Global economy report : May 2014

Global Economy Report

Global Economy Report

The Global Economy Report is prepared in cooperation by the Macroeconomic Research Division of Banca Aletti and the Global Governance Programme of the Robert Schuman Centre for Advanced Studies of the European University Institute.

The objective of the Report is to provide an analysis of the current and expected macroeconomic and financial conditions at the global level, with also a focus on key economic areas such as Europe, the USA and ASIA.

This report has been prepared by:

- Daniele Limonta (daniele.limonta@alettibank.it) - Massimiliano Marcellino (massimiliano.marcellino@eui.eu) - Alessandro Stanzini (alessandro.stanzini@alettibank.it) - Maria Eleonora Traverso (mariaeleonora.traverso@alettibank.it) with the collaboration of:

- Alberta Martino (alberta.martino@eui.eu)

EXECUTIVE SUMMARY

 A major question in the current global economic context is whether or not the

euro area crisis is finished.

 Financial markets seem to think so, given the major recovery in stock indexes

and the low public and private bond prices also for the euro peripheral countries. However, the real economy still presents substantial unbalances in several euro countries and various risk elements are present.

 In this report we analyze the main positive and negative arguments in favour

of a marked and permanent improvement in the economic and financial conditions in the euro area.

The main elements suggesting that the situation in the euro area is recovering are:

1. Positive growth data in the past quarters in several countries

2. Encouraging business’ and households’ surveys

3. Improved financial conditions in Southern Europe

4. Improved conditions in the real estate market

5. Less restrictive fiscal policy

6. Expansive monetary policy

7. Creation of a series of institutions that should favour a stronger

The main risk factors include:

1. The labour market situation is dramatic and will probably not improve in the short

run

2. Credit market remains fragmented, with access difficulties and diverse rates

3. The AQR and stress tests are necessary and useful, but in the short term they do

not help, just like Tapering in the US if accelerated

4. Inflation might remain very low for a long time, increasing real costs of private

and public debt and giving an incentive to postpone consumption and investment

5. A strong result for extremist parties at the European elections could have

important effects on a national level

6. A sudden stop in emerging countries would create market volatility and a

contraction in commerce

7. The Ukraine scenario could degenerate

Overall, we retain a positive view on the economic performance of the euro area.

We expect GDP growth of about 1-1.2% for 2014, increasing to about 1.6% in 2015. The major driver of growth is the German economy, whose GDP will likely grow well above 2%. We expect positive growth also in France and Italy, about 0.8% and 0.4% respectively, with values above 1% for both countries in 2015.

Inflation will remain subdued, we expect about 0.8% in 2014 and 1.2% in 2015. For core inflation we predict similar values, about 0.7% in 2014 and 1.0% in 2015.

THE END OF THE

EURO AREA CRISIS?

Distance from peak Q1-08 (bln euro)

Right scale

GDP DYNAMICS (fig.1)

In Q1-2014, Eurozone aggregate income grew by 0.2% compared to the previous period, growing for the fourth quarter in a row; recovery started accelerating after the slowdown of 2013’s second semester. GDP’s trend growth rate, +0.9%, is the highest since mid 2011 and suggests an acceleration of the economy. Income level is still well below pre-crisis values, but highest of the past two years.

NATIONAL ACCOUNTS Q1-14

Fonte: Thomson Reuters Datastream 2011 2012 2013 2014 -3 -2 -1 0 1 2 3 4 1Y % change of GDP : Germany 1,4% 1Y % change of GDP : France 0,8% 1Y % change of GDP : Italy -0,9% 1Y % change of GDP : Spain 0,6%

Fonte: Thomson Reuters Datastream

2008 2009 2010 2011 2012 2013 90 92 94 96 98 100 102 104

Germany is the driving economy, with an income increase of 0.8% on previous quarter and of 2.3% on a yearly basis (highest since 2011). France’s growth is null (+0.0%), but the trend rate is amply positive (+0.8%) and highest of the past two years. Spain grew by 0.4% vs. previous period, generating the greatest growth since beginning of 2008. Italy, with its GDP correction (-0.1%), registers negative yearly growth rate.

