second half doc

Important disclosures appear at the back of this document

Global Economics Weekly Issue No: 10/29

July 28, 2010

Goldman Sachs Global Economics, Commodities and Strategy Research

at https://360.gs.com

Looking into the Second Half In our final weekly before a brief summer break, we look back over the year so far and forward to the second half of the year and the market themes and questions that we think will dominate there. While the year has proceeded in distinct phases – from US growth upgrade to European sovereign risk to US slowdown worry – many assets are not far from where they begun 2010.

In thinking about this evolution and the path forward, we find it helpful to think about three sources of risk exposure. The first is US growth risk and the issue of whether the market has priced enough of a slowing. The second is non-US growth risk broadly speaking and whether the market is too optimistic or too pessimistic there. Running around this issue is whether it is possible to see slowing in the US without seeing more serious slowing elsewhere (the ‘decoupling’ debate returns!). The third is the kind of systemic risk that has reappeared with worries about sovereign exposures and the banking system.

We think the second half of the year will be dominated by a set of judgments that relate to these three areas. First, how deep a US slowing and what kind of policy response might be forthcoming? Second, how much decoupling is possible (and will China’s policy shift meaningfully)? Third, will sovereign and systemic risks intensify again or settle? Our own forecasts envisage a period of some muddiness in the near-term that ultimately resolves towards a more positive global view. But given the fragilities in the system, we will be watching our various proprietary tools (GLI, FSI, FCIs) and trying to stay open-minded.

Jim O’Neill [email protected] +44 (0)20 7774 2699 Dominic Wilson [email protected] +1 212 902 5924 Kevin Daly [email protected] +44 (0)20 7774 5908 Anna Stupnytska [email protected] +44 (0)20 7774 5061 Swarnali Ahmed [email protected] +44 (0)20 7051 4009 Alex Kelston [email protected] +1 212 855 0684 Stacy Carlson [email protected] +1 212 855 0684

This is our last Global Economics Weekly for the Summer. We will resume publication on September 1.

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99.7

99.8

99.9

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100.1

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100.3

100.4

100.5

100.6

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

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Jan-09 May-09 Sep-09 Jan-10 May-10

IndexIndex US Downside Surprises Dominate

USA

Euroland

Asia ex Japan (rhs)

Source: Goldman Sachs Global ECS Research

Surprise Indices in:

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118

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Jan-10 Mar-10 May-10 Jul-10

IndexIndex Market Has Moved Through Three Phases

S&P 500 (lhs)

GS Wavefront Consumer Growth


PHASE 1 PHASE 2 PHASE 3

July 28, 2010 Issue No: 10/29 2

Global Economics Weekly Goldman Sachs Global Economics, Commodities and Strategy Research

Looking into the Second Half In our final weekly before a brief summer break, we look back over the year so far and forward to the second half of the year and the market themes and questions that we think will dominate there. While the year has proceeded in distinct phases – from US growth upgrade to European sovereign risk to US slowdown worry – many assets are not far from where they begun 2010.

In thinking about this evolution and the path forward, we find it helpful to think about three sources of risk exposure. The first is US growth risk and the issue of whether the market has priced enough of a slowing. The second is non-US growth risk broadly speaking and whether the market is too optimistic or too pessimistic there. Running around this issue is whether it is possible to see slowing in the US without seeing more serious slowing elsewhere (the ‘decoupling’ debate returns!). The third is the kind of systemic risk that has reappeared with worries about sovereign exposures and the banking system.

Most asset classes are a mixture of all three risk exposures, but the mix varies widely. In terms of our own views, we continue to think that US growth risk is not fully reflected and that the downgrade to US growth views that the market has been making takes us only part of the way to where we need to be. In contrast, we still find ourselves more upbeat than consensus on the non-US growth picture. Particularly as concern deepened in May and June, we have also found ourselves on the more benign side of the debate about the impact of sovereign and system risks, though the issue is unlikely to disappear and there are plenty of political road-bumps that could resurface in the months ahead.

