial production: We expect industrial production to rise 0.3% and manufacturing output to rise 0.2% in June.Manufacturing activity was hit by a decline in auto production in April and May, resulting from supply-chain disruptions following

the earthquake in Japan. We expect another small drop in auto output in June. However, strength in the ISM manufacturing

survey points to solid growth in manufacturing activity more broadly.

University of Michigan consumer sentiment: We expect the University of Michigans index of consumer sentiment to increase to

73 (previous: 71.5) in the July preliminary survey. We see the recent rally in equity markets and lower gasoline prices as the main

factors driving the improvement. The stabilization of gasoline prices should lead to some further moderation of near-term

inflation expectations.


13/49


8 July 2011 13

OUTLOOK: EURO AREA

Austerity hurts and inflation bites

Following the strong growth in Q1 this year, and given what we believe was a weakQ2, real GDP growth in H2 is set to be more modest than thought previously.

Even in Germany so far the powerhouse of growth among the large core countries indications increasingly suggest that its activity expansion is about to moderate notably.

Despite this, the ECB remains in gradual tightening mode so as to normalise rates.After yesterdays rate hike, we expect another 25bp hike to occur in December.

Following its very strong first quarter activity expansion (Q1 real GDP growth reached

0.84%), euro area growth faced increasing headwinds in the second quarter, suggesting

that real GDP growth slowed to 0.3% in Q2. This was not a surprise: the previous growth

pace was unsustainable, driven to a large extent by the favourable effects of unwinding

weather-induced distortions to construction and transport activity, and supported by still-

strong foreign demand.

Rising inflation and higher financing costs have started to erode domestic purchasing

power, as evidenced by weak car and retail sales (Figures 1 and 2). Moreover, the adverse

effects of fiscal austerity applied across almost all euro area countries, a broad-based

slowdown in foreign demand (partially reflecting temporary adverse effects in Japan and the

US, but also weaker demand in large parts of Asia for consumer durables such as cars) and

rising uncertainties related to the resolution of problems faced by the periphery countries

(most notably Greece, Portugal and Ireland) have been and are likely to continue to be a

drag on real GDP growth. This weeks (surprisingly ambitious) announcement by Italy of

EUR68bn in additional fiscal tightening over the next three years proves a good case in point

in this regard.

Along those lines, we expect Germany so far the powerhouse of growth and the main driving

force behind above-potential growth in the euro area to expand more modestly. In fact,

survey indicators have been pointing to growth moderation in the quarters to come, and

recent factory orders have revealed a notable slowdown in foreign demand (Figures 3 and 4),

Frank Engels

+49 (0)69 7161 [email protected]

Real GDP growth has been

facing increasing headwinds

Rising inflation, fiscal austerity

and slowing foreign demand are

the main drivers of this

deceleration in growth

Figure 1: Car sales have taken a turn weaker Figure 2: as have euro area retail sales

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

00 01 02 03 04 05 06 07 08 09 10 11

Germany

Italy

France

Spain

85

90

95

100

105

110

115

120

125

130

05 06 07 08 09 10 11

France

Ireland

EuroGermany

Greece

Portugal

Italy

Spain

Source: Haver Analytics, Barclays Capital Source: Haver Analytics, Barclays Capital

Germany likely to expand

more modestly


14/49


8 July 2011 14

while domestic demand held up reasonably well. Similarly, car and truck production, as well

as vehicle exports, have turned lower in Q2, thus resembling recent trends in car sales in

important export markets, specifically of German car producers across Asia (for more

details, see Emerging Asia: Auto sales - Pulling over, 6 July 2011). As a consequence, we

have lowered our euro area growth forecasts moderately for Q3 and Q4 11 (by 0.1pp each)

and for 2012 (by 0.2pp), thus implying annual real GDP growth rates of 1.9% and 1.6%,

respectively. Weaker private consumption and foreign demand growth are the main driversbehind this revision.

The recent decline in the macro momentum has not gone unnoticed by the ECB in its policy

statement. The tone of the economic analysis has been softened somewhat to reflect the

weaker incoming data and greater uncertainty. Despite this, as widely expected, the ECB

announced a 25bp increase in its policy rate from 1.25% to 1.50%, arguing that medium-

term inflation risks were still skewed to the upside and the risk of second-round inflation

pressures thus had to be addressed, particularly since monetary liquidity remained ample

and the overall policy stance still accommodative. Moreover, in line with our expectations,

the ECB provided no further indications as to future policy adjustments and reiterated that

uncertainty remained elevated. Against this backdrop, we continue to expect the ECB to

pause the tightening cycle until late this year, with the next 25bp rate hike most likely inDecember. As in previous ECB policy meetings, the tensions in European government bond

markets did not feature prominently in the introductory statement, even though the ECB

decided to lift minimum rating restrictions on Portuguese debt pledged as collateral in its

repo operations. Instead, the crisis in the periphery received focal attention at the press

conference. It became clear that the ECB remains of the view that fiscal policies ought to

address the problems and that any euro area-wide solution would need to be sought and

coordinated by euro area governments. We take issue with this stance because, in our view,

even marginally negative news such as this weeks rating downgrade of Portugal by

Moodys results in substantial spread widening across periphery bonds, reflecting poor

liquidity. We believe that European policymakers need to realise that both the EFSF and ECB

should lend support to liquidity and prices of periphery sovereign bonds to contain

financing costs and, thereby, limit contagion.