TREND CHANGE (fig.2) COMPARATIVE LEVELS (fig.3)

GERMANY

FRANCE

ITALY

SPAIN

NATIONAL ACCOUNTS Q1-14

RETAIL SALES

In March 2014, aggregate retail sales in Eurozone registered a better than expected dynamic, growing by 0.3%, vs. an expected -0.2% contraction. Trend growth rate is at +1.3%, a four year high. Increase in private consumption is triggered by constant progression in households’ consumer confidence, that in April registered end of 2007’s highs.

REAL, ex Auto

month/month

3m/3m ann.

Right scale

YoY, right scale

Eurozone; changes Quarterly Averages RETAIL SALES

Eurozone’s recovery accelerated at the beginning of second quarter, with economic activity expanding at a faster pace than the past three years, based on PMI Composite index. Simultaneous improvement in manufacturing (53.4) and services (52.1); the index relative to this compartment reported the highest level since mid 2011.

BUSINESS’

QUALITATIVE INDEXES

PMI COMPOSITE

PMI COMPOSITE OUTPUT

PMI MANUFACTURING

PMI COMPOSITO NUOVI ORDINI

In 2014, Eurozone’s Manufacturing PMI was higher than global PMI, inverting the negative difference of European vs. Global economy, persistent in the previous three years. According to the industrial businesses’ purchasing managers survey, Eurozone’s economy is second only to the US, while China and Japan feature a sensible instability.

BUSINESS’

QUALITATIVE INDEXES

GRECIA

PMI Manufacturing indexes comparison

EUROPE AND INTERNATIONAL CYCLE

PMI Manufacturing indexes comparison

According to April survey, European households’ financial expectations are highest since 2009’s highs, while expectations on the economy are best since 2007.

Both indicators are on values greatly higher than long term averages.

HOUSEHOLDS’

INTERBANK-OIS 1m differential CDS PREMIUM EUROZONE BANKS

FINANCIAL CONDITIONS

OIS SPREAD & CDS € BANKS COUNTRY RISK– CDS 5 YEAR

5 year Credit default swap

Source: Thomson Reuters Datastream 2009 2010 2011 2012 2013 2014 -1400 -1200 -1000 -800 -600 -400 -200 0 -1400 -1200 -1000 -800 -600 -400 -200 0 SPA -165.386 POR -237.636 ITA -174.713 IRE -138.559

Source Bloomberg, rating 04/2/2014

CSDR COUNTRY RISK

Rating and differential on German ten-year rates

FINANCIAL CONDITIONS

EUROZONE TEN YEAR RATES Benchmark bonds

FINANCIAL CONDITIONS

… and levels of 10 year rates (although it’s better to examine real rates that so far have decreased a bit less).

0 2 4 6 8 10 12 14 0 2 4 6 8 10 12 14 GER 3.14 2.98

Monthly changes

BUILDING PRODUCTION

Yearly changes

BUILDING PRODUCTION

HOUSING MARKET

After a prolonged period of contraction, also the housing market starts to return stable …

index HOUSING PERMITS Yearly change HOUSING PERMITS 50 100 150 200 250 300 350 400 50 100 150 200 250 300 350 400 -60 -40 -20 0 20 -60 -40 -20 0 20 -3,51%

Fonte: Thomson Reuters Datastream

00 02 04 06 08 10 12 14 -40 -30 -20 -10 0 10 -40 -30 -20 -10 0 10 -27

Fonte: Thomson Reuters Datastream

04 05 06 07 08 09 10 11 12 13 14 -15 -10 -5 0 5 10 -0,9 -2,0 Building Residential

HOUSING SECTOR CONFIDENCE INDEX BUILDING PRODUCTION

S 0.6 -2.8 -0.7 -3.3 -0.6 0.4 -2.4 -0.7 -2.4 -1.3 0.0 -2.1 -0.9 -3.9 -0.8 GER FRA ITA SPA NED 2013 2014 2015 S 78.4 93.5 132.6 93.9 73.5 76.0 95.6 135.2 100.2 73.8 73.6 96.6 133.9 103.8 73.4 GER FRA ITA SPA NED 2013 2014 2015 S 0.0 -4.3 -3.0 -7.1 -2.5 0.0 -3.9 -2.6 -5.6 -2.8 -0.1 -3.4 -2.2 -6.1 -1.8 GER FRA ITA SPA NED 2013 2014 2015

