Suffolk County Council The Cost of Austerity European Economic Outlook Azad Zangana Schroders’ European Economist James Montefiore Client Director 25 July 2012 For professional investors only. This material is not suitable for retail clients
Key issues European Economic Outlook • Growth vs. Austerity, can there be a winner? • Where next for the Eurozone? • When will the UK recession end? 1
Backlash against austerity gains legitimacy Hollande victory lends credibility to growth debate Source: Telegraphy online 2
Austerity is clearly affecting growth Divergence in recovery paths within Europe GDP level (100=2008 peak) 104 104 Austria 102 102 Germany 100 100 France 98 98 Spain 96 96 Portugal 94 94 Italy 92 92 90 90 88 88 Ireland 86 86 84 84 Greece 82 82 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Quarters Source: Eurostat, Thomson Datastream. Updated: 12 July 2012 3
Eurozone recession likely to be underway Leading indicators vs. Eurozone GDP growth GDP Growth (Y/Y) 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 Source: Thomson Datastream, Markit, BNB, Schroders. Updated 12 July 2012 4
More growth comes at a cost, and debt levels are already high Peripheral government bond spreads and debt to GDP levels Government debt as % of GDP 10-year Govt. bond yield spreads over Bunds, % 180 50 45 160 Greece 40 140 debt swap 35 completed 120 30 100 25 80 20 60 15 40 10 20 5 0 0 Ger Ire Gre Spa Fra Ita Neth Por Jan 09 Sep 09 May 10 Jan 11 Sep 11 May 12 2008 2009 2010 2011 2012 2013 Italy Greece Ireland Spain Portugal 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
Greece endgame in sight 6
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 others. However, Greece remains deeply uncompetitive, and we think Greece will be forced to abandon the Euro in 2013. Source for image: Schroders 7
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 8
Banks must hold on to the confidence of investors Premium for cost of borrowing for banks vs. non-banks Spread between European financial & non-financial corporate credit yields, bps 2500 2000 1500 1000 500 0 -500 2007 2008 2009 2010 2011 2012 AA A BBB Source: Thomson Datastream, Schroders. Updated 10 July 2012 9
However, ECB itself will be a big loser from a Greek exit TARGET 2.0 central banks’ claims at ECB €bn 800 600 400 200 0 -200 -400 -600 -800 -1000 2004 2005 2006 2007 2008 2009 2010 2011 2012 Germany France Core (Fr, Ger, Fin, Neth, Aust) Italy Peripheral (Por, Ire, It, Sp, Gr) Greece Source: Thomson Datastream, Schroders. Updated 18 July 2012 10
Greek and Spanish deposits flying out of the door Household and non-bank corporate deposits in banks Change in banking deposits, y/y 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% 2007 2008 2009 2010 2011 2012 Greece Spain Source: Thomson Datastream, Bank of Spain, Bank of Greece. Updated 10 July 2012 11
Who will suffer if the Eurozone goes into recession? Eurozone exports by partners Czech Rep. Norway Poland Hungary UK Switzerland Russia Brazil India China US Japan Australia Canada 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% % of total exports % of GDP Source: IMF Direction of Trade (DOT) database. Average between 2006-11. Updated 22 May 2012 12
Example: UK exports to peripheral Europe underperforming Export values levels by partner (Jan’10=100) 120 135 130 110 125 100 120 90 115 110 80 105 70 100 60 95 90 50 Jan 10 Jul 10 Jan 11 Jul 11 Jan 12 Jan 10 Jul 10 Jan 11 Jul 11 Jan 12 China Australia Norway Germany Austria Spain Italy Ireland Greece Portugal Source: ONS, Schroders. Updated 12 July 2012. 13 13
Expect another bad Q2 Diamond Jubilee holiday will cause loss of output Month on month growth Mining & quarrying inc Electricity, gas, steam oil & gas extraction Manufacturing and air con Total Production Services 0% -1% -1.1% -1.4% -1.6% -1.6% -2% -1.8% -2.0% -3% -3.0% -4% -5% -4.9% -5.3% -6% -5.9% -7% June '02 (Golden Jubilee) April '11 (Royal Wedding) Source: ONS, Market, Schroders. Updated 06/03/2012. 14 14
Austerity UK will keep growth subdued for most of this decade Public sector net borrowing & change in cyclically adjusted budget deficit % of GDP PSBR, % of GDP 3.0 14 12 11.1 2.5 Fiscal tightening 9.3 10 2.0 delayed 8.3 8 1.5 5.9 5.8 6 4.3 1.0 4 2.8 0.5 2 1.1 0 0.0 09/10 10/11 11/12 12/13 13/14 14/15 15/16 16/17 10/11 11/12 12/13 13/14 14/15 15/16 16/17 Structural Cyclical Budget '12 Autumn Statement '11 Budget '11 PBR '10 Source: OBR, HMT, Schroders. Updated 23/03/2012. 15 15
Risks to inflation outlook are on the upside at the 2-year horizon Schroders inflation forecast Y/Y 7% VAT rises to 17.5% 6% First BoE rate hike 5% 4% 3% 2% VAT rises to 20% 1% 0% -1% -2% Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Forecast RPI RPIX CPI CPI target bands Source: ONS, Schroders. Updated 18 July 2012. 16 16
Fundamental step-change in pricing pressures from goods UK goods vs. services inflation Y/Y 6% 5% 4% 3% 2% Average since '00 = +3.7% 1% 0% Average since '06 = +2.5% -1% -2% '00-'05 average = -0.6% -3% 00 01 02 03 04 05 06 07 08 09 10 11 12 Above 3% annual CPI inflation Goods Services Source: ONS, Schroders. Updated 18/07/2012. 17 17
Interest rates flat as a pancake Schroders interest rate forecast BoE ECB Fed Oct 11 0.50 1.50 0 - 0.25 % Nov 11 0.50 1.25 0 - 0.25 1.75 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 1.50 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 1.25 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 1.00 Sep 12 0.50 0.75 0 - 0.25 Oct 12 0.50 0.75 0 - 0.25 0.75 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 0.50 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 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 0.00 Aug 13 0.50 0.75 0 - 0.25 Jul Sep Nov Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov Sep 13 0.50 0.75 0 - 0.25 2012 2013 Oct 13 0.50 0.75 0 - 0.25 Nov 13 0.50 0.75 0 - 0.25 BoE ECB Fed Dec 13 0.50 0.75 0 - 0.25 Source: Schroders, June 2012 forecast Please see the forecast risk warning on the important information slide 18
Important information 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 19
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