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									                          Europe United Kingdom

                          29 June 2012

                          Focus Europe                                                                                    Special Report
                                                                                                                          Table of Contents

                          Progress, but still not there                                                                   Eurostress: Progress, but still not there........... Page 03
                                                                                                                          ECB Preview: A rate cut ................................... Page 06
Global Markets Research

                                                                                                                          France: Early U-turn on fiscal policy ................. Page 10
                                                                                                                          Euro Sovereign Events: What to watch ........... Page 13
                                                                                                                          Inflation............................................................. Page 14
                                                                                                                          UK: 11 key financial statistics ........................... Page 15
                          All the points we expected from the Euro summit (seniority removed on the                       Hungary: NBH inflation scenarios..................... Page 22
                          bank recapitalisation loan to Spain, growth initiative, “federal” supervision                   Rate Views ....................................................... Page 25

                          of banks) are there, but the possibility of direct recapitalization is a positive,              Research Team
                          significant surprise. However, we remain prudent on secondary market
                          intervention. There was a mere restatement of the current guidelines’                           Euroland
                          minimal conditionality, not a substantial loosening, and the question mark                      Gilles Moec
                          on the EFSF/ESM’s funding capacity remains. We cannot easily infer from                         (+44) 20 754-52088
                          the summit’s communication that the ECB is ready to fill that gap. The                          Peter Sidorov
                          Europeans have cracked open more doors than we thought, but they still                          (+44) 20 754-70132
                          have a lot on their plate. In particular, the discussion on fiscal                              Marco Stringa
                          integration/debt mutualisation has not started in earnest.                                      (+44) 20 754-74900

                          France is altering its macro strategy earlier than we thought, towards more                     Mark Wall
                          credible fiscal austerity. Progress still needs to be seen on structural reforms                (+44) 20 754-52087
                          though, and the debate on sovereignty transfers, in exchange for debt
                          mutualisation, will not be easy.                                                                UK/Scandinavia
                          On 5 July, the ECB Governing Council meets to consider the monetary policy                      George Buckley
                          stance. We expect the refi rate to fall by 25bp to 0.75% but, on balance, we                    (+44) 20 754-51372
                          expect the deposit rate to be cut by a smaller amount, possibly 15bp to a
                          level of 0.10%. We do not expect new liquidity and non-standard monetary                        Central Europe
                          policies to be announced on 5 July.                                                             Caroline Grady
                          In this week's UK article we take a look at the latest national accounts.                       (+44) 20 754-59913
                          There was a fall in household incomes and the saving ratio in Q1, and while
                          the latest recession is now a little deeper than we originally thought, the                     Inflation Strategy/Economics
                          2008-09 has been revised shallower.                                                             Markus Heider
                                                                                                                          (+44) 20 754-52167
                          We also take a look at the latest Inflation Report in Hungary where the NBH
                          presents a baseline plus three alternative scenarios for the inflation and rates
                          outlook. We see the alternative scenario of improved risk perceptions under
                          an IMF/EU deal as the most likely.
                          EU summit pushes yields back down
                                         10YR government bond spreads, %
                                                                                     Spain         Ireland        Italy





                              01/06/2012                          09/06/2012          17/06/2012             25/06/2012
                          Source: DB Global Markets Research, Bloomberg Finance LP

                          Deutsche Bank AG/London
                          All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local
                          exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche
                          Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm
                          may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single
                          factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1.
                          MICA(P) 072/04/2012.
29 June 2012                     Focus Europe

 Economic Forecasts
                                                             Real GDP                                         Consumer Prices                                        Current Account                                          Fiscal Balance
                                                             % growthb                                          % growthc                                              % of GDPd                                                % of GDP
                                                       2011        2012F        2013F                        2011        2012F         2013F                        2011        2012F        2013F                       2011F        2012F         2013F
Euroland (top-down)                                       1.5          -0.4          0.2                        2.7           2.5           1.7                        0.0          -0.1          0.1                       -4.1          -3.2          -2.5

Germanyb                                                  3.0           0.8          1.0                        2.5           2.0           1.5                        5.7           5.9          5.0                       -1.0          -0.6          -0.5
France                                                    1.7          -0.3          0.0                        2.3           2.3           1.7                       -2.2          -2.3         -2.6                       -5.2          -5.0          -4.0
Italy                                                     0.5          -2.3         -0.4                        2.9           3.2           2.1                       -3.3          -2.3         -1.6                       -3.9          -2.3          -1.5
Spain                                                     0.7          -1.5         -0.8                        3.1           1.9           1.2                       -3.5          -2.9         -2.5                       -8.9          -6.2          -4.9
Netherlands                                               1.1          -1.1          0.3                        2.5           2.6           1.8                        8.4           7.5          7.0                       -4.7          -4.7          -3.5
Belgium                                                   1.9           0.2          0.3                        3.5           3.1           1.8                       -0.8           1.5          2.0                       -3.7          -3.4          -3.2
Austria                                                   3.0           0.3          0.5                        3.5           2.4           1.8                        1.9           3.0          3.0                       -2.6          -2.9          -2.8
Finland                                                   2.9           1.8          0.8                        3.3           3.0           1.7                        1.0           1.5          2.0                       -0.5           0.3           0.3
Greece                                                   -6.9          -5.9         -3.1                        3.1           1.6           0.7                       -9.6          -7.0         -6.0                       -9.1          -8.0          -6.1
Portugal                                                 -1.6          -2.6         -0.6                        3.6           3.3           1.3                       -6.7          -5.5         -4.0                       -4.2          -5.5          -4.0
Ireland                                                   0.7          -0.5          0.6                        1.2           1.9           1.5                        0.1           1.5          2.0                     -13.1           -8.6          -8.4

UK                                                        0.8           0.0          1.8                        4.5           2.8           1.9                       -1.9          -2.4         -2.0                       -8.3          -6.3          -6.1
Sweden                                                    4.0           1.0          2.0                        2.6           1.5           1.6                        7.0           6.5          6.0                        1.9          -0.5           0.5
Denmark                                                   0.8           0.5          1.5                        2.8           2.5           2.0                        6.6           5.0          4.5                       -1.6          -4.5          -3.5
Norway                                                    1.5           3.0          2.0                        1.3           1.2           2.0                      14.5          16.0         14.0                       10.0          13.5          12.0
Switzerland                                               2.1           1.7          1.5                        0.2          -0.5           0.5                      14.8          13.5         12.5                         0.4          -0.3          -0.5

Poland                                                    4.3           2.5          2.0                        4.3           3.6           3.3                       -4.3          -4.0         -3.6                       -5.1          -3.2          -3.0
Hungary                                                   1.7          -1.3          1.0                        3.9           6.1           4.2                        1.4           0.8          0.8                        4.2          -3.0          -2.9
Czech Republic                                            1.7          -0.8          1.0                        1.9           3.4           2.4                       -3.1          -2.7         -2.9                       -3.1          -2.9          -2.7

US                                                        1.7           2.3          2.6                        3.1           2.3           2.5                       -3.1          -3.1         -3.1                       -8.3          -6.2          -5.1
Japan                                                    -0.7           3.1          1.2                       -0.3           0.5          -0.1                        2.1           2.0          2.6                     -10.0         -10.1           -9.2
World                                                     3.6           3.2          3.6                        4.5           3.5           3.5
(a) Euro Area and the Big 4 forecasts are frozen as of 23/03/12. All smaller euro area country forecasts are as of 23/.3/12. Bold figures signal upward revisions. Bold, underlined figures signal downward revisions. (b) GDP figures refer to working day
adjusted data. (c) HICP figures for euro-zone countries and the UK (d) Current account figures for Euro area countries include intra regional transactions. (e) The revised inflation forecasts assume brent oil of $75/pb at the end of 2009 and $63.9/pb on
average in 2010.
Source: National statistics, national central banks, Deutsche Bank forecasts.