DEBT/GDP estimates 2013-2015 DEBT-SURPLUS/GDP estimates 2013-2015

S 2.2 -2.0 2.2 -3.7 -0.7 2.0 -1.5 2.6 -2.1 -1.0 1.7 -1.0 2.9 -2.6 -0.2 GER FRA ITA SPA NED 2013 2014 2015

SURPLUS-PRIMARY DEFICIT/GDP estimates 2013-2015 DEBT-SURPLUS/GDP ADJUSTED FOR THE CYCLE

FISCAL POLICY

EU COMMISSION’S FORECASTS

-5 -4 -3 -2 -1 0 1 2 3 -5 -4 -3 -2 -1 0 1 2 3 S 07 08 09 10 11 12 13 14 15 -4 -3 -2 -1 0 1 2 -4 -3 -2 -1 0 1 2 S 1990 1995 2000 2005 2010 2015 -3 -2 -1 0 1 2 -3 -2 -1 0 1 2

OECD COUNTRIES – PRIMARY BALANCE ADJ. FOR THE CYCLE

OECD data – quota % change on potential GDP

FISCAL RESTRICTION FISCAL EXPANSION -3 -2 -1 0 1 2 -3 -2 -1 0 1

2 _{EUROZONE– PRIMARY BALANCE ADJ. FOR THE CYCLE}

OECD data – quota % change on potential GDP

USA – PRIMARY BALANCE ADJ. FOR THE CYCLE

OECD data – quota % change on potential GDP

FISCAL RESTRICTION

JAPAN– PRIMARY BALANCE ADJ. FOR THE CYCLE

OECD data – quota % change on potential GDP

So 04 05 06 07 08 09 10 11 12 13 14 010 20 30 40 50 010 20 30 40 50

Central bank assets as a percent of IMF nominal GDP forecast

S 2009 2010 2011 2012 2013 2014 0.0 0.5 1.0 1.5 2.0 2.5 3.0 0.0 0.5 1.0 1.5 2.0 2.5 3.0 rif mg 0.75 eur3m 0.28 refi 0.25 eonia 0.15 depo 0 o/n (EONIA) EURIBOR 3m depositi o/n Principal refinancing Marginal refinancing

ECB – OFFICIAL RATES’ CORRRIDOR

In the May meeting, the ECB Steering Committee kept rates unchanged and avoided recourse to unconventional measures, in line with market consensus. However, President Draghi declared the possibility to activate all available options, including acquisition of financial assets (QE Fed style), non sterilisation of government bonds in SMP (over 200 bln in ECB style QE, i.e. not effective), negative rates on deposits, or other measures on liquidity in favour of private credit, directly or through the credit system.

CENTRAL BANKS’ BALANCES

Total asset, % nominal GDP (IMF data)

US FED EUROZONE ECB UK BoE JP BoJ

MONETARY POLICY

THE PILLARS

SSM-BU OMT

ESM

FISCAL COMPACT

FISCAL COMPACT agreement for a more rigid financial regulation, in line with sustainability

So 2008 2009 2010 2011 2012 2013 2014 88 90 92 94 96 98 100 102 104 88 90 92 94 96 98 100 102 104

EMU -MEMBER COUNTRIES’ GDP

EUROSTAT data – fixed Prices – 100= 2008 economic crisis

GERMANY AUSTRIA EIRE FRANCE NETHERLANDS SPAIN ITALY PORTUGAL

NEGATIVE ASPECTS

Unemployment reduction since mid 2013, unemployment rate’s stabilisation below peak, plus improved expectations (Employment sub-index of PMI survey at 50.7, best since end of 2011), certify that aggregate labour market has passed the point of cyclical low… EMPLOYMENT 1Y change PMI COMPOSITE EMPLOYMENT UNEMPLOYMENT RATE Right scale UNEMPLOYMENT 1M change Unemployment LABOUR MARKET

Employment and Expectations

LABOUR MARKET

LABOUR MARKET

PMI Employment:

So 02 04 06 08 10 12 14 010 20 30 40 50 60 70 010 20 30 40 50 60 70 GER FRA AUT NED GRE ITA IRE SPA POR FIN BEL 7.8 23.4 9.5 11.3 56.8 42.7 25.9 53.9 35.4 20.5 23.9 YOUTH UNEMPLOYMENT Source EUROSTAT

Source: Thomson Reuters Datastream 0 5 10 15 20 25 GRE 26.7 SPA 25.6 CYP 16 POR 15.3 SLO 14.2 SLK 13.3 ITA 12.7 EMU 11.8 IRE 11.7 FRA 9.8 LTV 9.8 FIN 9.5 NLD 8.7 BEL8.5 LUX 7.1 GER 6.7 EST 5.6 AUS 4.8 MAL 4.6 DISOCC. -5anni UNEMPLOYMENT RATE

Source: NATIONAL STATISTIC OFFICES

… but the situation is dramatic in several countries.

-30 -20 -10 010 20 30 40 -30 -20 -10 010 20 30 40

France _{Germany Italy}

Netherl… Austria _Belgium

Spain Portugal Ireland

Greece -1.15 -40 -30 -20 -10 010 20 30 40 -40 -30 -20 -10 010 20 30 40 France Germany Italy Netherland Austria Belgium Spain -2.99

BUSINESS CREDIT- TREND

One year growth rates HOUSEHOLD CREDIT- TREND One year growth rates

CREDIT MARKET

Fo -1,4 1,1 -1,4 2,2 -3,0 -1,2 -11,6 -5,2 -2,0 -3,0 1,1 8,0 BUSINESS HOSEHOLDS

GER FRA ITA

SPA NED BEL

BUSINESS AND HOUSEHOLDS CREDIT

One year growth rates

BUSINESS AND HOUSEHOLDS CREDIT

One year growth rates

… the situation is improving very slowly…

CREDIT MARKET

… on an aggregate level, banking market fragmentation remains high…

CREDIT MARKET

Banks’ aggregate data vs Italy, Eire, Greece, Spain

S 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 46810 12 14 46810 12 14 8.74 7.5 11.1 10.3 5.7 4.5 5.1

GRE ITA POR

SPA FRA NED

AUT GER So 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 23456782345678 6.17 4.37 6.1 4.9 2.3 3.0 3.2 2.3 GRE ITA POR SPA FRA GER NED AUT

INTEREST RATES ON CREDIT

Business credit under 1 bln euro Consumer credit – variable rate 1-5 years INTEREST RATES ON CREDIT

CREDIT MARKET

… and rates’ differentials between countries remain significant, as do rates’ levels in some countries.

The AQR and stress tests certainly don’t help.

The end of tapering in the USA and, in the medium term, the increase in US rates are another risk factor (although they could help in terms of exchange rate).

-2 -1 012345AUSTRIA 1,4 MALTA 1,4 FINLAND 1,3 BELGIUM 0,9 GERMANY 0,9 LUX 0,8 EUROZONE 0,7 ESTONIA 0,7 FRANCE 0,7 SLOVENIA 0,6 EU 0,6 ITALY 0,3 IRELAND 0,3 NETHERLANDS 0,1 SLOVAKIA -0,2 SPAIN -0,2 PORTUGAL -0,4 CYPRUS -0,9 GREECE -1,5 -0,5 0,0 0,5 1,0 1,5 2,0 2,5 ITALY 2,2 GREECE 1,8 SPAIN 1,6 PORTUGAL 1,4 CYPRUS 1,3 NETHERLANDS 1,1 MALTA 1 AUSTRIA 0,9 SLOVENIA 0,7 EU 0,7 FRANCE 0,5 IRELAND 0,5 ESTONIA 0,4 FINLAND 0,3 GERMANY 0,3 EUROZONE 0,2 BELGIUM 0 LUX 0 SLOVAKIA 0

In the month of April 2014, the final inflation figure was at 0.7%, up from March’s 0.5%, lowest since November 2009. In all Eurozone countries, trend inflation is lower than short and long term averages. Low inflation increases the real cost of private and public debt and encourages to postpone investment and consumption.