The recent decline in the macro

momentum has not gone

unnoticed by the ECB

yet the policy rate has been

raised to 1.5%

Minimum rating restrictions on

Portuguese debt have been

suspended by the ECB

We believe it is time for European

policymakers to address the lack

of price and liquidity support in

periphery bond markets

Figure 3: Foreign core manufacturing orders and Ifoexpectations seem to roll over

Figure 4: and PMI survey information points to downsiderisks to future growth

0

20

40

60

80

100

120

140

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

-50

-40

-30

-20

-10

0

10

20

Foreign Manufacturing Core

Orders, LHS

IFO Business expectat ions,

RHS

-5

-4

-3

-2

-1

0

1

2

3

Nov-01 May-03 Nov-04 May-06 Nov-07 May-09 Nov-10

PMI productionPMI new orders - finished goods inventoryManufacturing production

Source: Haver Analytics, Barclays Capital Source: Markit, Haver Analytics, Barclays Capital
https://live.barcap.com/go/publications/content?contentPubID=FC1726273https://live.barcap.com/go/publications/content?contentPubID=FC1726273


15/49


8 July 2011 15

DATA REVIEW & PREVIEW: EURO AREA

Julian Callow, Fabio Fois, Frank Engels, Franois Cabau, Marion Laboure, Marcus Widen, Thorsten Polleit


Main indicators Period Previous BarCap Actual Comments

E17: PPI, % m/m (y/y) May 0.9 (6.7) R -0.1 - 0.2 (6.2) Shows further evidence of pipeline pressure

E17: Retail sales, % m/m (y/y) May 0.7 (0.8) R -1.3 -1.1 Imply weakness in private consumption in Q2

E17: Final composite PMI, index Jun 53.6 P 53.6 53.3New orders index at its lowest level sinceNovember 2009; services should be the mainsupport to growth in Q2

Sweden: Interest rates announcement, % Jul 1.75 2.00 2.00

Hiked the repo rate to 2.0%, and left its policy rateforecast unchanged, implying a high probability oftwo more hikes during the three remaining meetingsthis year and further normalisation during 2012

E17: Final GDP, % q/q Q1 0.8 P 0.9 0.8 No revision from the preliminary figure

Germany: Factory orders, %m/m (y/y) May 2.9 (10.6) -1.3 (8.7) 1.8 (12.2)Owing to strong rise in domestic capital goodsorders; foreign orders down strongly

France: Trade balance, bn May -7.2 R -5.7 -7.4 French export momentum fades

Germany: Industrial production, % m/m May -0.8 R 0.7 (7.2) 1.2Industrial production growth has remainedresilient for now despite global headwinds

E17: ECB Interest rate announcement, % Jul 1.25 1.50 1.50 As widely expected

Germany: Trade Balance sa, bn May 11.9 R 12.1 12.8 Defying global trends

Italy: Industrial production, % m/m May 1.1 (3.8) R -0.5 (2.1) -0.6 (1.8)May's decline in IP still consistent with positive q/qGDP growth in Q2

Preview of week ahead

Sunday 10 July Period Prev 2 Prev 1 Latest Forecast Consensus

06:30 E17: ECB President Trichet speaks at the annual Aix-en-provence economic forum in France

07:15 Global: Banque de France Governor Noyer & OECD Secretary General Gurria speak at Economic Forum in France

Monday 11 July Period Prev 2 Prev 1 Latest Forecast Consensus- EU: Eurogroup meeting

- France: French Senate examines revised bill seeking to impose constitutional rules on balancing the Government's Budget

13:00 E17: Banque de France Governor Noyer speaks on security of payment cards

15:00 E17: ECB Executive Board member Bini Smaghi speaks at a panel debate organised by the Ruling Companies Association

06:45 France: Industrial production, % m/m (y/y) May 0.4 (5.8) -1.1 (3.2) -0.3 (2.6) 0.5 0.5

08:00 Norway: CPI, % m/m (% y/y) Jun 0.3 (1.0) 0.5 (1.3) -0.2 (1.6) - -

Euro area Eurogroup/Ecofin meetings: We expect the Eurogroup/Ecofin meetings to focus on the results of the EU bank stress

tests and discuss implications for possible backstops. The meeting will also focus on the ongoing discussions with the private

sector on private sector involvement (PSI) and how to proceed on Greece.

