Suffolk County Council The Cost of Austerity European Economic - - PowerPoint PPT Presentation

European Economic Outlook

Suffolk County Council

Azad Zangana Schroders’ European Economist James Montefiore Client Director

25 July 2012

For professional investors only. This material is not suitable for retail clients

The Cost of Austerity

1

Key issues

European Economic Outlook

• Growth vs. Austerity, can there be a winner?
• Where next for the Eurozone?
• When will the UK recession end?

2

Backlash against austerity gains legitimacy

Hollande victory lends credibility to growth debate

Source: Telegraphy online

3

Austerity is clearly affecting growth

Divergence in recovery paths within Europe

Source: Eurostat, Thomson Datastream. Updated: 12 July 2012

Greece Germany Spain Austria France Portugal Italy Ireland

82 84 86 88 90 92 94 96 98 100 102 104 82 84 86 88 90 92 94 96 98 100 102 104 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Quarters GDP level (100=2008 peak)

4

Eurozone recession likely to be underway

Source: Thomson Datastream, Markit, BNB, Schroders. Updated 12 July 2012

Leading indicators vs. Eurozone GDP growth

• 6%
• 4%
• 2%

0% 2% 4% 6% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Eurozone GDP BNB survey PMI composite

GDP Growth (Y/Y)

5

More growth comes at a cost, and debt levels are already high

Peripheral government bond spreads and debt to GDP levels

Source: Thomson Datastream (right); European Commission Spring 2012 Forecast (right). Updated: 22 May

• 2012. Please see the forecast risk warning on the important information slide.

5 10 15 20 25 30 35 40 45 50 Jan 09 Sep 09 May 10 Jan 11 Sep 11 May 12 10-year Govt. bond yield spreads over Bunds, % Italy Greece Ireland Spain Portugal

Greece debt swap completed

20 40 60 80 100 120 140 160 180 Ger Ire Gre Spa Fra Ita Neth Por Government debt as % of GDP 2008 2009 2010 2011 2012 2013

6

Greece endgame in sight

7

Sovereign debt crisis reaches dangerous stage

Greece could exit Eurozone in 2013

• Greece finally has a new government

that wants to stay in the Eurozone.

• However, it also plans to test the

Troika’s resolve by trying to postpone and reverse some fiscal and structural reforms.

• Given the stress now present in Spain

and Italy, we believe the Troika is likely to relax the conditions on Greece, in order to focus on the

• thers.
• However, Greece remains deeply

uncompetitive, and we think Greece will be forced to abandon the Euro in 2013.

Source for image: Schroders

8

What to expect from a Greek exit?

Greece could exit Eurozone this year

• Exit would happen during a

weekend/out of business hours.

• Capital controls would instantly be

applied including border checks.

• All deposits would be switched into

the new Drachma, and the Bank of Greece would start to replace. physical currency as soon as possible

• The Drachma is expected to

depreciate by 30-70%, causing high inflation in the first few years, along with a very deep recession.

• However, local tourism and some

export industries will begin to boom, which should lead to the start of the recovery.

Source for image: Reuters

9

Banks must hold on to the confidence of investors

Source: Thomson Datastream, Schroders. Updated 10 July 2012

Premium for cost of borrowing for banks vs. non-banks

• 500

500 1000 1500 2000 2500 2007 2008 2009 2010 2011 2012 Spread between European financial & non-financial corporate credit yields, bps AA A BBB

10

However, ECB itself will be a big loser from a Greek exit

TARGET 2.0 central banks’ claims at ECB

Source: Thomson Datastream, Schroders. Updated 18 July 2012

• 1000
• 800
• 600
• 400
• 200

200 400 600 800 2004 2005 2006 2007 2008 2009 2010 2011 2012 €bn Germany France Core (Fr, Ger, Fin, Neth, Aust) Italy Peripheral (Por, Ire, It, Sp, Gr) Greece

11

Greek and Spanish deposits flying out of the door

Source: Thomson Datastream, Bank of Spain, Bank of Greece. Updated 10 July 2012

Household and non-bank corporate deposits in banks

• 25%
• 20%
• 15%
• 10%
• 5%

0% 5% 10% 15% 20% 2007 2008 2009 2010 2011 2012 Change in banking deposits, y/y Greece Spain

12

Who will suffer if the Eurozone goes into recession?

Source: IMF Direction of Trade (DOT) database. Average between 2006-11. Updated 22 May 2012

Eurozone exports by partners

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% Canada Australia Japan US China India Brazil Russia Switzerland UK Hungary Poland Norway Czech Rep. % of total exports % of GDP

13 13

Example: UK exports to peripheral Europe underperforming

Export values levels by partner (Jan’10=100)

Source: ONS, Schroders. Updated 12 July 2012. 50 60 70 80 90 100 110 120 Jan 10 Jul 10 Jan 11 Jul 11 Jan 12

Spain Italy Ireland Greece Portugal

90 95 100 105 110 115 120 125 130 135 Jan 10 Jul 10 Jan 11 Jul 11 Jan 12

China Australia Norway Germany Austria

14 14

Expect another bad Q2

Diamond Jubilee holiday will cause loss of output

Source: ONS, Market, Schroders. Updated 06/03/2012.