Forecasts: Euroland GDP growth by components1 and central bank rates
Euroland, % qoq                                           11-Q1               11-Q2            11-Q3              11-Q4             12-Q1            12-Q2F            12-Q3F              12-Q4F               2011             2012F              2013F
GDP                                                            0.7                0.1               0.1               -0.3                0.0              -0.4               -0.2                0.0              1.5              -0.4                0.2
Private Consumption                                           -0.1               -0.4               0.3               -0.5                0.0              -0.2               -0.5               -0.2              0.2              -0.7               -0.2
Gov. Consumption                                              -0.1                0.0              -0.3               -0.1                0.2              -0.2               -0.1                0.0            -0.3               -0.7               -0.3
Investment                                                     1.8               -0.1              -0.3               -0.4               -1.4              -1.5               -3.0               -1.5              1.4              -4.9               -1.9
Stocks (contribution)                                          0.1                0.1              -0.2               -0.3               -0.2              -0.1                0.1               -0.1              0.1              -0.6                0.1
Exports                                                         1.4               1.1               1.5               -0.7                1.0               0.4                0.0                0.5              6.2               2.1                2.3
Imports                                                         0.8               0.6               0.7               -1.7                0.1              -0.1               -1.5               -0.8              3.9              -1.6                0.5
Net Trade (contrib..)                                           0.3              0.4                0.3                0.4                0.4               0.2                0.6                0.5              1.1               1.6                0.8

HICP inflation, % yoy                                           2.5               2.7               2.7                2.9               2.7                2.5               2.4                2.3               2.7               2.5                1.7
Core inflation, % yoy                                           1.3               1.7               1.7                2.0               1.9                1.5               1.3                1.4               1.7               1.5                1.5

EMU4 GDP, % qoq
Germany                                                         1.3               0.3               0.6               -0.2               0.5                0.2               0.4                0.2               3.0               0.8                1.0
France                                                          0.9               0.0               0.3                0.1               0.0               -0.4              -0.5               -0.1               1.7              -0.3                0.0
Italy                                                           0.1               0.3              -0.2               -0.7              -0.8               -1.0              -0.4               -0.1               0.5              -2.3               -0.4
Spain                                                           0.4               0.2               0.0               -0.3              -0.3               -0.5              -0.9               -0.8               0.7              -1.5               -0.8

Central Bank Rates (eop)
ECB refi rate                                                1.00               1.25              1.50               1.00              1.00               1.00               0.75              0.75
US fed funds target rate                                     0.25               0.25              0.25               0.25              0.25               0.25               0.25              0.25
BoE bank rate                                                0.50               0.50              0.50                0.50             0.50               0.50               0.50              0.50
BoJ O/N call rate                                            0.10               0.10              0.10               0.10              0.10               0.10               0.10              0.10
Source: National statistics, national central banks, Deutsche Bank forecasts. (1) Forecasts in lower table as of 01/06/12

Page 2                                                                                                                                                                                                        Deutsche Bank AG/London
29 June 2012    Focus Europe

Eurostress: Progress, but still not there
    Our expectations for this summit were very low             direct recapitalisation. Even then, the devil will be in the
    (see FE last Friday). All the points we expected           details (what kind of 'recap' securities will be used?). The
    (seniority removed on the bank recapitalisation            associated conditionality is vague, perhaps usefully so. It
    loan to Spain, growth initiative, “federal”                could be as narrow as "institution specific" or as broad as
    supervision of banks) are there, but the possibility       "economy wide". This is a potential change from the
    of direct recapitalisation (i.e. without raising the       current system. Indeed, so far – and this had been re-
    receiving countries’ public debt) is a positive,           stated by the Eurogroup when “pre-agreeing” the Spanish
    significant surprise. However, we remain prudent           request for support - only “institution specific” and
    on secondary market intervention.                          “sector specific” conditionality was mentioned in the
                                                               EFSF guidelines on the “recap only” loans. This opens the
    That in essence complying with the ordinary fiscal
                                                               door to impose additional fiscal and structural policy
    surveillance framework would suffice as a basis
                                                               measures onto receiving countries. Nevertheless, a direct
    for a MoU triggering EFSF/ESM support in the
                                                               recap facility is effectively being endorsed by EA leaders.
    market is a welcome clarification that would help
                                                               This is a significant step, we think, towards 'burden-
    removing the political stigma for Spain and Italy
                                                               sharing' and relieving the negative feedback loop between
    if/when requesting such intervention, but this is
                                                               sovereigns and banks.
    merely a re-statement of the current guidelines’
    minimal conditionality, not a substantial
                                                               Spain's ESM loans will NOT be senior. This, we believe
                                                               is an important precedent. As we have stated in Focus
    The question mark on the EFSF/ESM’s funding                Europe last week, ESM seniority is not in the legal clauses
    capacity remains. The ECB is mentioned in the              of the ESM Treaty, but in the political preamble. All it took
    statement as the EFSF/ESM’s agent – which it               to rescind this is a statement from leaders, at least at the
    already is. This may be a hint that some form of           European level. This is it. Naturally, removing seniority
    “plugging” of the rescue mechanism to the ECB is           from the Spanish recapitalization loan will not matter any
    envisaged, or that the Europeans merely expect             longer once the country benefits from the direct
    the central bank to resume SMP on the basis of             recapitalisation procedure.
    this morning’s agreement, but the statement
    remains so cryptic that we warn against over-
                                                               This is not explicit in the Euro group’s statement, but we
                                                               think this is the logical conclusion. Although Spain would
    In a nutshell, we think that the Europeans have            be borrowing money to recapitalise its banks through the
    cracked open more doors than we thought, but               current procedure (the Eurogroup “urges the rapid
    they still have a lot on their plate. There will be        conclusion of the MoU attached to the financial support to
    more “crucial summits”. The only reference to the          Spain”), there is a hint that direct recapitalisation may be
    “roadmap” prepared by Van Rompuy, Barroso,                 extended to this country once the facility exits. Indeed,
    Draghi and Juncker came in the EU 27                       the statement clearly signals that with Ireland the
    conclusions, not in the Eurogroup statement, and           Eurogroup are to examine how to "improve" upon an
    was remarkably non-committal. The discussion on            already "well-performing" adjustment program. Not only is
    fiscal integration/debt mutualisation has not              this a positive for Ireland (public debt would be reduced to
    started in earnest.                                        c.90% of GDP from 116% of GDP if the fraction
                                                               attributable to the bank recapitalisation was removed from
Direct bank recapitalization is                                the stock of debt). This is a clear jump forward with EU
unexpected and significant progress                            burden-sharing. The Irish program may be deemed "well-
                                                               performing", but there is still a stated common
Direct bank recapitalisation is foreseen when the
                                                               commitment to improving the program. Moreover, "similar
common supervisory regime for banks is in place. This
                                                               cases will be treated equally". Coming in the paragraph
is a significant development which sets a positive
                                                               that opens the door to direct bank recapitalisation, this
precedent beyond Spain. Timing is uncertain. Proposals
                                                               raises the possibility that good compliance by Spain with
for the common supervision, under the ECB, will come
                                                               an EFSF/ESM bank recap loan might be a basis to improve
"shortly" and be considered by the Council "as a matter of
                                                               upon the arrangement when new policy tools become
urgency by the end of 2012". There may well be a gap
                                                               available. Public debt, in our baseline, would peak at 86%
between agreement on the terms of common
                                                               of GDP instead of 95% if the sovereign is “de-linked”
supervision, ratification, implementation and possibility of
                                                               from the cost of bank recapitalization.

Deutsche Bank AG/London                                                                                              Page 3
29 June 2012     Focus Europe

A lot still needs to be fleshed out. We will particularly       exception after Greece, Portugal and Ireland). This could
focus on any residual involvement of the sovereign in the       be relevant for investors if the ESM were to actively
structure used to recapitalize banks. Indeed, various           engage in bond market intervention.
solutions could ultimately rest on a guarantee by the
                                                                We think that the statement contains more actual good
“receiving sovereign” of the ESM’s risk.
                                                                news for Spain, where the focus definitely is on banks,
                                                                than for Italy, since the potential for decisive market
Still very vague on market intervention                         intervention remains unclear.