France Industrial Production: We forecast French industrial production to have increased 0.5% m/m (+0.5% y/y) in May

(consensus: 0.5%; previous: -0.3% m/m and 2.6% y/y), led by a 0.3% m/m (+4.2% y/y) increase in manufacturing production

and a 3.7% m/m (-4.7% y/y) increase in energy production. Such an outcome would leave April-May industrial production 0.7%

below Q1 (which itself was 1.8% above Q4).


16/49


8 July 2011 16


- EU: EU Economic & Financial Affairs Council (ECOFIN) Meeting in Brussels

07:30 EU: EU Competition commissioner Almunia testifies before EU Parliament's economic committee

05:30 France: HICP, % m/m (y/y) Jun 0.9 (2.2) 0.4 (2.2) 0.1 (2.2) 0.0 (2.2) 0.0 (2.2)

05:30 France: CPI, % m/m (y/y) Jun 0.8 (2.0) 0.3 (2.1) 0.1 (2.0) 0.0 (2.1) -

05:30 France: CPI ex tobacco index Jun 121.90 122.32 122.40 122.45 -

06:00 Germany: Final HICP, % m/m (y/y) Jun 0.3 (2.7) -0.2 (2.4) 0.0 (2.4) P 0.0 (2.4) 0.0 (2.4)

06:00 Germany: Final CPI, % m/m (y/y) Jun 0.2 (2.4) 0.0 (2.3) 0.1 (2.3) P 0.1 (2.3) 0.1 (2.3)

07:30 Sweden: CPI Headline, % m/m (y/y) Jun 0.7 (2.9) 0.4 (3.3) 0.2 (3.3) -0.1 (3.2) -

07:30 Sweden: CPIF, % m/m (y/y) Jun 0.4 (1.5) 0.4 (1.8) 0.1 (1.7) -0.1 (1.6) -

09:00 Portugal: HICP, % m/m (y/y) Jun 1.6 (3.9) 0.6 (4.0) -0.1 (3.7) 0.1 (3.6) -

Sweden CPIF: We expect Swedish headline CPI to decrease 0.1% m/m, bringing the inflation rate to 3.2% y/y. On the Riksbank

preferred inflation measure, CPIF, we also forecast a decrease of 0.1% m/m with an inflation rate of 1.6%, slightly lower than the

Riksbank's forecast of 1.7% y/y.


07:00 Spain: Final HICP, % m/m (y/y) Jun 0.9 (3.5) -0.1 (3.4) 3.0 P -0.2 (3.0) -0.2 (3.0)

09:00 E17: Industrial production, % m/m (y/y) May 0.6 (7.8) 0.0 (5.8) 0.4 (5.5) 0.6 -Euro area Industrial production: We look for euro area industrial production to increase by 0.6% m/m in May (consensus:

+0.5% m/m), after a modest +0.4% m/m rise in the first month of the quarter. This would then leave industrial production in

May 1.2% above Q1. Assuming a flat reading in June, this would thus be consistent with industrial production having slightly

slowed down in Q2 from 1.8% q/q in Q4 to 1.2% q/q in Q1 and 1.0% q/q in Q2.


- Global: EU/IMF/ECB hold press conference on Irish progress

- France: Bank holiday (National Day)

08:00 E17: ECB publishes monthly bulletin Jul

06:00 Finland: HICP, % m/m (y/y) Jun 0.6 (3.5) 0.2 (3.4) -0.1 (3.4) 0.1 (3.3) -

07:00 Slovakia: HICP, % m/m ( y/y) Jun 0.4 (3.8) 0.5 (3.9) 0.3 (4.2) 0.1 (4.3) -

08:00 Austria: HICP, % y/y Jun 1.2 (3.3) 0.6 (3.7) -0.1 (3.7) -0.1 (3.6) -

08:00 Italy: Final HICP, % m/m (y/y) Jun 1.0 (2.9) 0.2 (3.0) 0.1 (3.0) P 0.1 (3.0) 0.1 (3.0)

08:00 Italy: Final CPI, % m/m (y/y) Jun 0.5 (2.6) 0.1 (2.6) 0.1 (2.7) P 0.1 (2.7) 0.1 (2.7)

09:00 E17: Final HICP, % m/m (y/y) Jun 0.6 (2.8) 0.0 (2.7) (2.7) P -0.1 (2.7) 0.0 (2.7)

09:00 E17: HICP ex tobacco, index (2005 = 100) Jun 112.11 112.75 112.74 112.67 -

09:00E17: 'Eurostat' core (HICP x fd, alc, tob, ene), %m/m (y/y) Jun

1.4 (1.3) 0.5 (1.6) 0.0 (1.5) 0.0 (1.5) -

10:00 Ireland: HICP, % m/m (y/y) Jun 0.5 (1.2) 0.3 (1.5) 0.0 (1.2) 0.1 (1.4) -

Euro area HICP: We are in line with the consensus in expecting the euro area final HICP to be confirmed at 2.7% y/y in June,

unchanged versus May, though we are slightly below-consensus in expecting it to have declined -0.1% on the month against

market expectations for a flat reading. Also in line with the consensus, we expect the Eurostat core HICP to have held steady at