As a result, we have argued that we want to be ‘short US growth risk’, ‘long non-US growth risk’ and to try to earn ‘systemic risk premia’. For now this has pushed us towards relative trades between the US and the rest of the world in equities and FX, and a preference for earning risk premium through parts of credit. We have also begun

to look more positively again at broad EM and China-related exposures.

We think the second half of the year will be dominated by a set of judgments that relate to these three areas. First, how deep a US slowing and what kind of policy response might be forthcoming? Second, how much decoupling is possible (and will China’s policy shift meaningfully)? Third, will sovereign and systemic risks intensify again or settle? Our own forecasts envisage a period of some muddiness in the near-term that ultimately resolves towards a more positive global view. But given the fragilities in the system, we will be watching our various proprietary tools (GLI, FSI, FCIs) and trying to stay open-minded.

Three phases this year We see three distinct phases in the evolution of the markets this year. In the first phase from early December to early April, the market was dominated by further evidence of acceleration in the global growth cycle but led by consistent upgrades to US growth views. European sovereign worries flared in the background but only briefly spilled into broader markets. Over this phase, risky assets generally did well, but US outperformance was clear in the performance of the USD, the outperformance of US equity indices and of domestic-facing cyclical stocks within the US market.

In the second phase, from mid-April to mid-May, the European sovereign crisis intensified dramatically and funding stresses, systemic risk and concerns about Europe’s political and economic health came to the fore. The sharp rise in volatility, a blow-out in peripheral European sovereign spreads, a further rapid decline in the EUR and intense pressure on global asset markets were the major symptoms. Reinforcing this process were increasing signs that global cyclical indicators were peaking.

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118

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IndexIndex First Phase of Market Driven by USConsumer Upgrade

S&P 500 (lhs)

GS Wavefront Consumer Growth



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IndexIndex Second Phase Saw Sovereign Risk and Volatility Spike

Spain 5-yr CDS (lhs)

VIX



July 28, 2010 Issue No: 10/29 3


Since mid-May, a third phase generated by the combination of an aggressive European policy response and increased evidence of a US slowdown has been evident to varying degrees across markets. This has been associated with a gradual relaxation of some of the extreme worries about sovereign risk and a greater focus on pricing a slower US growth picture. The USD has been weakening for nearly two months now, US equities have underperformed both Europe and EM (with domestic outperformance within the market also reversing) and US yields have fallen sharply both in absolute and relative terms.

Despite these phases, we have ended up ‘round-tripping’ in many places. US equities are almost exactly flat on the year, as are broad EM equities, while Europe and China have been clearer underperformers. Commodities and broad cyclical equities (as captured by our Wavefront Growth basket) are down a touch, while US consumer-facing equities are still up year-to-date. And the VIX and corporate credit spreads are a touch higher. But many things are more or less where they started the year, despite following a volatile path in the interim.

The most striking exceptions are in government bonds and currencies. US 10-year yields are around 80bp below where they began the year and US 2-year yields more than 50bp lower and German yields have also fallen. In contrast, Greek sovereign spreads are (even now) over 400bp wider than at the start of the year and Spanish spreads are still close to double their starting point (though the all-in yield has changed relatively little). In FX, the EUR is even now 10% below where it started the year and the JPY has also rallied sharply in line with the fall in US rates. This means that point-to-point by far the biggest repricing this year has not been in the market’s overall growth and risk view but in the relative pricing of sovereign risk and a realization that policy rates will stay lower for longer in both the US and Eurozone.