We were not expecting a sanctioning of market                   There is not enough precise information in the
intervention by the EFSF/ESM and it did not materialise,        Eurogroup’s statement to let us conclude that Europe
although it was discussed and forms part of the                 has found a credible manner to deal with what in our
Eurogroup’s statement.                                          view is the rescue mechanism’s main limitation: the
                                                                fact that it has not ready access to cash. The ESM’s
There was a lot of press coverage (El Pais, Corriere della      paid in capital will amount to only EUR 32bn by October.
Sera) the morning after the Eurogroup’s announcement on         We do not think that the ESM would have the possibility
how Spain and Italy reportedly threatened to veto the           to leverage this capital base sufficiently swiftly in the
'growth initiatives' deal if there was no progress towards      market to create a credible backstop for Spain or Italy if
a policy to help ease the strains on their markets. It was      these countries actually triggered the support. Indeed,
said that no agreement was reached yet on the                   market intervention is intrinsically different from bank
conditionality of intervention, though possibly by the 9        recapitalization since actual cash is needed, instead of
July ECOFIN meeting.                                            merely writing bonds – which have never been issued in
The paragraph in the leaders’ statement on the                  the market - to receiving credit institutions, which would
commitment to helping stabilise markets makes a lot of          then repo them at the ECB.
reference to conditionality. The insistence on the fact that
conditionality might be light because all that is required is   Growth initiative: no silver bullet, as
compliance        with     the    agreed    country-specific
recommendations under the Excessive Deficit Procedure,
may be misleading. In fact, this is no different to the
minimum requirements already detailed in the guidelines         Van Rompuy unveiled the expected “growth initiative”,
for EFSF direct intervention support. Yes, there must be        which as we thought is a combination of a EUR 10bn
an MoU signed by a government benefiting from this aid.         boost to EIB capital which could potentially unleash EUR
No, it need not include new, tougher fiscal adjustment          60bn in additional lending, EUR 5bn or project bonds
measures. Nevertheless, the day after the Eurogroup             (including private sector participation) and EUR 55bn for
announcement both Mario Monti and Mariono Rajoy said            undisbursed structural funds. We have warned in FE last
that their countries would not be availing of these             week that there could be some double counting there, as
facilities, at least for the time being. Conditionality has     EIB lending in some countries is collateralized by
not been made materially more lenient.                          structural funds.

Potentially important was the reference to the ECB
and its role in EFSF/ESM direct intervention. The ECB           No progress on the “road-map”
role as "agent" was welcomed. There ought not to have
been any statement here. It was agreed months ago that          The Eurogroup statement did not refer to the “roadmap”
the ECB would act as agent for these interventions. Why         towards fiscal integration. A reference to it can be found
mention it now if not new news? Technically, the ECB            in the conclusions of the European Council, released a
agency role merely means the central bank provides all          few hours later. To say that it is non committal is probably
the trading functions for the EFSF/ESM direct intervention,     a euphemism: “ following an open exchange of views,
but none of the financing. Maybe leaders are trying to          where various opinions were expressed “ (which in our
create a deliberate ambiguity, to give the impression that      view suggests that we are far from a consensus) “the
ECB balance sheet might also have some involvement, or          President of the European Council was invited to
that the leaders hope progress on issues like direct bank       develop….a specific time-bound road map for the
recapitalisation, of which the ECB is a proponent, might        achievement of a genuine EMU” with the same deadlines
create the conditions for more ECB balance sheet aid.           as in the first draft, i.e. October and December 2012. “

We would however warn against over-interpreting that            In a way, we can see this positively, as firm commitments
segment of the statement. We also note that the removal         on a more stringent fiscal framework – in particular for
of seniority is for the time being specific to Spain (another   France - were not pre-conditions for German concessions

Page 4                                                                                             Deutsche Bank AG/London
29 June 2012    Focus Europe

on the EFSF/ESM, but deep down it is also a sign that this
discussion – the crucial one from a long term point of
view – has not really started. The only notable progress on
these issues is the fact that Francois Hollande announced
the morning after the release of the Eurogroup statement
that he could now present to parliament the fiscal
compact for ratification (see companion paper in this
week’s FE).

Politically the Eurogroup statement is remarkably
balanced. Germany did not have to make any concession
on debt mutualization – which was in our view Mrs
Merkel’s first preoccupation. Symmetrically, France does
not have to engage in a tricky political debate on fiscal
sovereignty transfers. The only Geman concession was on
direct bank recapitalisation - while ultimately maintaining
an implicit “right of veto” since Mrs Merkel made clear
that the Bundestag would have to vote on that new
procedure. Spain is in our view the main beneficiary, while
Francois Hollande can tell in Paris that he won on the
growth initiative, as well as on imposing some “short
term fixes”

The Eurozone currently is in a situation of “mulltiple
equilibria”. In Ireland or Spain, the root of the crisis was
clearly in unsustainable private sector debt, which itself
triggered a banking crisis which the local government
could not curb on their own strength. The Europeans have
probably this week made good progress on solutions
there. Still, in some other countries, such as Italy, the
difficulties can be attributed to a large legacy debt
combined with slow growth. What these countries need
is a credible “intervention mechanism” which can help
them on and off as they make progress on structural
reforms. In our view, this intervention mechanism still has
not been found. This leaves the ECB, as often, in a crucial

                          . Gilles Moec, (44) 20 7545 2088
                             Mark Wall, (44) 20 7545 2087

Deutsche Bank AG/London                                        Page 5
29 June 2012    Focus Europe

ECB Preview: A rate cut
    On 5 July, the ECB Governing Council meets to              from it. But it is not for the ECB to resolve this more
    consider the monetary policy stance. The ECB               fundamental problem. Resolution lies in the realm of the
    faces two problems currently. First, current               national governments, individually and collectively. There
    economic conditions are deteriorating and near-            are questions as to whether the ECB ought to supply
    term inflation expectations are beginning to fall.         ‘bridge’ facilities in the face of market skepticism as
    Unless this can be dismissed at simply volatility in       governments implement the reforms and integration
    the economic cycle, the appropriateness of the             necessary for a more sustainable euro area, but on the
    current 1% refi rate can be questioned. Second,            back of another EU summit which unusually exceeded
    there are questions around localized difficulties of       low expectations, the pressure may be off the ECB for
    bank access to liquidity.                                  now.

    We expect the refi rate to fall by 25bp to 0.75%           The ECB has to balance price stability and financial
    but, on balance, we expect the deposit rate to be          stability against the moral hazard of strong support
    cut by a smaller amount, possibly 15bp to a level          undermining the pressures for reform and integration. For
    of 0.10%. There are grounds to cut rates. The              the ECB at the current juncture, to err on the side of
    economic cycle has faltered, price expectations            caution does not equate to being over accommodative. If
    are declining and the signals from money and               anything, particularly with non-standard policies, the ECB
    credit are not positive.                                   incentive is skewed the other way – to under
                                                               accommodate and keep EU leaders under pressure to
    We do not expect new liquidity and non-standard            deliver a more sustainable solution to the crisis.
    monetary policies to be announced on 5 July. The
    ECB has already recently announced ABS
    collateral rule changes, which are positive at the         ECB has reason to cut interest rates
    margin, and the ECB will be pleased by the euro            Draghi admitted that a “few” Council members wanted to
    area leaders’ agreement to introduce common                cut policy rates at the last meeting on 6 June. We believe
    supervision of euro area banks (under the ECB)             there will be majority support for a cut on 5 July. We
    and to eventually create a direct bank                     expect the refi rate to fall by 25bp to 0.75% but, on
    recapitalization capability. This ought to                 balance, we expect the deposit rate to be cut by a smaller
                                                               amount, possibly 15bp to a level of 0.10%.
    contribute to relieving the negative feedback loop
    between sovereigns and banks.                              There are grounds to cut rates. The economic cycle has
                                                               faltered. The updated staff GDP growth forecasts released
On 5 July, the ECB Governing Council meets to consider         last month showed no change in central forecasts relative
the monetary policy stance. We expect the Council to           to a quarter earlier. However, they were set a few weeks
announce a reduction in interest rates, taking the refi rate   earlier and the ECB admitted the data were deteriorating.
below 1% for the first time. Our baseline is not to expect     Draghi admitted to “serious” downside risks at last
the ECB to unveil non-standard policy moves at this time.      month’s press conference, far more concerning language
We believe another 3Y LTRO is probably inevitable, but a       than was in the prepared press statement (“increasing
negative Bank Lending Survey will be the key piece of          downside risks”); Draghi has reiterated the “serious” risk
                                                               rhetoric since the last meeting.
evidence to convince the ECB to deliver more very long
term liquidity. The ECB won’t have this report in hand until   The very latest survey evidence gives little reason to think
the August Council meeting. However, the ECB has no            the loss of momentum is mere volatility. The Flash PMI
pre-commitment. Much may yet depend on how markets             report for June was surprisingly unchanged relative to
fare in the days after the EU summit and the days before       May. The details were, however, still concerning.
the ECB meeting.                                               Germany was weaker on the month, whereas France was
                                                               a source of gain (albeit in the context of a volatile
The ECB Governing Council faces two problems currently.
                                                               performance by France so far this year). If this was a sign
First, current economic conditions are deteriorating and
                                                               of the euro area’s Germany mainstay faltering, it could be
near-term inflation expectations are beginning to fall.
                                                               an important leading indicator for the euro area at large.
Unless this can be dismissed at simply volatility in the
                                                               Concerning also were the strong drops in expectations in
economic cycle, the appropriateness of the current 1%
                                                               the service sector (the only forward-looking indicator in
refi rate can be questioned. Second, there are questions
                                                               the entire PMI survey). In Germany, the month-on-month
around localized difficulties of bank access to liquidity.
                                                               decline set a new record. The EC economic sentiment
Some may see a more fundamental problem, namely the            report, out this week, showed further broad-based
broader euro debt crisis. The two problems above flow          declines in June.