1.5% y/y. We project the euro area HICPx to have to have edged down to 112.67 from 112.74 (no consensus available).Friday 15 July Period Prev 2 Prev 1 Latest Forecast Consensus

- EU: European bank stress test results expected to be released

10:00 E17: ECB Executive Board member Bini Smaghi inaugurates an art exhibition

06:00 EU 27: New car registrations, % y/y Jun -5.0 -4.1 7.1 - -

09:00 E17: Trade balance, bn (sa) May -2.7 -2.2 -2.9 -1.6 -3.3

Euro area Trade balance: Notably, on the back of a 0.9bn increase in the German trade balance surplus to 12.8bn, and only

a slight increase of the French trade deficit by 0.2bn in May, we expect the euro area trade deficit to improve from 2.9bn to

1.6bn, which would therefore more than offset last months increase from -2.2bn.


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8 July 2011 17

OUTLOOK: UNITED KINGDOM

Q1 wan, Q2 too

The available data suggest that growth in Q2 was even weaker than the disappointing0.5% expansion in Q1, and we now expect growth to have been just 0.2% q/q.

The PMIs point to a slowing in Q2, and the available official data on services,construction and IP similarly point to a weak GDP estimate.

Such tepid growth rates are likely to keep the MPC nervous about tighteningmonetary policy and to increase the pressure for a further expansion of QE.

The UK data conveyor belt has paraded a long line of disappointing activity numbers. The

weather-related contraction in Q4 10 was followed by only a pallid rebound in Q1, implying

zero growth over the two quarters. The indicators for Q2 have been similarly unimpressive.

This week we received the final set of PMIs for Q2 and the last of the official data that will

feed into the first estimate of Q2 GDP, which is due to be published on 26 July. Although it is

important to be mindful of the uncertainty surrounding forecasts of preliminary GDPestimates, the indications so far are that Q2 growth was lower than the 0.5% q/q in Q1, and

we now expect growth to have been just 0.2% q/q (our previous forecast was 0.3%).

Our composite PMI was 53.7 in Q2, down from 56.6 in Q1. A mechanical mapping across to

GDP points to a 0.3% q/q expansion, which is a touch above our new forecast (Figure 1).

The drop-off in momentum was largest in manufacturing, for which the output index fell

from 61.6 in Q1 to 53.0 in Q2, the largest quarterly decline in its 19-year history. The

services and construction PMIs also fell on the quarter, although by appreciably less.

The PMIs have failed to match the variability in the official GDP estimates in recent quarters

one reason the Q4 contraction came as such a surprise. Q2 activity is also likely to have

been affected by some temporary factors, in particular the extra public holiday for the royal

wedding in April and supply-chain dislocation that followed the Japanese tsunami. Oil and

gas output was also affected by maintenance-related closures. The extent to which these

disruptions have been reflected in the PMIs is unclear, so we caution against taking the PMI-

based indicator as the final word on Q2 growth.

Simon Hayes

+44 (0) 20 7773 [email protected]

Our composite PMI points to a

slowing in GDP in Q2

Figure 1: GDP and the composite PMI

-2.5

-2.0

-1.5

-1.0

-0.5

0.00.5

1.0

1.5

2.0

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

% q/q

GDP

Estimate based on composite PMI

BarCap Q2 forecast

Source: Haver Analytics, Barclays Capital


18/49


8 July 2011 18

This week also brought official May data for industrial production and construction output.

These are the last of the official output data that will be published ahead of the preliminary

estimate of Q2 GDP. Before considering the outturns, it is worth reiterating the sparseness

of the available information set at this stage. The white segments in Figure 2 denote data

that we do not yet have to estimate overall GDP growth. The biggest blind spot relates to

services: without the May and June Index of Services, we are in the dark for about 50% of

Q2 activity. In fact, the available data cover just 41% of GDP. Our forecast of the preliminaryestimate therefore requires us to guess what the ONS will include for these components. (In

fact, given that the ONS itself has only about 60% of the full information needed, we have to

guess the ONSs guesses.)

According to the Index of Services, services output fell by 1.2% m/m in April. Some of this

weakness can be attributed to the extra public holiday, but exactly how much is unknown. If

we unwind all of this fall in May and assume an additional 0.5% m/m rise in June, then

services output would have grown by 0.5% q/q in Q2, down from 0.9% in Q1, contributing

0.4pp to q/q GDP growth. IP in May was held back by maintenance-related closures that

produced a 5.7% m/m drop in oil and gas output. We should therefore expect some

rebound in June, and factoring in a 0.5% m/m increase, we forecast that IP fell by 1.3% q/q

in Q2 after falling by 0.1% in Q1. This would subtract 0.2pp from q/q GDP growth. Lastly,we expect construction output to have been close to flat in Q2 after the large 3.4% q/q

contraction in Q1. Putting these together points to growth of 0.2% q/q.