How our views have changed This evolution has matched our outlook in places and challenged it in others. In a series of pieces analyzing this stage of the cycle and the post-housing bust experiences elsewhere, we argued that 2010 would be a year in which stocks went through a flatter period with more moderate returns as the acceleration period in the global growth

0.0335

0.0340

0.0345

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0.0375

0.0380

1.34

1.36

1.38

1.40

1.42

1.44

1.46

1.48

1.50


IndexIndex Focus Shifted from Relative US Strengthto Weakness

International vs Domestic equities in US (lhs)EM equities vs SPX



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%% Third Phase Driven by US Slowdown Fear

US 2-year swap rate (lhs)

Euro 2-year swap rate (rhs)


PHASE 1

PHASE 2

PHASE 3

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Jan-09 May-09 Sep-09 Jan-10 May-10

IndexIndex US Downside Surprises Dominate

USA

Euroland

Asia ex Japan (rhs)


Surprise Indices in:

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

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98 99 00 01 02 03 04 05 06 07 08 09 10

% mom

Global Industrial Production*, 3mma

GLI Momentum

* Includes OECD countries plus BRICs, Indonesia and South AfricaSource: OECD, GS Global ECS Research

GLI Momentum vs. Global Industrial Production*

July 28, 2010 Issue No: 10/29 4


picture ended; that yields would fall rather than rise in the US as disinflation and a sub-par recovery continued; and that the unique US housing experience would see the re-emergence of differentiation between the US and the rest of the world and a moderate form of ‘decoupling’ on that basis.

With global equity markets flat, bond yields lower and the market shifting back towards a US slowdown, many of these features still look relevant to us. The slowing in the US economy that we have long forecast for 2010H2 is becoming more visible than seemed likely a few months ago. European data has so far validated our forecast of relative resilience. And while our (improved)

GLI now shows a clear peak in March 2010, it is at this point still consistent with relatively robust growth rates, as are the PMIs as Kevin Daly and Alex Kelston recently illustrated.

What we have missed so far includes three major issues. First, we underestimated the spread of the European sovereign crisis to broad risk sentiment (and of course initially to the EUR) and the extreme resurgence of both volatility and financial risk. Second, we have underestimated the impact of ultra-low G3 rates on the profile of interest rates globally. While many central banks have seen rates rise significantly relative to the G3, the absolute pace of tightening – in Europe in particular – has been slower than we initially envisaged. In most cases, this has not been because our growth and inflation forecasts have been too ‘hawkish’ but because the reaction function of central banks has been different (more dovish) than we expected. Third, we have been a little early to activate a view that our more robust EM growth views would translate into better absolute EM asset performance.

Looking at the changes to our own key forecasts since the start of the year (set out in the table), our global growth forecasts have actually risen both for this year and next. Within this, our US GDP growth views are modestly higher for 2010 and our China growth views lower. Our views for the Eurozone are not meaningfully different than they were at the start of the year. But they have remained stable alongside significant reductions to our European rate forecasts for the end of 2010 (across most European economies) and a substantial weakening in the currency, so easing financial conditions have more or less offset the impact of fiscal austerity and sovereign risk. This pattern of revisions broadly fits the revisions that markets have also made so far this year.

Three risks and how to think about them – We have recently identified three sources of ‘exposure’ that run through many macro assets to help us focus on the asset landscape. The first is exposure to US growth risk. The second is exposure to non-US growth risk. The third is exposure to systemic (and sovereign) risk, closer to a pure risk premium.

Our own current views on these three areas are as follows:

On US growth risk, our forecasts remain firmly below consensus on an absolute and relative basis (recent data weakness has pushed the consensus towards our 2010H2 US GDP growth forecast of 1.5%, but it remains above 2.5%). We do not think our US growth views are fully priced across markets. This is clearest from looking at our front-end views which remain lower than the forwards even after the recent rally, both in absolute terms and relative to the entire G10. Benchmarking to the relative performance of US equity markets, the picture is a little less clear, though on a relative basis here too domestic-facing parts of