Page 6                                                                                            Deutsche Bank AG/London
29 June 2012               Focus Europe

Figure 1: PMI weak, expectations declining rapidly                             and flow of flows associated with the ‘other financial
                                                                               institutions’ sector, a heterogeneous sector consisting of
                           EA composite output PMI
                                                                               investment funds, security dealers, hedge funds, private
  70                       EA services expectations PMI
                                                                               equity funds and central counterparties. There was a
  65                                                                           substantial rise in OFI overnight deposits and bank lending
                                                                               through CCPs, both of which speak of declining risk
                                                                               Figure 3: M3 accelerated, but liquidity being held on
                                                                               shorter duration, signaling risk aversion
                                                                                14                                        M3
                                                                                          % yoy
  40                                                                                                                      Long-term financial liabilities
    2006          2007          2008       2009        2010   2011   2012         8
Source: Deutsche Bank, Markit

Levels are informative too. The euro area composite PMI
was 46.0 in June, according to the flash estimate. The
medium level at which the ECB has cut interest rates                              2
since 1999 is 47.0. The medium 3-month decline in the
composite PMI preceding a policy rate cut has been 1.5
points. In June 2012, the index is down 3.0 point. Levels                        -2
and momentum are within ECB rate cut territory.                                    2005        2006         2007   2008    2009    2010     2011    2012
                                                                               Source: Deutsche Bank, ECB

Inflation is also easing up quickly, care of declining energy
prices. It now looks like headline HICP will be below 2%                       Both households and non-financial corporates increased
yoy before the end of this year. The basis effects should                      overnight deposits in May at the expense of longer term
push inflation down sharply in the early months of 2013.                       deposits. Again, this is not a positive signal. Lending to
With visibility on economic activity absent, even core                         corporates contracted in month-on-month terms in May.
inflation is likely to look a little better. Business selling                  Lending has contracted in 4 of the last 6 months. Lending
price expectations are starting to fall quickly, according to                  to households was positive, but weak. While it may be
the surveys.                                                                   that demand for credit itself is weak, the limp flow of
                                                                               credit to the real economy may be concerning to the ECB.
Figure 2: Selling price expectations are declining,
signaling an easing in the rate of core inflation                              Figure 4: Credit to corporates contracted again in May
                   Selling price expectations                                     50           Net new monthly lending, EURbn:

     30            12-mth chg in core HICP yoy inflation, pp (rhs) 2.0            40                                        Households
     25                                                                           30                                        Non-financial corporates
     20                                                                           20
     15                                                                 1.0
     10                                                                 0.5        0
       0                                                                0.0      -10
      -5                                                                -0.5     -20
    -10                                                                          -30
    -20                                                                 -1.5
        1991 1994 1997 2000 2003 2006 2009 2012                                  -50
                                                                                       2011                                             2012
Source: Deutsche Bank, European Commission, Eurostat                           Source: Deutsche Bank, ECB

M3 re-accelerated in May to 3.0% yoy from 2.5%. M1
growth nearly doubled to 3.4% yoy. This ought not deter
the ECB from thinking from reducing interest rates. As has
become quite normal, month-to-month movements in
aggregate money supply are being dominated in the ebb

Deutsche Bank AG/London                                                                                                                               Page 7
29 June 2012                 Focus Europe

Quarter point off refi rates, but deposit                              euro area. He described them as technically feasible, but
                                                                       balanced that view with a discussion of potential
rate to remain non-zero                                                drawbacks.
With the refi rate at 1% and the deposit rate at 0.25%,
ECB policy rates are already at historic lows. With                    For instance, one byproduct of zero interest rates in Japan
“serious” risks to the economic outlook, the ECB has an                was increased central bank intermediation in funding. The
argument to cut rates to new historic lows.                            reason being that banks could no longer afford to maintain
                                                                       their costly money market trading operations and hence
The ECB needs to reach a difficult balance between the
                                                                       pulled out of the market. Additionally, zero or negative
various policy rate options. It will seek to support those
                                                                       deposit rates could perversely impede credit creation and
banks in receipt of ECB liquidity by reducing the cost the
                                                                       potentially increase financial instability. Without a return
funds without reducing the incentive on banks to
                                                                       on central bank deposits, banks may struggle to pay a
restructure unsustainable balance sheets. At the same
                                                                       sufficient return to their own depositors. On the one hand,
time, the ECB will seek to disincentivise individual banks
                                                                       this could threaten the stability of the deposit base. On
from holding excess liquidity without causing
                                                                       the other, it could reduce banks’ incentives to engage in
unintentional harm to the system.
                                                                       low-return real economy lending in favour of higher yield
We expect the refi rate to be cut 25bp to 0.75%. It is less            (riskier) alternatives.
obvious with the deposit rate. A 25bp cut to zero is
                                                                       Coeure was not categorically ruling out zero or negative
possible, but on balance we suspect the ECB would
                                                                       rates, but concluded that “such steps would be warranted
prefer a non-zero rate (maybe cut 15bp to 0.10%).
                                                                       only in the face of clear downward risks to price stability”.
Figure 5: Refi rate to fall to 0.75%, deposit rate cut to              Cutting the refi rate by 25bp and the deposit rate by less
possibly 0.10%                                                         than 25bp will reduce the ‘excess liquidity premium’, the
    7.00                                                               cost to a bank of borrowing refi funding from the ECB and
                 ECB policy rates              Deposit rate
                                               Refi rate               depositing the proceeds back at the ECB as liquidity
    6.00                                                               insurance. In doing so, the ECB might incentive liquidity
                                               Marginal lending rate
    5.00                                                               hoarding, not something they want to promote.
                                                                       While there is clearly a substantial degree of funding
                                                                       being put on the ECB’s overnight deposit facility every
    3.00                                                               day, the ECB is of the option that it is not generally the
                                                                       same institutions doing the borrowing and the depositing.
    2.00                                                               One should anticipate an increase in deposits as a natural
                                                                       consequence of the increase in ECB liquidity operations
    1.00                                                               — the liquidity can still churn through the system settling
                                                                       various obligations but still end up on deposit at the ECB,
                                                                       for security purposes. It sounds like the ECB is not
        1999         2001       2003   2005   2007   2009
                                                                       uncomfortable reducing marginally the liquidity premium.
Source: Deutsche Bank, ECB
                                                                       Could the ECB cut the refi rate more than 25bp?
                                                                       Conceivably, yes. But we see reasons why the ECB is
Reducing the refi rate will be of benefit to those
                                                                       unlikely to choose a cut of a larger magnitude. First, in the
borrowing from the ECB. Liquidity tendered in recent
                                                                       absence of real belief in comprehensive resolution of the
years has been granted with an indexed rate, meaning it
                                                                       crisis, the ECB would be wise to keep some powder dry.
benefits from any rate cut. As a policy move, this will be
                                                                       Second, the weaker euro currency is a source of
especially beneficial to peripheral banks.
                                                                       additional monetary easing. Over the last six months, the
Given the connection between the deposit rate and the                  euro area trade-weighted index is down 3.6%.
overnight rate, care of excess liquidity, the best way to
reduce money market rates (general borrowing costs) will
                                                                       No new measures for ‘localised’ bank
be to reduce the deposit rate. Given the deposit rate
proximity to zero, this opens the debate about the pros                funding difficulties; new 3Y LTRO not on
and cons of a zero interest rate policy, or even negative              agenda (yet)
rates.                                                                 The rates corridor can influence financial stability. Cutting
                                                                       the refi rate more than the deposit rate, assuming bank
We do not believe the ECB is ready to endorse such a
                                                                       lending rates are more closely aligned to the deposit rate
policy. Back in February, ECB Executive Board Member
                                                                       (overnight rates), ought to improve bank margins and thus
Benoit Coeure discussed these matters in a speech. He
                                                                       aid the internal recapitalization process and support
neither ruled in nor ruled out zero or negative rates in the
                                                                       financial stability.