• 3.0%
• 5.9%
• 1.8%
• 4.9%
• 2.0%
• 1.1%
• 1.4%
• 5.3%
• 1.6%
• 1.6%
• 7%
• 6%
• 5%
• 4%
• 3%
• 2%
• 1%

0% Mining & quarrying inc

• il & gas extraction

Manufacturing Electricity, gas, steam and air con Total Production Services June '02 (Golden Jubilee) April '11 (Royal Wedding) Month on month growth

15 15

Austerity UK will keep growth subdued for most of this decade

Public sector net borrowing & change in cyclically adjusted budget deficit

Source: OBR, HMT, Schroders. Updated 23/03/2012. 11.1 9.3 8.3 5.8 5.9 4.3 2.8 1.1 2 4 6 8 10 12 14 09/10 10/11 11/12 12/13 13/14 14/15 15/16 16/17 PSBR, % of GDP Structural Cyclical 0.0 0.5 1.0 1.5 2.0 2.5 3.0 10/11 11/12 12/13 13/14 14/15 15/16 16/17 % of GDP Budget '12 Autumn Statement '11 Budget '11 PBR '10

Fiscal tightening delayed

16 16

Risks to inflation outlook are on the upside at the 2-year horizon

Schroders inflation forecast

Source: ONS, Schroders. Updated 18 July 2012.

• 2%
• 1%

0% 1% 2% 3% 4% 5% 6% 7% Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Y/Y Forecast RPI RPIX CPI CPI target bands

VAT rises to 20% VAT rises to 17.5% First BoE rate hike

17 17

Fundamental step-change in pricing pressures from goods

UK goods vs. services inflation

Source: ONS, Schroders. Updated 18/07/2012.

• 3%
• 2%
• 1%

0% 1% 2% 3% 4% 5% 6% 00 01 02 03 04 05 06 07 08 09 10 11 12 Y/Y Above 3% annual CPI inflation Goods Services '00-'05 average = -0.6% Average since '06 = +2.5% Average since '00 = +3.7%

18

Interest rates flat as a pancake

Schroders interest rate forecast

Source: Schroders, June 2012 forecast Please see the forecast risk warning on the important information slide 0.00 0.25 0.50 0.75 1.00 1.25 1.50 1.75 Jul Sep Nov Jan 2012 Mar May Jul Sep Nov Jan 2013 Mar May Jul Sep Nov % BoE ECB Fed

BoE ECB Fed

Oct 11 0.50 1.50 0 - 0.25 Nov 11 0.50 1.25 0 - 0.25 Dec 11 0.50 1.00 0 - 0.25 Jan 12 0.50 1.00 0 - 0.25 Feb 12 0.50 1.00 0 - 0.25 Mar 12 0.50 1.00 0 - 0.25 Apr 12 0.50 1.00 0 - 0.25 May 12 0.50 1.00 0 - 0.25 Jun 12 0.50 1.00 0 - 0.25 Jul 12 0.50 0.75 0 - 0.25 Aug 12 0.50 0.75 0 - 0.25 Sep 12 0.50 0.75 0 - 0.25 Oct 12 0.50 0.75 0 - 0.25 Nov 12 0.50 0.75 0 - 0.25 Dec 12 0.50 0.75 0 - 0.25 Jan 13 0.50 0.75 0 - 0.25 Feb 13 0.50 0.75 0 - 0.25 Mar 13 0.50 0.75 0 - 0.25 Apr 13 0.50 0.75 0 - 0.25 May 13 0.50 0.75 0 - 0.25 Jun 13 0.50 0.75 0 - 0.25 Jul 13 0.50 0.75 0 - 0.25 Aug 13 0.50 0.75 0 - 0.25 Sep 13 0.50 0.75 0 - 0.25 Oct 13 0.50 0.75 0 - 0.25 Nov 13 0.50 0.75 0 - 0.25 Dec 13 0.50 0.75 0 - 0.25

19

For professional advisers only. This material is not suitable for retail clients. Schroders has expressed its own views and these may change. The data contained in this document has been sourced by Schroders and should be independently verified before further publication or use. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested. The forecasts included in this presentation should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. We accept no responsibility for any errors of fact or opinion and assume no obligation to provide you with any changes to our assumptions or forecasts. Forecasts and assumptions may be affected by external economic or other factors. Source: Citywire ‘More ratings than anyone else’, as at 30 November 2011. Issued in July 2012 by Schroder Investments Limited, 31 Gresham Street, London EC2V 7QA. Registered No: 2015527

• England. Authorised and regulated by the Financial Services Authority. UK02291

19

Important information

20

Appendix

21

Shape of things to come

Baseline GDP forecast

Source: Schroders June 2012 forecast.