Bigger Changes to Rates/FX Than Equities/Growth31-Dec-09 27-Jul-10

EquitiesSPX 1115.1 1113.8Eurostoxx 2965.0 2769.3

EM equities 100.0 99.7China H-shares 12794.1 11931.1

WF Growth 97.2 94.8

WF Consumer Growth 95.1 98.2

Volatility/CreditVIX (%) 21.7 23.2CDX (bp) 85.5 102.5

CDX HY (bp) 515.6 553.4

BondsUS 10-year (%) 3.85 3.08

US 2-year (%) 1.14 0.65German 10-year (%) 3.3 2.66

German 2-year (%) 1.35 0.87

Spain 5-yr CDS (bp) 116 175Greece 5-yr CDS (bp) 288 709

FX/CommoditiesEUR/$ 1.43 1.30

USD/JPY 93.09 87.90EUR/CHF 1.48 1.38

AUD/$ 0.90 0.90

Crude Oil 79.4 77.5Copper 7375.0 7059.0Source: Goldman Sachs Global ECS Research

GDP Growth: GS vs Consensus

GS (Current)

GS (23 Dec 2009)

Consensus (Current)* GS Consensus*

USA -2.4 2.6 2.3 3.1 2.4 3.0Japan -5.2 3.4 1.5 3.2 1.7 1.6Euroland -4.0 1.4 1.5 1.1 2.2 1.4UK -4.9 1.3 1.9 1.3 3.2 2.1Europe -3.9 1.5 1.7 1.3 2.5 1.7China 8.7 10.1 11.4 10.1 10.0 9.1India 7.4 8.2 8.2 8.3 8.7 8.3Brazil -0.2 7.8 5.8 7.1 4.5 4.4Russia -7.9 5.8 4.5 5.1 6.1 4.7BRICs 5.3 8.9 9.2 8.8 8.7 8.0Advanced Economies -3.1 2.6 2.2 2.7 2.6 2.5

World -0.6 4.7 4.4 4.6 4.8 4.3* Consensus Economics July 2010 Source: Goldman Sachs Global ECS Research

% yoy 20092010 2011

July 28, 2010 Issue No: 10/29 5


the US market have also looked too optimistic versus our forecasts.

On non-US growth risk, we continue to have a more positive view in general. Our global growth forecast remains above consensus and we see more tightening than the market in a significant number of the G10. Our European growth views in particular are now clearly more optimistic than others, as Erik Nielsen and team have set out for some time, and the latest data has been quite encouraging on that front. For China, the other big market focus, we see more deceleration in the near-term, but our medium-term view is more constructive. In particular, we are now watching closely for signs of a shift towards a more supportive policy stance. China-related assets have been heavily discounted over the last 12 months and we think the market is not priced for the reacceleration in growth that our own forecasts envisage. Because EM has been tightening, the impact of some deceleration in growth raises less of a policy dilemma here and continued low real rates in many places may again prove equity-supportive.

On systemic risk, we have argued for several weeks that the heightened concern about sovereign defaults (in Spain in particular) and about broad financial system risk has been excessive. And our models across asset classes point to elevated risk premia in many places. We have seen significant compression in some of these risk premia (and falls in volatility) from the highs in May and June. And we doubt that the sovereign crisis is ‘over’ in any definitive sense. But on balance our view remains that systemic risk and asset market volatility are overpriced.

Asset market implications Our own views can be seen through this lens. Looking at the remainder of the year, our forecasts suggest that we should be: positioned for weaker US growth and low policy rates, at least on a relative basis; positioned for better growth outcomes in other parts of the world and a still-reasonable global growth picture, with an increasing focus on the potential for a more positive shift in policy in China; positioned to earn high risk premia where we can do that in ways consistent with our growth views.

To translate these views into assets means understanding the mix of these three exposures that different assets deliver. In rates markets, front-end markets have the tightest links with local domestic growth views. As per our Sudoku models, longer-dated yields are a more complicated mix of sensitivities to local growth, global growth and overall risk premia. In equities, relative performance of domestic-focused equities to other areas is also often a cleaner expression of growth views than a straight directional view at the index level. The relative performance of indices – particularly of EM to DM –also bears some relationship to the pattern of growth surprises in each area.