Page 8                                                                                                    Deutsche Bank AG/London
29 June 2012                 Focus Europe

As far as the liquidity and non-standard monetary policies
are concerned, we do not expect new policies to be
announced on 5 July. The ECB has already recently
announced ABS collateral rule changes. These were a
clear step in the direction of relieving the ‘localized’ issues
with bank funding that Benoit Coeure referred to in his FT
interview last week. A 3Y LTRO, which he characterized
as a more “generalized” liquidity tool, does not have
much Council support currently. We think a third 3Y LTRO
will probably be inevitable, but the Council is not yet ready
to support it. The next Bank Lending Survey, which the
ECB will have for the following Council meeting in early
August, could prove critical if it shows a deterioration in
lending standards. The flow of lending to non-financial
corporates was negative in May.

The ECB will also likely be pleased by the euro area
leaders’ agreement to introduce common supervision of
euro area banks (under the ECB) and to eventually create a
direct bank recapitalization capability. The ECB is a major
proponent of these policies which will make a direct
contribution to relieving the negative feedback loop
between sovereigns and banks. Although implementation
will take time (see accompanying paper in this Focus
Europe), the ECB may feel less pressure to come in with a
new means of addressing localized bank funding

The political attempts to incentivize Spain and Italy to
trigger the EFSF direct market intervention tools could
also be positive from an ECB perspective. Success there
would reduce the expectation and pressure on the ECB to
re-engage the SMP.

Figure 6: ECB balance sheet: no new policies (yet)
                             ECB (Eurosystem) total assets, EURbn





        1999        2001        2003   2005   2007    2009   2011

Source: Deutsche Bank, ECB

                                        Mark Wall, (44) 20 7545 2087
                                       Gilles Moec, (44) 20 7545 2088

Deutsche Bank AG/London                                                 Page 9
29 June 2012   Focus Europe

France: Early U-turn on fiscal policy
    Upon his election to the French presidency,             and peer pressure (from Germany) are forcing the new
    Francois Hollande had the choice of two different       French socialist administration to review very quickly this
    strategies on economic matters.                         framework. From the pure point of view of domestic
                                                            political strategy, it may also be more rational: instead of
    First, an initial lurch to the left with the
                                                            being forced in the second half of the mandate to offset
    implementation of a number of flagship measures
                                                            the profligacy of the first half and engage in significant
    to reassure his traditional electorate, followed by
                                                            austerity just before the next presidential elections, it may
    a gradual move towards a more prudent fiscal
                                                            make more sense to be “done with the unpleasant part”
    policy, to keep the market turmoil which has
                                                            now to have a chance to regain some room for
    engulfed the periphery at bay.
                                                            manoeuvre towards the end of the presidential tenure.
    Second, simultaneously implementing a few
    largely symbolic measures as quickly as possible        The Prime Minister waited only 8 days after the second
    while immediately pursuing a more austere fiscal        round of the parliamentary elections which gave
    policy than announced during the campaign.              Hollande’s socialist party a solid majority in the lower
                                                            house (it already dominated the upper house) before
    In our view, the significant change in the
                                                            announcing that central government’s spending would
    tax/spending mix of the fiscal consolidation
                                                            remain stable in value over 2013-2015, except for pension
    unveiled on Monday 25 June by the Prime
                                                            liabilities and debt servicing cost. Furthermore, the same
    Minister is a clear sign that the socialist
                                                            rule will be applied on central government transfers to the
    administration is choosing the second approach.
                                                            local authorities. This will force austerity on this layer of
    While such a move was in our view an important
                                                            administration as well. Indeed, by law local authorities
    gesture towards Germany ahead of the European
                                                            have to balance their budget (before investment). This
    summit on 28/29 June, this is prolonged by the
                                                            means that any increase in current spending would
    announcement, later this week that Hollande
                                                            automatically trigger an increase in local taxes, which is
    would ask the French parliament to endorse the
                                                            unlikely ahead of a string of local elections in 2014. The
    fiscal compact. However, two elements probably
                                                            political significance of the austerity imposed on local
    should be added to boost Paris’ credibility in the
                                                            authorities is not anecdotal. Indeed, the socialist party
    negotiations on the future of EMU which will
                                                            controls all but one region, as well as a majority of the
    necessarily continue after this week: (i) progress
                                                            “departments” and big cities. This was not an easy
    on the extent of sovereignty transfers that Paris
    would be willing to accept in exchange for debt
    mutualization and (ii) complementing the fiscal
                                                            Although the government did not communicate on a
    efforts with structural reforms, in a context of
                                                            quantified target for social security (it only mentions the
    sluggish – at best – economic growth in France
                                                            need to “control” spending there), we provide here an
    which could be seen as impairing the country’s
                                                            estimate of the impact on total government spending of
    capacity to comply with the fiscal rules. These are
                                                            the announcement. Central government – once controlling
    politically trickier..
                                                            for the various transfers across the layers of public
Significant change of tack on public                        administration – accounts for roughly a third of public
                                                            spending, local authorities a fifth and social security a bit
spending                                                    less than half. Under a conservative assumption of
Hollande’s campaign manifesto was based on a rise in        nominal GDP growth of 2.5% p.a until 2015, social
public expenditure of 1% per annum in real terms            security spending in volume rising by 1.5% p.a. (a pace
throughout the mandate. The decline in the ratio of         which we think is almost incompressible given the
government spending over GDP (currently 56%, the            demographic drift and elevated unemployment),
highest in Europe) would come entirely from the “growth     stabilizing expenditure in the other sub sectors would
dividend”, i.e. a targeted GDP growth rate of more than     bring total public spending to 54.2% of GDP by 2015, 1.8
2.0% per annum. In practice, the bulk of the reduction in   pp below last year’s record level.
the deficit to 3.0% in 2013 and zero in 2017 would come
from significant rate hikes.                                The effort on expenditure alone would bring the deficit to
                                                            3.4% of GDP by 2015. This would still leave a very
The deterioration in market conditions – even if French     significant share of the consolidation to tax hikes, to bring
sovereign bonds remain remarkably unscathed so far –        the deficit to 3.0% by 2013 from 5.2% in 2011. However,

Page 10                                                                                        Deutsche Bank AG/London
29 June 2012     Focus Europe