The MPC voted to keep policy on hold this week, as had been expected. The committee has

become increasingly concerned about the growth outlook, noting in the minutes of the June

meeting that extending QE remained an option. Although Q2 GDP is likely to have been

depressed artificially by temporary factors, if the ONS publishes a number as low as we

expect, the calls for more QE are likely to grow louder. However, we would continue to

highlight the influence of high and rising inflation on this decision. Although soft activity is

likely to mean that an interest rate hike is unlikely over the next several months, if we are

right to expect inflation to rise above 5% in the autumn, we still doubt a majority of MPC

members would be comfortable sanctioning more QE.

Information gaps mean there

is always great uncertainty in

forecasting the preliminary

GDP estimate

Figure 2: Published information on Q2 GDP

Apr IoS

25%May IoS

25%

Apr IP

6%

May IP

6%Jun IP

6% Apr Construction

2%

May Construction

2%

Agriculture

1%

Jun IoS

25%

Jun Construction

2%

Note: White segments indicate components for which no information has been published.Source: Haver Analytics, Barclays Capital

The available data suggest

our 0.3% q/q forecast is in

the right ballpark, with risks

to the downside

Such weak growth is likely to

prompt calls for more QE


19/49


8 July 2011 19

DATA REVIEW & PREVIEW: UNITED KINGDOM

Blerina Urui


Main Indicators Period Previous Barclays Actual Comments

Construction PMI Jun 54.0 53.0 53.6 Output growth remains solidServices PMI Jun 53.8 53.2 53.9 Services sector continues expansion

Halifax house price index, % m/m (3m/y) Jun 0.1 (-4.2) - 1.2 (-3.5) Market conditions remain challenging

Industrial output, % m/m (y/y) May -1.7 (-1.2) 1.0 (-0.6) 0.9 (-0.8)

Manufacturing output, % m/m (y/y) May -1.6 (1.2) R 0.8 (1.9) 1.8 (2.8)Rebound in IP, but growth ratedampened by falling oil and gas output

BOE Bank Rate decision, % Jul 0.5 0.5 0.5

BOE asset purchase decision, bn Jul 200 200 200.0MPC held monetary policy unchangedas expected

PPI input prices, % m/m (y/y) Jun -1.7 (16.1)R 0.2 (16.4) 0.4 (17.0)

PPI output prices, % m/m (y/y) Jun 0.2 (5.4 R) 0.0 (5.5) 0.1 (5.7)

PPI core output prices, % m/m (y/y) Jun 0.2 (3.4) 0.1 (3.1) 0.2 (3.2)

UK producer prices increased at amoderate pace on the month to June,but pipeline inflationary pressuresremain strong

Preview of week ahead

Monday 11 July Period Prev 2 Prev 1 Latest Forecast ConsensusNo data releases or policy speeches scheduled


00:01 RICS house price balance Jun -23 -21 -28 -26 -25

00:01 BRC total sales, % y/y Jun -1.9 6.9 -0.3 - -

09:30 CPI, % m/m (y/y) Jun 0.3 (4.0) 1.0 (4.5) 0.2 (4.5) 0.3 (4.5) 0.3 (4.5)

09:30 RPI, % m/m (y/y) Jun 0.5 (5.3) 0.8 (5.2) 0.3 (5.2) 0.3 (5.3) 0.3 (5.2)

09:30 RPIx, % m/m (y/y) Jun 0.5 (5.4) 0.9 (5.3) 0.3 (5.3) 0.3 (5.4) (5.3)

09:30 Visible trade balance, bn May -6.9 -7.7 -7.4 -7.3 -7.4

RICS house price balance: We expect a small increase in the price balance to -26 from -28 in May; however, the data would

still be consistent with tough conditions in the housing market mainly owing to weak demand. Data from other surveys such

as the Nationwide and the Halifax indices also suggested the housing market remained broadly subdued in June.

Inflation data: We expect June CPI inflation to have remained at 4.5% y/y, and RPI inflation to have increased to 5.3% from

5.2% in May. We expect further price pressure from food and energy to be partially offset by a decline in inflation for non-

energy industrial goods, in part owing to early summer discounting as retailers responded to disappointing sales in May.

Visible trade balance: We forecast a slight narrowing in the trade deficit to 7.3bn in May from 7.4bn previously. We expect

the fall in oil and gas extraction during May from maintenance-related closures to have increased the oil deficit, but weaker

demand for imports to have offset its effect.


09:30 Average earnings, % 3m/y May 2.2 2.5 1.8 2.3 2.1

09:30 Core average earnings, % 3m/y May 2.1 2.1 2.0 1.9 2.0

09:30 Claimant count unemployment, k Jun 6.4 16.9 19.6 14.9 15.0

09:30 ILO unemployment rate, % May 7.8 7.7 7.7 7.7 7.7

Labour market: We forecast headline average weekly earnings to have increased by 2.3% 3m/y in May from 1.8% 3m/y

previously and core earnings growth at 1.9% 3m/y from 2.0% 3m/y previously. We expect the claimant count to have

increased by 14.9k from 19.6k previously, in line with our assessment of a deterioration in labour market conditions for Q2

and as indicated by the weakness in the REC jobs survey data. We forecast the ILO measure of unemployment to have

remained unchanged at 7.7%.