Purer exposures to systemic risk premia tend to be available in credit and volatility. Commodities have the opposite flavour, providing more direct exposure to growth views than to pure risk adjustments, though with a global (and increasingly an EM-demand related) tilt. FX is a more complicated mix, but relative growth and rates views are an important driver of G10 in particular but also beyond. And the absolute state of the global cycle and risk premium clearly impact many of the more cyclical and EM currencies as we have also shown in the past.

Using that template for mapping, this mix biases us towards relative trades in equities and FX (including a stronger bias towards USD weakening); a cautiously optimistic view of the overall risk picture particularly later in the year; a preference near-term for credit over equities and other risk assets as a more focused way to earn elevated risk premia without excessive growth risk; and a bias towards global growth exposures. Our latest asset allocation views, set out in a recent GOAL publication, embody a lot of this thinking, arguing for a preference for credit within risk assets, a generally pro-risk stance and using commodity exposures to access the potential for better than-expected growth outside the US and in China in particular.

More specifically, the same approach suggests that the key asset market themes for the second half of the year are likely to include:

In equities, a muddier risk picture as the market balances slowing US growth with better news elsewhere, but one that is more likely to resolve in favour of higher equity markets as the year proceeds.

Continued underperformance of US exposures and a renewed bias to seek commodity and emerging market exposure within and across equity markets. In particular, if expectations of Chinese growth begin to move higher again as we ultimately expect, this should reinforce the outperformance of EM equities that has resumed in recent months, alongside the continued easiness in policy in much of EM.

A renewed search for carry and credit exposures as volatility drifts back towards more normal levels. This drift may be punctuated by periodic bouts of sovereign concern as political news on this front comes and goes.

In rates, continued anchoring of G3 bond yields as policy rates remain low and disinflation continues in the US and Eurozone. Further separation of relative rate spreads as a number of smaller G10 markets tighten more than priced (Sweden, Switzerland, Norway, UK, Australia).

In FX, a renewed bias towards USD weakness alongside renewed appreciation in Asian FX (and other crosses with similar relative exposures like AUD/CAD) if China-US outperformance becomes evident again and CNY drift continues as per our

July 28, 2010 Issue No: 10/29 6


forecasts. In line with that theme, some of the split between the G3 core and ‘periphery’ currencies may re-emerge, a trend that has been on hiatus, but that would be more likely if risk sentiment broadly improves further.

What we are watching Given our view of the three key risk exposures, we are watching the following:

1. How much will the US/world slow? Our biggest worry is that the US slowdown will be more rapid than we think and that policy is then extremely constrained in dealing with it here. And that is the risk we think is most worth seeking protection against. But despite the recent evidence of slowing, a more moderate outcome than our own forecasts is conceivable too. While recent data has reinforced our comfort with our below-consensus US forecast, the data has oscillated above and below expectations all year, so the latest news may overstate the deterioration in the trend just as the March/April data likely overstated the acceleration. Our Global Leading Indicator (newly improved) and our regular sifting of the PMI and export data will be a critical part of our assessment. The levels of the GLI remain consistent with strong global industrial growth, but the pace of recent deceleration in momentum needs to be watched.

2. How much (and where) can the rest of the world ‘decouple’? The latest data has been supportive of our view of moderate ‘decoupling’, but a sharper slowing

in the US would be a challenge. A world in which non-US growth turns out somewhat better than expected offsetting disappointing US growth news will feel very different to one in which we shift back from a US to a global slowdown. Beyond the generic question, we are particularly focused on whether European data continues to slow less than expected or whether inventory dynamics ultimately follow the US pattern and whether we get further noises about policy shifts away from tightening in China.