at least this week’s announcement allows for a much               procedures for other laws, such as budget bills for
better tax/spending mix, as it is a consensual academic           instance). However, this may not be seen as sufficiently
finding that fiscal retrenchments focused on spending             binding by the European Court of Justice which is tasked
cuts are less detrimental to economic growth than those           with controlling the strength of the national legal
based on tax hikes.                                               provisions. the fifth Republic has shaped French politics
                                                                  around strong loyalty of the majority parliamentary groups
While additional announcements will come with the                 to the President. In our view, if Francois Hollande decides
regular budget bill for 2013 which will be unveiled in            to endorse the fiscal compact, he will have little difficulty
September, some decisions are likely to be taken for 2012         in imposing it, but again, the communication around it, to
already by July. Les Echos this week reported on a                manage public opinion, may be tricky.
package of EUR 7.5bn for this year (EUR19bn over 2013),
some 0.3% of GDP, normally enough to bring the deficit            At the same time, goalposts are moving. The “roadmap”
back from a “spontaneous” trajectory of 4.8% of GDP               sketched out by Van Rompuy, Barroso, Draghi and
this year to the official target of 4.5%. The main measures       Juncker points to another step towards fiscal integration,
would be a rise in the wealth tax (EUR 2.5bn), closing the        i.e. “a priori” oversight of national fiscal decisions at the
tax exemption on overtime (EUR 1bn), financial transaction        “federal level”. This would be the condition for genuine
tax (EUR 350mn), tax on dividends (EUR 300mn).                    debt mutualization. In our view, getting from Paris a leap
                                                                  from the “fiscal compact” to further limitation of national
Rules versus discretion                                           sovereignty in the timeframe relevant to deal with the
                                                                  current market turmoil is unlikely. In our view, a move by
However, Paris so far had remained silent on the kind of          Paris on the “fiscal compact” might have been enough to
framework which would turn this discretionary austerity           get concessions on some short term fixes (ESM’s greater
move into a legally enforceable rule. The fiscal compact,         flexibility, as described in FE last Friday), but not more.
signed by the previous French administration,
incorporates, as its most salient points, a “debt brake”
                                                                  Challenging Macro position
and a limit to the structural deficit of 0.5% of GDP. The
rules need to be embedded in the national legal                   France has so far managed to stay above “the flotation
framework through provisions of "binding force and                line” and has not fallen into outright recession. However,
permanent character, preferably constitutional". Francois         the dataflow for Q2 point to GDP contraction. A recession
Hollande had made the endorsement of the fiscal                   lasting from 2012 Q2 to 2012 Q4 is our baseline. There is
compact conditional on a “growth initiative”. The principle       nothing much France can do to revive growth in the short
of the latter was agreed at the Euro summit on 28/29              run. Indeed, in our view, the deterioration in economic
June. This logically triggered the announcement by                conditions can be ascribed to three elements:
Francois Hollande that he would present it to parliament
for endorsement “as soon as the growth pact is ready”,            First and foremost, a dearth of credit. The credit impulse –
which we think should be sometime this summer.                    the yoy change in the flow of net new credit to companies
However, the French President was ambiguous on                    and households – has fallen markedly in the last few
additional concessions, such as some form of debt                 quarters, to -4.2% of GDP in the three months to April
mutualisation.                                                    2012 (last available data) , a steep change from a recent
                                                                  peak at 5.6% of GDP in the three months to June 2011.
Endorsing the fiscal compact as such is not necessarily           This may come as a surprise, given the fact that the
politically costless for the French President. While he           French banking system is not faced with major
commands a majority in both houses, a constitutional              imbalances in private sector debt observed in some
revision requires a 60% threshold. Some support from the          peripheral countries, nor with over-exposure to a
centre-right will be necessary. This is not a problem per se      deteriorating domestic bond market.           However, the
– UMP, the centre-right party – is intellectually in              French banking sector is not immune to the overall turmoil
agreement with the fiscal rules in its overwhelming               in the Euro area and the uncertainty it creates, nor to the
majority – but the right is likely to score political points on   regulatory changes which may stifle balance sheet
this issue, since the socialist party in the summer of 2011       expansion. The latest Banque de France bank lending
refused to support the inclusion in the French constitution       survey pointed to some tentative improvement in credit
of a much less ambitious fiscal rule.                             standards for business lending, but this could well reverse
                                                                  in the next survey (to be conducted in July).
There may be a temptation in Paris to incorporate the
fiscal compact at a lower level of the legal order, for           Second, the impact of the fiscal tightening we described
instance via an organic law (basically a bill which organizes     above.

Deutsche Bank AG/London                                                                                                Page 11
29 June 2012     Focus Europe

Third, lower foreign traction. In the spring of 2011, yoy        The French corporate sector’s “operational profitability”
growth in French exports peaked at 16%. It has                   (gross operating surplus / gross value added) stood at
decelerated to 5.8% in April 2012. This slowdown is now          28.1% in Q4 2011, the lowest level on record since 1990.
primarily attributable to the periphery: the contribution to     This actually calls for higher productivity and/or wage
the overall change in French exports from the fall in Italian,   moderation. Productivity can be fostered by labour market
Spanish, Portuguese, Irish and Greek imports was -0.6%           flexibility. On both counts, the government needs to start
in April 2012. The global economy is slowing down, and           a negotiation with the unions.
this reflects on the already less than brilliant French export
performance.                                                     Hollande, while he can probably claim to have had a
                                                                 decisive impact on the Euro summit this week, has a lot
These elements are combining into a lack of economic             on his plate at the moment, on both the domestic and
momentum which is triggering a substantial increase in           international stages.
unemployment. The unemployment rate reached 10.0%
in Q1 2012 for the first time since 1999 (measure                                          Gilles Moec, (44) 20 7545 2088
excluding overseas territories). Registered unemployment
has risen by 8.0% yoy in May 2012. This in turn triggers
precautionary savings, with a savings ratio which has
reached 16.2% in Q4 2011, a bit more than a percentage
point above the 20 year average. This suggests that
consumption, the engine of French growth, will bring only
a muted contribution to growth in the next few quarters.

However, beyond this recession in the short run, which
we think is unavoidable, France is faced with structural
issues which probably matter more for the current
European discussion. Indeed, Germany may be
unimpressed by progress on discretionary and/or rule-
based fiscal prudence if France’s growth potential drifts
down, as any French government could be constantly
tempted to re-engage in expansive budgetary policies to
start up the economy.

On this area – structural reforms – Paris is silent. Some
projects or actual decisions could go in the wrong
direction. For instance, reducing the rebates on payroll
taxes on low-wage workers would in our view reduce
labour supply. The increase in the minimum wage is also a
negative signal. Still, in our view the government has
actually been careful to deliver what is a merely symbolic
push. The minimum wage will increase by 2.0%, out of
which 1.4 pp come from the strict implementation of the
automatic indexation mechanism. The “discretionary
push”, at 0.6%, was only a third of the one granted by the
previous socialist administration upon taking office in
1997. Even the employers’ federation leader called the
move “reasonable”. But there is no plan to address
French rigidities in the labour market in particular.

Page 12                                                                                            Deutsche Bank AG/London
29 June 2012    Focus Europe

Euro Sovereign Events: What to watch
The following is a list of key events to watch over the          July
next several weeks – events that could have bearing
on how the euro sovereign debt crisis evolves.                     1 July: Cyprus becomes EU President. Cyprus will
                                                                   resume the six-month rotating presidency of the EU.
                                                                   4 July: Merkel to meet Monti in Rome.
    29 June: German government and opposition
                                                                   5 July: ECB Governing Council meeting, followed
    parties to approve ESM/Fiscal Compact. With a
                                                                   by interest rate announcement and news conference.
    compromise being found between the ruling coalition
                                                                   We expect a 25bp policy interest rate cut. The ECB
    (CDU/FDP) and the opposition (SPD/Greens) on a
                                                                   may be reluctant to cut the deposit rate to zero. With
    roadmap to financial market taxation on 20 June, the
                                                                   easier collateral rules already announced on 22 June
    path is cleared for ratification of the ESM/
                                                                   and the next Bank Lending Survey not due until 2
    Fiscal Compact. A broad majority in the Bundestag
                                                                   July, the policy moves on 5 July could be restricted to
    and Bundesrat will likely ratify the accompanying laws
                                                                   the cut in interest rates.
    on 29 June. In both chambers, ESM needs a simple
    majority and the Fiscal Compact a two-thirds majority.         5 July: Spain auction. Bonds.
    Some of the states facing budgetary problems in
                                                                   9-10 July: Eurogroup/ECOFIN finance ministers
    implementing the budget rules of the Fiscal Compact
                                                                   meeting. 9 July is to be the start date for ESM,
    until 2014 (stricter than the German debt brake so far)
                                                                   successor to EFSF. This is also the date on which the
    have demanded financial support from the federal
                                                                   Eurogroup is to formally approve the MoU on Spanish
    level to comply with the provisions - which looks
                                                                   bank recapitalisation aid. Additionally, we might get
    likely to be granted in some form. However, the law
                                                                   more clarity on the interest rate charge that will come
    on ESM will not be signed by the President
                                                                   with the capital injection and on the duration of the
    immediately after the Houses' approval: On 21 June,
    the Constitutional Court asked the President not to
    sign the law on the ratification of ESM until the              10 July: Greece auction. Bills.
    Court's second Senate has investigated it in case of
                                                                   12 July: Italy auction. Bills.
    constitutional complaints, which the Left Party has
    announced it would file immediately after                      13 July: Italy auction. Bonds.
    parliamentary approval. (Barbara Böttcher, Tel.
                                                                   17 July: Spain auction. Bills.
                                                                   17 July: Greece auction. Bills.
    29 June: Germany: Left party to file a
    constitutional complaint against ESM ratification.             19 July: Spain auction. Bonds.
    As mentioned above, immediately after the vote in
                                                                   24 July: Spain auction. Bills.
    both parliamentary chambers on ESM, the Left Party
    (Die Linke) is set to file a constitutional complaint          25 July: ECB lending survey. The ECB is due to
    preventing the President from signing the law. The             publish its third lending survey of the year on
    Constitutional Court is fully aware of (1) the political       Wednesday 25 July. The survey could provide the
    background of the complaint, (2) the urgency of the            ECB with a key piece of evidence to justify additional
    matter and (3) its particular responsibility to ensure a       3Y LTROs — if lending standards tighten again,
    timely set-up of ESM. In its past judgments, it has            another liquidity push may be necessary to avert a
    never caused any delay in setting up or running euro           harsher credit crunch. The ECB plans to publish one
    area rescue mechanisms. Given the Court’s                      more lending survey this year, on 31 October.
    awareness of the sensitivity of the issue, it is likely to
                                                                   26 July: Italy auction. Bonds.
    rule constructively and in time, i.e. before July 9, so
    that the start of ESM is not jeopardised. (Nicolaus            27 July: Italy auction. Bills.
    Heinen, Tel. +49(69)910-31713).
                                                                   30 July: Italy auction. Bonds.
    30 June: Deadline for EBA capital targets. Banks
                                                                                         Gilles Moec, (44) 20 7545 2088
    have until the end of June to satisfy the EBA core tier
                                                                                       Peter Sidorov, (44) 20 7547 0132
    one capital ratio of 9%.
                                                                                       Marco Stringa, (44) 20 7547 4900
                                                                                          Mark Wall, (44) 20 7545 2087