No data releases or policy speeches scheduled

Friday 15 July Period Prev 2 Prev 1 Latest Forecast Consensus

No data releases or policy speeches scheduled


20/49


8 July 2011 20

OUTLOOK: JAPAN

An interim assessment

The BoJ will revisit its GDP and CPI forecasts next week, likely projecting slightlylower real growth and modest core inflation for FY11.

While such inflation could virtually be erased by the CPI rebasing, perceptions haveclearly changed, both among households and businesses.

Consumers are starting to spend and higher bonuses may help, but sluggish basewages, together with several economic and political risks, cloud the outlook.

The BoJ will revisit its GDP and CPI forecasts when it conducts an interim assessment of its

semi-annual Outlook Report on 11-12 July. Although the real GDP forecast could be lowered

slightly for FY11, we expect few other changes (Figure 1). If so, the new forecasts will

project a picture of marginal real growth and modest core inflation for the current year.

Note, however, that these forecasts do not factor in the August CPI rebasing, which we

estimate will lower the core CPI by about 0.6pp. All else being equal, this means technicalfactors are likely to result in forecasts for slightly stronger real growth and virtually zero

inflation in October, when the BoJ publishes its next Outlook Report.

Even so, price perceptions are clearly changing. A Cabinet Office survey, for example, finds

that nearly 70% of Japanese households expect prices to be higher one year forward. In this

context, the latest Tankan report suggests terms of trade are improving, at least for large

companies. This is also evident in the corporate goods price index, which shows rising

prices not only for market-sensitive goods and basic materials but also for processed goods.

Over the next six months or so, we believe the core CPI is likely to be somewhat weaker

than we had previously forecast, but mainly due to a downward revision to our oil price

assumptions. Further forward, however, there is likely to be an offsetting effect as the

output gap is reduced by the earthquake impact on potential GDP (downward) and

reconstruction efforts on real GDP (upward).

For now, we expect real GDP to see a V-shaped recovery from Q3 2011 to Q1 2012. As

discussed last week, this partly reflects an expectation for private capex to start increasing in

Q3 on support from post-earthquake reconstruction demand an outlook unchanged by

this weeks machinery orders data. On a more microeconomic level, our chief equity

strategist points out in this weeks Japan Cross Asset Monthlythat companies with high

levels of free cash flow and relatively high returns on equity have become more aggressive

in their capital investment.

This week also provided evidence that consumption is finding firmer ground. New auto

sales (new passenger vehicle registrations and minicar sales), for example, showed anotherstrong increase (m/m, sa) in June after the steep quake-induced drops of March and April.

Base effects alone will give them a boost of 18.5% in Jul-Sep even if monthly sales are flat

during that period. The composite index of consumption also rose for a second consecutive

month, even in the face of bad weather and adverse calendar effects. In this light, our

forecast of a Q2 upturn in GDP-based private consumption is unchanged. In addition to

buying cars, consumers also spent money to cope with restrictions on electric power,

purchasing high-efficiency air conditioners and cool summer apparel, for example. Sales of

flat-panel TVs also showed strong growth prior to a switch to digital terrestrial broadcasting

on 24 July 2011.

Kyohei Morita

+81 (3) 4530 [email protected]

Yuichiro Nagai

+81 (3) 4530 1064

[email protected]

James Barber, CFA

+81 (3) 4530 1542

[email protected]

BoJ reassesses prior to the

rebasing

Price perceptions changing

regardless of the technicalities

Outlook for a V-shaped recovery

supported by recent data on

capex

and consumption


21/49


8 July 2011 21

Higher summer bonuses, which led to a surprise increase in wages per worker, may have

helped. However, scheduled pay (the core component of wages) fell for a fifth consecutive

month, suggesting that companies still prefer to treat labor as a variable cost rather than a

fixed cost. Wages have become more volatile as a result.

It is easy to understand why, despite improving sentiment, companies remain apprehensive

about increasing base wages. There are a number of risks to the economy. Althoughindustrial production is near pre-earthquake levels, it looks set to flatten out in Jul-Sep due

to constraints on electric power over the summer months. For now, we view this as a

temporary drag on growth. As discussed in our Japan Cross Asset Monthly, however, it is

also part of a larger energy problem involving questions about the future feasibility of

nuclear power. In a nutshell, the use of thermal power makes it more expensive to do

business in Japan. In our view, this together with, for example, a proposal to raise

corporate taxes to finance reconstruction and a failure to engage more proactively in trade

agreements such as the Transport-Pacific Partnership (TPP) agreement threatens to

accelerate the exodus of businesses and employment opportunities from Japan.