3. Will sovereign and system risk intensify again or fade? This is arguably the hardest issue to handicap. We think that the recent European policy response – including the European stress tests – has increased the chances that we can muddle through the most intense risks. But the political challenges of dealing with the fiscal adjustments that are needed in many places are intense and the political calendar in a range of places may heat up at the end of the summer. And it is too early to be sounding an ‘all clear’ on these issues.

One of the greater difficulties of macro trading in 2010 relative to 2009 – and one that we always feared – has been that the underlying dynamics have tended to be less stable and, ironically, it has been easier to envisage a wide range of outcomes. In part, that is the nature of this stage of the recovery, which is almost always muddier than the initial acceleration period. Additionally, it is an indication that the healing from the global recession and financial crisis is still a work in progress.

Dominic Wilson

July 28, 2010 Issue No: 10/29 7


Equity Risk and Credit Premiums

In June, our ECP was 326bp higher than the most recent trough in November 2008.

The US ERP has increased by 70bp since its most recent trough in early April, due to the fall in real bond yields.

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% US ERP

US ERP, calculated daily

US ERP 200 Day Moving Average

Source: GS Global ECS Research

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% Our ECP Decreased by 23bps in June

1985-1998 average

2 standard deviations band

Credit relativelyexpensive

Source: GS Global ECS Research

I, Dominic Wilson, hereby certify that all of the views expressed in this report accurately reflect personal views, which have not been influenced by considerations of the firm’s business or client relationships. Global product; distributing entities The Global Investment Research Division of Goldman Sachs produces and distributes research products for clients of Goldman Sachs, and pursuant to certain contractual arrangements, on a global basis. Analysts based in Goldman Sachs offices around the world produce equity research on industries and companies, and research on macroeconomics, currencies, commodities and portfolio strategy. This research is disseminated in Australia by Goldman Sachs JBWere Pty Ltd (ABN 21 006 797 897) on behalf of Goldman Sachs; in Canada by Goldman Sachs & Co. regarding Canadian equities and by Goldman Sachs & Co. 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Current Estimates for the Equity Risk Premium*

Real GDP Growth

Real Earnings Growth +

Dividend Yield =

Expected Real Return -

Real Bond Yield =

Implied ERP

Expected Inflation

Expected Nominal Return

US 3.0 3.0 2.1 5.1 1.2 3.9 2.0 7.1Japan 1.5 1.5 1.9 3.4 0.6 2.9 0.5 3.9UK 2.8 2.8 3.3 6.1 -0.5 6.6 2.0 8.1Europe ex UK 2.3 2.3 3.1 5.4 -0.5 5.9 2.0 7.4World 2.5 2.5 2.5 5.0 0.5 4.5 1.8 6.8

Source: Datastream; real GDP grow th and expected inflation are GS Economics Research forecasts.*Calculated as of 27 July 2010

Issue No: 10/28 8 July 21, 2010

The World in a Nutshell

OUTLOOK KEY ISSUES

UNITED STATES It is now reasonably clear that real GDP growth dropped below its 2.5%-3% long-term potential range last quarter. We expect Q2 growth of 2% (annual rate), followed by a further deceleration to 1.5% in both Q3 and Q4. This slowdown is happening just ahead of the loss of growth support from fiscal stimulus and the inventory cycle that we have been anticipating would occur at mid-year.

With various headwinds to private-sector growth (excess vacant housing, state and local budget stresses, lack of lending, reluctance to hire) still firmly in place, we expect real GDP growth to slow in the remainder of 2010, and we worry that reacceleration in 2011 will not occur as now projected. Despite these growing downside risks, US authorities (including Fed Chairman Bernanke in recent testimony) do not exhibit much urgency to apply more policy stimulus.

JAPAN Our real GDP growth forecast is +3.4%yoy for 2010 and +1.7%yoy for 2011. Exports and production have slowed as the yen has appreciated in response to the expected US slowdown. Domestic consumption has held up well but has been concentrated in durable goods, supported by government subsidies. Once their subsidies end, there is no guarantee of sustained consumption. Meanwhile, the labour market seems to be over the worst.