Deutsche Bank AG/London                                                                                           Page 13
29 June 2012    Focus Europe

   The June euro area HICP flash prints at 2.4% in line         1. Change in y/y inflation in June across countries…
   with consensus, but above our forecasts. A strong
   rise in seasonal food prices is among the factors
   putting upward pressure on inflation.                          0.1
   We see headline inflation falling 0.2pp in June and
   remaining at lower levels in H2.
According to Eurostat’s flash estimate, euro area year-on-
year inflation remained stable at 2.4% in June. This was in
line with consensus forecasts, but higher than we                -0.4             change in % y/y inflation between
                                                                                  May and June
thought. A sharp rise in seasonal food prices as well as         -0.5
late summer sales in France may have put upward                  -0.6
pressure on prices.                                              -0.7
                                                                                  ge                              it                          sp                      be
Across countries, y/y inflation fell by 0.1pp in Spain, 0.2pp
                                                                Source: Bloomberg Finance LP, Deutsche Bank
in Germany and 0.6pp in Belgium, but rose by 0.1pp in
Italy (chart 1). Despite the upward surprise from Italy, this
would be consistent with a 0.1pp fall in euro area inflation,   2. …and across COICOP groups in Italy
and points to a strong outcome in France. Some
temporary upward pressure on the French year-on-year                                                    CPI Italy: contribution to change in % y/y
inflation rate may have come from the late timing of             0.10                                   between May & Jun, pp
summer sales which started on 27-June, one week later
than in 2011; this may have pushed up clothing inflation.        0.05

Looking across components of available country CPI data,         0.00
some unexpected upward pressure has come from
seasonal food prices. Chart 2 shows the contribution to         -0.05
the June rise in y/y CPI inflation in Italy from the 12
COICOP groups. Upward pressure came above all from
food items which alone added more than 0.1pp to the








increase in headline inflation, as food CPI rose to 2.8%
y/y, from 2.0%. This was more than we were expecting.
                                                                Source: ISTAT, Deutsche Bank

German CPI details show a similar acceleration in food
inflation. On the basis of the state reports, we estimate       3. Seasonal food inflation increased strongly
overall food CPI to have risen to 3.5% y/y, from 2.5% in        10                                                                                                                20
May (chart 3). This was driven by seasonal food inflation                  % y/y                       Germany
which jumped to around 4.4% y/y, from -2.7% in May                8                                                                                                               15
(chart 3). This is likely to mean a stronger increase in euro
                                                                  6                                                                                                               10
area unprocessed food inflation than we were assuming.
This could continue over the summer, but with processed
                                                                  4                                                                                                               5
food inflation decelerating on the back of lower
agricultural prices, we see overall euro area food inflation
                                                                  2                                                                                                               0
falling through the second half of this year.

In all, while June HICP was higher than we were                   0                                                                                                               -5
forecasting, we continue to see euro area inflation falling
in the coming months, as food and energy inflation are           -2                                      CPI food                                                                 -10
expected to ease on the back of lower commodity prices                                                   CPI seasonal food (rhs)
                                                                 -4                                                                                                               -15
and weak growth is putting downward pressure on core
                                                                   2001           2003                 2005                   2007            2009             2011
inflation. We expect headline inflation to decline by 0.2pp     Source: FSO, Deutsche Bank
in July, as energy prices could continue to fall, and some
of the special June factors reverse.                                                                              Markus Heider, (44) 20 7545 2167

Page 14                                                                                                                                   Deutsche Bank AG/London
29 June 2012     Focus Europe

UK: 11 key financial statistics
    The ONS this week revealed the full National                 However, between Q4 last year and Q1 2012 the ratio
    Accounts detail behind the Q1 2012 GDP data. In              actually rose, by 0.6pp, interrupting its trend decline.
    the release, as always, there was a substantial              There were two components to this rise. First, the
    amount of sectoral financial data relating to                numerator – total household financial liabilities – rose
    households and corporate, such as debt, assets,              modestly, by 0.1% qoq. This is not such an important
    incomes, profits, savings, gearing and lending.              move – nominal debt levels have moved broadly sideways
                                                                 (slightly upwards, in fact) since the start of 2008 when the
    We take a look at some of these key numbers in
                                                                 ratio of debt to income peaked. As a result, while net
    this article. The headline-grabbers include a rise
                                                                 new borrowing has fallen sharply, households have not
    in the debt/income ratio due to a fall in incomes,
                                                                 repaid a penny of their outstanding debt since the crisis
    a fall in (and downward revisions to) the saving
                                                                 began. Rather, what has been responsible for the decline
    ratio, a rise in government borrowing, a switch in
                                                                 in the debt ratio over that period has been rising (only
    corporate borrowing from bank to market-based
                                                                 moderately, of course) gross incomes. In Q1, however,
    debt, and the credit impulse turning positive due
                                                                 incomes fell by 0.3%, the largest quarterly decline since
    to less deleveraging in Q1 than in Q4 last year.
                                                                 2009, explaining the small rise in the debt/income ratio.
    In addition, while there was no change to the
    headline quarterly rate of economic growth in Q1,            It is worth bearing in mind that the fall in disposable
    Q4 was revised slightly lower and there were                 income was not the result of lower wages & salaries –
    changes to the figures back through time. In                 they grew modestly during the quarter (by 0.1% qoq).
    particular we note that the 2008-09 recession is             Rather, a fall in net property income (interest & dividends)
    no longer as deep, the peak to trough decline now            among other reasons could be blamed.
    being 6.3% versus the 7.1% previously estimated.
                                                                 A recent article by MPC member Ben Broadbent argued
    But this does not help solve the productivity
                                                                 that, “there is no discernible relationship, in cross-country
    riddle – the annualised average growth since the
                                                                 data, between levels of indebtedness and subsequent
    end of the recession (i.e. since mid-2009) has been
                                                                 rates of economic growth”. However, he also suggested
    revised down from 1% to 0.9%, one-third of the
                                                                 that there is “some information” in prior debt movements
    typical post-recession recovery rate we have seen
                                                                 for future growth, but that the explanatory power is
    in the UK since the early 1800s. At the same time,
                                                                 limited. Still, the rise in debt/income ratios could be one
    the unrevised employment figures show private
                                                                 reason that consumer spending – and, given its size in the
    sector jobs up 850k (3.75%) over the same period.
                                                                 National Accounts, overall GDP – has fared poorly in the
    Other softer news this week included a worsening             recovery. Relative to other European countries household
    in the budget deficit, a fall in house prices, weaker        debt/income remains high in the UK (only Sweden,
    mortgage lending and deterioration in the terms              Norway, Netherlands, Denmark and Ireland are higher).
    of credit in the credit conditions survey. An
    improvement in retail sales bucked the trend, but            Largest rise in household debt/income since early-08
    this looks likely to have been due to the Queen’s            180          Household debt, % of total disposable
    Jubilee and expectations of increased spending                            income (dotted lines: avgs since 1987)
    during the Olympics.                                         160

                                                                                                  Of which secured
11 key financial statistics                                      140
In this article we begin by taking a look at the key financial
indicators published in this week’s Q1 2012 National
Accounts. We start with the household sector figures,
move on to corporate, then take a look at what the data
mean for our credit impulse. We finish with a look at GDP
in Q3 and beyond.

1. Household debt
                                                                     1987 1990 1993 1996 1999 2002 2005 2008 2011
Household debt has been on a declining trend since the           Source: DB Global Markets Research, ONS, Haver Analytics

2008-09 recession began. It peaked at just under 175%
and in the first quarter of this year stood at 152.3%.