• 5%
• 4%
• 3%
• 2%
• 1%

0% 1% 2% 3% 06 ii iii iv07 ii iii iv 08 ii iii iv09 ii iii iv10 ii iii iv11 ii iii iv 12 ii iii iv13 ii iii iv GDP growth, Q/Q

Germany France Italy Spain

• 5%
• 4%
• 3%
• 2%
• 1%

0% 1% 2% 3% 4% 2006 2007 2008 2009 2010 2011 2012 2013 2014 GDP growth, Y/Y

Emerging EA Wider EA EA4

Y on Y France Germany Italy Spain Eurozone 2008

• 0.2%

0.8%

• 1.2%

0.9% 0.3% 2009

• 3.0%
• 5.1%
• 5.5%
• 3.7%
• 4.3%

2010 1.6% 3.6% 1.8%

• 0.1%

1.9% 2011 1.7% 3.1% 0.5% 0.7% 1.5% 2012 0.3% 1.1%

• 2.0%
• 1.2%
• 0.2%

2013 0.0% 0.2%

• 1.5%
• 1.2%
• 0.7%

2014 0.4% 1.3%

• 0.2%
• 0.8%

0.0%

Q on Q France Germany Italy Spain Eurozone

Q1 0.9% 1.3% 0.1% 0.4% 0.7% Q2 0.0% 0.3% 0.3% 0.2% 0.2% Q3 0.3% 0.6%

• 0.2%

0.0% 0.1% Q4 0.1%

• 0.2%
• 0.7%
• 0.3%
• 0.4%

Q1 0.0% 0.5%

• 0.8%
• 0.3%

0.0% Q2

• 0.1%

0.2%

• 0.7%
• 0.6%
• 0.2%

Q3 0.2% 0.3%

• 0.2%
• 0.4%

0.0% Q4 0.2% 0.3%

• 0.1%
• 0.1%

0.1% Q1 0.2% 0.3%

• 0.2%

0.0% 0.1% Q2

• 0.5%
• 0.5%
• 0.9%
• 0.7%
• 0.7%

Q3

• 0.2%
• 0.3%
• 0.5%
• 0.4%
• 0.7%

Q4 0.2% 0.2%

• 0.2%
• 0.2%
• 0.1%

2013 2012 2011

22 22

Shape of things to come

Baseline UK GDP forecast

Source: ONS, Schroder. Updated 12/07/2012.

• 4.0

1.8 0.8

• 0.1

0.7

• 6
• 4
• 2

2 4 6 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Year on Year % contributions to GDP Households Investment Government Net Trade Inventories Statistical Discrepancies GDP

Schroders forecast

23

Commodity prices set to help lower inflation in 2012

Annual commodity price inflation and implied rates by forwards

Source: Thomson Datastream, Bloomberg, Schroders. Updated 22 May 2012

• 75%
• 50%
• 25%

0% 25% 50% 75% 100% 125% 150% 175% 2007 2008 2009 2010 2011 2012 Monthly Y/Y change in price Forward contracts Cotton Wheat Oil

24 24

Leading indicators suggest weaker near term growth

GDP growth vs. Schroders Activity Index

Source: ONS, Markit, Schroders. Updated 12 July 2012.

• 2.5%
• 2.0%
• 1.5%
• 1.0%
• 0.5%

0.0% 0.5% 1.0% 1.5% 2.0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 q/q GDP growth Schroders Activity Index

James Montefiore – UK Institutional Client Director

Biographies

Joined Schroders in 2000 as UK Institutional Client Director, based in London Responsible for client servicing to UK pension funds and their consultants Previously worked at Threadneedle and Scottish Widows in a similar role. Prior to that he worked as a private client investment manager/analyst for private bankers, Adam & Company in Edinburgh from 1989. Began his career in financial services with private client stockbroker Williams de Broe from 1987 Prior to the financial industry he served for 8 years as an officer in the Royal Marines from 1979. An Associate of the UK Society of Investment Professionals (UKSIP), previously known as AIIMR. Member of the CFA Institute. A Fellow of the Chartered Institute of Securities & Investment

25

Azad Zangana – European Economist

Responsible for formulating the house view on the UK and Eurozone economies. He is based in the Schroders’ Economics Group in London. Investment career commenced when he joined Schroders in 2009. Prior to joining Schroders he was an Economist at HM Treasury working on UK Macroeconomic Analysis and Eastern Europe. Azad is a regular contributor to the press including television and radio appearances. He holds an MSc in Economics, University of Southampton and BSc in Economics, Royal Holloway, University

• f London. He also holds the Investment Management Certificate (IMC).

26

For professional advisers only. This material is not suitable for retail clients. Schroders has expressed its own views and these may change. The data contained in this document has been sourced by Schroders and should be independently verified before further publication or use. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested. The forecasts included in this presentation should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. We accept no responsibility for any errors of fact or opinion and assume no obligation to provide you with any changes to our assumptions or forecasts. Forecasts and assumptions may be affected by external economic or other factors. Source: Citywire ‘More ratings than anyone else’, as at 30 November 2011. Issued in July 2012 by Schroder Investments Limited, 31 Gresham Street, London EC2V 7QA. Registered No: 2015527

• England. Authorised and regulated by the Financial Services Authority. UK02291

26

Important information