We also continue to monitor the risks associated with overseas economic deceleration. This

weeks machinery orders data, while firm for the core component, saw a third consecutive

decline in overseas orders. Viewed together with machine tools data, where the overseas

component began to fall even prior to the earthquake, these figures suggest a possible

impact from a slowdown abroad. The deceleration in China, which accounts for nearly 20%

of Japanese exports (2010), is a particular concern, at least over the short term. In its

previous economic assessment, the BoJ added signs of deceleration in emerging markets

to its list of risk factors. This is likely to be unchanged in next weeks report.

The BoJ is also likely to reiterate that attention should be paid for the time being to the

downside risks to economic activity, especially the possible effects of the disaster. Combined

with last months quasi-fiscal action, which helped specific companies and addressed

solvency concerns (see Japan Outlook Global Economic Weekly, 20 June 2011), such

remarks are about as close as the BoJ will get to telling the government to hasten the process

of compiling a third supplementary budget. We now know that budget passage is likely to be

delayed until at least late-autumn, but even that timeframe remains uncertain under current

political conditions. The pattern of economic growth could easily be affected by the size and

timing of that budget dubbed the reconstruction budget to distinguish it from its smaller

predecessors compiled for emergency assistance, temporary housing and initial clean-up.

Higher bonuses help, but base

wages remain sluggish

Figure 1: Real GDP and core CPI forecasts BoJ (majority of BoJ Policy Board members) versus BarCap and consensus

As of 28 Apr As of 12 Jul

FY10 median +2.8% +2.8%

(range) +2.8 to +2.8% +2.8 to +2.8%

FY11 median +0.6% Revision to

(range) +0.5 to +0.9% 0.1-0.4%??

FY12 median +2.9% No change??

(range) +2.7 to +3.0%

2.3%

BoJ

BarCap

Real GDP

Consensus

2.3%

0.1%

3.2% 2.9%

0.4%

As of 28 Apr As of 12 Jul

FY10 median -0.3% -0.3%

(range)

FY11 median +0.7% No change?

(range) +0.5 to +0.8%

FY12 median +0.7% No change?

(range) +0.5 to +0.7%

-0.8% -0.8%

BoJ

Core CPI

ConsensusBarCap

0.4%

0.5%0.3%

0.1%

Note: Core CPI excludes fresh foods. Forecasts do not factor in August rebasing, which we estimate will lower the core CPI by 0.6pp.Source: BoJ Outlook Report, EPS survey of Economic Planning Association, Barclays Capital Japan

Reasons behind the reluctance

to increase fixed costs (= risks toour economic outlook): the

energy situation

overseas economic

deceleration

and delays in passing the

third supplementary budget
https://live.barcap.com/go/publications/content?contentPubID=FC1727235https://live.barcap.com/go/publications/content?contentPubID=FC1722612https://live.barcap.com/go/publications/content?contentPubID=FC1722612https://live.barcap.com/go/publications/content?contentPubID=FC1727235


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8 July 2011 22

DATA REVIEW & PREVIEW: JAPAN

Kyohei Morita, Yuichiro Nagai, James Barber

Review of this weeks data

Main indicators Period Previous BarCap Actual CommentsWages per worker (% y/y) May -0.6 -0.5 1.1 Surprise uptick due to a surge in bonuses. Scheduled

pay, however, fell for a fifth consecutive month.Companies continue to adjust pay on a variable basis.

Core machinery orders (% m/m) May -3.3 2.5 3.0 Core orders will likely be weaker than major machinerymaker forecasts for Q2, but we still expect capex toturn up from Q3. Overseas orders, however, continueto fall.

Current account (JPY bn) May 406 125 591 Trade account showed a wider deficit, but this wasoffset by a large surplus in the income account.

Bank lending including shinkin banks(% y/y)

Jun -0.8 -0.5 -0.6 Despite a pick-up in demand from some companies inthe quake-hit region, loans are likely to continuetrending downward due to surplus liquidity in thecorporate sector

Economy Watchers DI Jun 36.0 NA 49.6 Larger improvement than market consensus, showingthat sentiment is also recovering along with theV-shaped recovery in industrial production.

Preview of the week ahead

Monday 11 July Period Prev 2 Prev 1 Latest Forecast Consensus

08:50 M2/M3 (% y/y) Jun 2.6/1.9 2.7/2.1 2.7/2.1 2.9/2.3 2.7/2.1


08:50 Corporate goods price index (% y/y) Jun 2.0 2.5 2.2 2.7 2.4

Index of tertiary industry activity (% m/m) May 0.8 -5.9 2.6 0.5 0.5

BoJ MPM ends No policy change expected. However, the BoJ will update its GDP and CPIforecasts as part of its interim assessment of the semiannual Outlook Report.

We expect a slight downward revision to real GDP for FY 11. Otherwise,forecasts should be largely unchanged. See Outlook section for details.

Week ahead: We estimate that M2 growth (excluding Japan Post Bank) strengthened to 2.9% y/y in June from 2.7% in May.

M3 (including Japan Post Bank) likely rose 2.3%, also stronger than in May (2.1%). More generally, the recent trend in money

stock data has been marked by slower growth in both quasi-money, such as time deposits, and broad liquidity.