The DPJ’s flagship policy of child-care allowance started in June, but its economic impact is uncertain. With the new Prime Minister in place, conditions may allow Japan to progress on its taxation system and fiscal challenges. The government announced its long-term fiscal reform plan, calling for a cap on JGB issuance, and hence a natural cap on spending growth. Prime Minister Kan has become vocal on a future consumption tax rate hike before the July Upper House election.

EUROPE Europe should continue to benefit from the stronger global growth environment. We expect EU-27 real growth to be 1.5%yoy in 2010 and 2.5%yoy in 2011. For the Euro-zone, we forecast growth at 1.4% in 2010 and 2.2% in 2011. However, the cyclical position of each country is different. While Euro-zone Q1 GDP disappointed us, we think a good deal of the overall shortfall was caused by the weather and will therefore show up in Q2.

The stress test results provided more disclosure but lower estimates of required capital than the market expected. We think the large amount of information on European banks is helpful and should increase transparency and help ease funding stresses. This should help the ongoing gradual healing process of the European financial system. Additionally, our analysis shows that bank exposures to sovereigns in Southern Europe, Ireland and Greece are manageable.

NON-JAPAN ASIA In China, we have lowered our real GDP growth forecast to 10.1% for 2010, from 11.4% previously. We have not changed our view of the trend level, and therefore once policy loosens, growth should quickly revert to trend. Thus, we have kept our 2011 GDP forecast unchanged at 10%. For Asia ex Japan we forecast 8.7% and 8.4% growth in 2010 and 2011.

Our forecasts for China assume the current policy tightening measures remain in place at least for another month, and then some loosening is likely in the three months starting from August. These measures include continued credit rationing, direct administrative controls on certain heavy industrial producers, and tightening measures on the property sector.

LATIN AMERICA Our LatAm growth forecast is 5.8% for 2010 and 4.7% in 2011. Our view is optimistic due to an encouraging global outlook, continuance of easy policy in the advanced economies, our expectation that global liquidity will lead to capital inflows to LatAm, and high commodity price forecasts.

We have lowered our Brazil growth forecast to 7.8%yoy in 2010. Although the lagged effects from strong policy stimulus should continue to boost domestic demand growth, recent data has been slightly weaker than expected. We also reduced our IPCA inflation forecasts to 6.0% in 2010 and 5.7% in 2011.

CENTRAL & EASTERN EUROPE, MIDDLE EAST AND AFRICA

CEEMEA activity data has slowed in recent months as industrial momentum has tapered and regional uncertainty has increased. We have revised down some of our forecasts in the region, but most still remain above consensus. The economies with strong balance sheet structures and easy financial conditions are expected to maintain strong growth.

In Hungary, disagreements between the government and the IMF/EU over 2011 fiscal targets pose a potential risk for the region. Looking further ahead, some of the job losses in Russia, Hungary, Turkey and the Czech Republic during the crisis may prove permanent, owing to the relative rigidity of their labour markets.

THE GLOBAL ECONOMY

CENTRAL BANK POLICIES

CURRENT SITUATION EXPECTATION

UNITED STATES: FOMC The Fed cut the funds rate to a range of 0%-0.25% on December 16, 2008.

We expect the Fed to keep the funds rate near 0% through the end of 2011.

JAPAN: BoJ Monetary Policy Board

The BoJ cut the overnight call rate by 20bp to 0.1% on December 19, 2008.

We expect the BoJ to keep the policy rate at 0.1% through 2011.

EUROLAND: ECB Governing Council

The ECB cut rates by 25bp to 1.0% on May 7, 2009.

We expect the ECB to keep the policy rate on hold until a 25bp hike in 2011Q2.

UK: BoE Monetary Policy Committee

The BoE cut rates by 50bp to 0.5% on March 5, 2009.

We expect the BoE to begin hiking in 2010Q4 and continue to 3.0% by end-2011.

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