Cyclical change; harmonised data on European basis

INFLATION BY COUNTRY

Annualised change; harmonised data on European basis

INFLATION BY COUNTRY

INFLATION

Annualised change

INFLATION BY MACROSECTOR

Variazioni tendenziali

FOOD (incl. Alcohol tobacco)

SERVICES ENERGY

INDUSTRIAL GOODS (non energy)

Also in April the principal contribution to deflation comes from the evolution of energy prices.

Weight 19.3%

Weight 10.9%

Up to September 2014, general inflation will remain around 1%, under pressure from ample unused resources in labour and goods’ markets, with a weak economic recovery. Only starting in October it will rise and favourable impulses will intensify in 2015. However, the persistent negative output gap will bind price dynamics, keeping it far from 2%. Average rate +0.8% in

2014, +1.2% in 2015. For core inflation we foresee a declining profile for the first three

quarters of this year, with a +0.6% low in the final months of 2014 and a gradual increase towards 1% in 2015. Average rate +0.7% in 2014, +1.0% in 2015.

INFLATION

Cpi headline

EUROPEAN ELECTIONS

A marked victory of anti-European populist parties could influence national politics, possibly undermining Governments. Both elements could increase uncertainty and have negative effects on financial markets and the economy.

EUROPEAN DEPENDENCY ON RUSSIAN GAS

Weight of Russian gas on total

0 5 10 15 20 25 30 35 40 EUROZONE 33.2 CIS&MONG. 16.6 EU ex €ZONE 14.2 CHINA 6.9 U.S. 5.5 AFRICA 5.5 TURKEY 5 JPN 4.2 MIDDLE EAST 2.1 KOREA 2 INDIA 0.7 BRAZIL 0.6 EXPORT/TOTAL EXPORT 10 year average 5 year average

UKRAINE – RUSSIA CRISIS

RUSSIA – EXPORT

Export quotas versus single countries and areas

The dependency of certain European countries in the euro area on Russia’s energy supplies is great, as are the trade ties.

UKRAINE – RUSSIA CRISIS

Bln USD– Source BIS

Banks’ exposure is overall limited for single countries, but on the Eurozone aggregate level it’s worth over 120 bn dollars.

Main phenomenons:

CHINA - SUDDEN STOP?

 Drop in exports

 Lower than expected growth for production, sales and investment  Qualitative indicators’ decrease

SHANGHAI CHAORI SOLAR DEFAULT  This company, that operates in materials for solar energy production, announced on 4 March 2014 that it will not be able to pay interests on a 5-year bond (expiry 2017). Bond worth 1 bln RMB, 8.98% coupon.

First technical default on the internal bond market in the recent history of the system

EASENING OF PRICE PRESSURE

 Stronger deflation upstream in the supply chain

Decreasing inflation at

consumption stage

Decrease in qualitative indicators

INCREASING WORRIES ON CHINA’S BRUSC LANDING

 Instant adjustment in raw materials’ prices

The correct interpretation of Chinese slowdown cannot exclude the context it belongs to…

CHINA - SUDDEN STOP?

Domestic authorities are trying to create

The greatest change in the

economic policy of the past

twenty years …

Balancing growth, inflation and

employment targets.

Various elements suggest that the situation in the euro area is recovering:

1. Positive growth data in the past quarters in several countries

2. Encouraging business’ and households’ surveys

3. Improved financial conditions in South Europe

4. Improved conditions in building market

5. Less restrictive fiscal policy

6. Expansive monetary policy

7. Creation of a series of institutions that should favour economic union (Fiscal

Compact, OMT, ESM, SSM)

However risk factors remain:

1. The labour market situation is dramatic and will probably not improve in the short

run

2. Credit market remains fragmented, with access difficulties and diverse rates

3. The AQR and stress tests are necessary and useful, but on the short term do not

help, just like Tapering in the US, when accelerated

4. Inflation might remain very low for a long time, increasing real cost of private and

debt and thus giving an incentive to postpone consumption and investment

5. A strong result for extremist parties at the European elections could have

important effects on a national level

6. A sudden stop in emerging countries would create market volatility and a

contraction in commerce

7. The Ukraine scenario could degenerate

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