We estimate that the domestic CGPI rose 2.7% y/y in June versus a 2.2% gain in May. Month on month, we expect the index to

increase 0.1% after Mays 0.1% decline. This assumes prices rose in textiles, chemicals and plastics, while falling for oil/coal

products and scrap. We expect CGPI inflation to remain around 2-3% y/y for the rest of the year.

For the index of tertiary industry activity, we look for a second consecutive increase in May (0.5% versus Aprils 2.6%). During

this period, sales were lower on the wholesale side, while increasing in retail. Within retail, the sharpest gains were in machinery,

including household appliances, and autos.


23/49


8 July 2011 23

OUTLOOK: CHINA

Rate hike cycle close to an end

The PBoC delivered an overdue benchmark interest rate hike on Wednesday, ahead ofthe release of the June CPI data, which we expect to jump to 6.3% y/y from 5.5% in May.

Minutes of the PBoC monetary policy committee meeting (held in July) emphasisedstability, targeted, and flexibility as well as the pace and intensity of policies.

We forecast Q2 real GDP growth of 9.4% y/y, versus 9.7% in Q1, and expect slower IP andtrade growth, as well as relatively stable domestic demand in June.

On Wednesday, the PBoC announced the third benchmark interest rate hike of 2011. This is

the fifth increase in the current tightening cycle, which started in October 2010. The

structure of the hike was symmetrical a 25bp increase in the lending and deposit rates

across all tenors, except the demand deposit rate, which was left unchanged (Figure 1).

While we had maintained our forecast of a rate hike in early to mid-July, the June rate pause

(versus a widely expected hike) suggested to us increasing domestic concerns about an

over-tightening of monetary policy. The timing of the July rate hike therefore suggests that

policymakers likely consider the risk of full-year inflation exceeding 5% as higher than the

risk of a sharp growth slowdown, especially as June CPI is expected to exceed 6% y/y (see

China: The much-anticipated interest rate hike to end the tightening cycle, or not?, 6 July).

Meanwhile, the wording of the Q2 PBoC Monetary Policy Committee meeting minutes

regarding the operational focus was amended to "Stability, targeted and flexibility" from

"Targeted, flexibility, and effectiveness" as in the Q1 11 and Q4 10 minutes (for details see

China: PBoC Q2 policy committee minute emphasise pace and intensity of policies, 5 July).

On credit expansion, the committee maintained its aim to "guide the banks to improve

credit support to key areas, as well as vulnerable segments of the economy" and added

"especially support to rural credit and SMEs lending".

The next key event to watch is the State Council mid-year regular meeting, usually held in

mid-July to discuss/assess the economic performance in the first half of the year, and set

the tone for policy in H2. Also, the NPC Financial and Economic Committee will hold an

economic assessment forum (on July 15-16 in the past three years), followed by a Politburo

meeting. These meetings should provide further clarification on policy directions in H2.

Jian Chang

+852 2903 [email protected]

Lingxiu Yang

+852 2903 2653

[email protected]

PBoC delivered its third

rate hike this year

Upside risks to inflation higher

than downside risks to growth

MPC minutes wording amended

to emphasise pace and intensity

of policies

Figure 1: The benchmark rate hike structure

Deposit and lending rate hike structure

Current Total 6 Jul 5 Apr 8 Feb 25 Dec 19 Oct Before

% pa (+) bp (+) bp (+) bp (+) bp (+) bp (+) bp % pa

Deposit

Demand 0.50 14 0 10 4 0 0 0.363 m 3.10 139 25 25 35 34 20 1.716 m 3.30 132 25 25 30 30 22 1.981 y 3.50 125 25 25 25 25 25 2.252 y 4.40 161 25 25 35 30 46 2.793 y 5.00 163 25 25 35 30 52 3.335 y 5.50 190 25 25 45 35 60 3.60

Lending1 y 6.56 125 25 25 25 25 25 5.311-3 y 6.65 125 25 30 25 25 20 5.403-5 y 6.90 114 25 20 23 26 20 5.76>5 y 7.05 111 25 20 20 26 20 5.94

Source: PBoC, Barclays Capital

The next key event is the regular

mid-year assessment meetings
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Overall, while we think policy rate hikes are close to an end, we do not rule out the

possibility of a fourth hike in Q3. Our baseline forecast is for CPI inflation to fall below 6% in

July (5.8%) and below 5% in September. A clear upside risk to this forecast would make

another rate hike more likely, in our view. We think the room for more RRR hikes is limited,

though they are possible given liquidity pressures arising from capital inflows. We expect

continued credit controls to contain 2011 M2 growth at 16% and new loans at CNY750bn.

We have held a view that interest rates needed to be raised to reverse the situation of

negative real rates, anchor inflation expectations and limit inefficient investment, given the

elevated inflation pressures in the Chinese economy (both in the near term and structurally

barcap july8 global economics weekly signs of a partial turn

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