Deutsche Bank AG/London                                                                                                     Page 15
29 June 2012               Focus Europe

2. Household liquid asset-to-liability ratio                         4. Household income gearing
Our US colleagues focus on two household balance sheet               Income gearing – interest payments relative to household
metrics: buying power and the liquid asset-to-liability ratio        income – has stuck at 5.8% over the past three quarters,
(see their latest article: Quarterly update on household             remaining around its record lows. 78% of outstanding
finances, 15 June 2012). The latter is shown in the chart            liabilities are mortgage debt, and mortgage rates,
below for the UK, with liquid assets defined as deposits,            according to the CML, rose between Q4 and Q1. This
fixed income securities and shares. The idea is that the             may account for the slight rise in gearing during the
higher this ratio, the easier it is to convert assets into cash      quarter (the 5.8% figure above is rounded, but to 2dp it
to meet obligations. While the US liquid asset ratio has             rose from 5.76% to 5.84%). Average mortgage rates in
moved back close to its long-run average after a sharp rise          Q2 could be slightly higher still than in Q1, but this should
in Q1, that of the UK is moving upwards more slowly.                 have only a marginal impact on gearing during the quarter.

Further upward progress on liquid asset/liability ratio              Income gearing up slightly as mortgage rates rise
2.2           Liquid asset-to-liability ratio of                     15                                    Interest payments, % household income
              the household sector                                                                         Official interest rate, %

1.6                                                                    9



0.8                                                                    0
   1987 1990 1993 1996 1999 2002 2005 2008 2011                         1987 1990 1993 1996 1999 2002 2005 2008 2011
Source: DB Global Markets Research, ONS, Haver Analytics             Source: DB Global Markets Research, ONS, Bank of England, Haver Analytics

3. Real household disposable incomes                                 5. Consumer spending
We discussed above the decline in nominal income in Q1,              The National Accounts release revised GDP and its
albeit not due to falling wages & salaries. In terms of real         components back through time. In this week’s report
incomes, they fell for a second consecutive quarter in Q1            while the level of real consumer spending was revised
by almost 1% qoq, but base effects (real incomes fell                higher, there were modest downward revisions to recent
even more sharply in Q1 2011) meant that the annual rate             growth rates – a slightly larger fall during the 2008-09
improved to be almost flat (it was more negative in Q4).             recession and a slightly weaker average recovery rate
Still, real income growth has been negative for much of              since. As the chart below shows, the big picture is
the past two years now. Continued falls in inflation could           unchanged – UK consumers continue to endure the worst
mean an improvement in real incomes going forward.                   downturn in the G7, helped by high inflation.

Real incomes fall for a second quarter in Q1                         Big picture on consumer spending remains unchanged
10                           Real household disposable                8                     Canada                       France
 9                           incomes, % yoy                           7                     Germany                      Italy
 8                                                                    6
                                                                                            Japan                        UK
 7                                                                    5
 6                                                                    4                     US
 5                                                                    3
 4                                                                    2
 3                                                                    1
 2                                                                    0
 1                                                                   -1
 0                                                                   -2
-1                                                                   -3
-2                                                                   -4
                                                                                     Real private
-3                                                                   -5
-4                                                                   -6
                                                                                     realtive to peak (%)
-5                                                                   -7
  1976 1980 1984 1988 1992 1996 2000 2004 2008 2012                        2006           2007            2008            2009             2010   2011
Source: DB Global Markets Research, ONS, Haver Analytics             Source: DB Global Markets Research, ONS, Haver Analytics

Page 16                                                                                                                         Deutsche Bank AG/London
29 June 2012               Focus Europe

6. Household saving ratio                                                             8. Net lending by sector
This week’s report shows the saving ratio at the end of                               The national accounts show the breakdown of net lending
last year revised down from 7.7% to 6.9% (there was also                              by sector. While government borrowing turned out to be
a 0.8pp revision down to the average ratio since the end                              higher in Q1, thanks to a slowing in the growth rate of tax
of the 2008-09 recession), falling further to 6.4% in the                             receipts and a rise in spending growth, the austerity
first quarter – its lowest for a year but roughly around its                          programme should mean the trend towards lower deficits
long-run average. These revisions might be interpreted as                             continues albeit with stronger growth required. Corporate
there having been less adjustment to households’ saving                               saving remained around the same in Q1 as in Q4, but with
behavior than we thought. Still, a lower saving ratio than                            financials up 1pp and non-financials down 1pp.
after the 1990s recession seems reasonable given the                                  Households continue to save albeit more modestly in Q1
lower unemployment and real interest rate environment.                                than Q4. The rest of the world remains a net lender to the
                                                                                      UK to the tune of 2.7% of UK GDP, up from 1.7% in Q4
Saving ratio justifiable at lower levels than the 1990s                               last year, reflecting the higher current account deficit.
            Trough (Q3 88/Q1 08)                              92 Q1 peak
  12                                                                                  Receipts fall/spending rise pushes public deficit up
                                                                                       10                Net lending by sector, % of GDP
  10                                                                                     8
     8                                                                                   6
     2                                               1980s/90s                          -2
                                                     Latest cycle                       -4
                                                                                        -6                                                   Government
   -2                         Quarters since trough
                                                                                        -8                                                   Corporations
         -6                 0          6            12                     18
Source: DB Global Markets Research, ONS, Haver Analytics                                                                                     Rest of world
7. Corporate cash holdings                                                               1987 1990 1993 1996 1999 2002 2005 2008 2011
                                                                                      Source: DB Global Markets Research, ONS, Haver Analytics
The combination of profitability having held up better than
expected and investment remaining weak has meant that                                 9. The current account deficit
corporate cash holdings have risen in recent years. This                              The current account deficit rose to over GBP11bn (nearly
has been concentrated in mining, energy and construction                              3% of GDP) in the first quarter of the year, reflecting
firms. However, Q1 saw a fall in cash holdings relative to                            sharply lower services and income surpluses. The former
GDP and as a proportion of total assets despite the rise in                           was related to a fall in the contribution of insurance and
gross profits during the quarter (up 2.2% qoq, after a rise                           other business activities, the latter due to both payments
in Q4) and the fact that business investment was revised                              on direct investment increasing and receipts falling. The
down (it did, nonetheless, grow at nearly 2% qoq).                                    goods trade deficit also rose from 6.4% to 6.7% of GDP.

Corporate cash holdings fall for a second quarter                                     Higher deficit due to services and income balances
40            Currency & deposits held by PNFCs as a % of                       225     1       Current account deficit, % of GDP

                                                                                200     0
35                      total PNFC financial assets (lhs)
                        total GDP (rhs)                                         175    -1
                                                                                150    -2

                                                                                125    -3

                                                                                100    -4
                                                                                75     -5

15                                                                              50     -6
  1989         1992 1995            1998 2001              2004 2007   2010              1987 1990 1993 1996 1999 2002 2005 2008 2011
Source: DB Global Markets Research, ONS, Haver Analytics                              Source: DB Global Markets Research, ONS, Haver Analytics

Deutsche Bank AG/London                                                                                                                                      Page 17
29 June 2012               Focus Europe

10. Corporate liabilities                                                          deteriorated (see section below). The European sovereign
After having fallen in the middle of last year, corporate                          and banking crisis is clearly having an impact on credit
debt of private non-financial firms has risen over the past                        supply on this side of the Channel.
two quarters relative to both profits and GDP. In outright
levels terms, liabilities are up more than 7% over the past                        The credit impulse versus real GDP growth
two quarters. However, this is the result of increased                              4                                               Forecasts based on                8
issuance in the capital markets, particularly bond issuance,                                                                        unchanged credit flows
while at the same time the outstanding stock of standard                            2
bank loans has declined. The data confirm what the Bank                                                                                                               4
of England noted in its last MPC meeting – that strong                              0
corporate bond issuance in the first quarter “had, in
aggregate, been accompanied by a reduction in borrowing                            -2                                                                                 0
from banks, suggesting that the terms of bank credit                                                                      Credit impulse (net
                                                                                                                          lending/ GDP, yoy                           -2
remained less favourable than those of raising funds in the                        -4
                                                                                                                          2qma change) - lhs
capital markets”.                                                                                                                                                     -4
                                                                                   -6                                     Real consumption
                                                                                                                          plus investment, %                          -6
Higher issuance offsets fewer bank loans
                                                                                                                          yoy 2qma - rhs
1700              PNFC total liabilities                                     310   -8                                                                                 -8
                                                                                     1988 1991 1994 1997 2000 2003 2006 2009 2012
1600                                                                         290   Source: DB Global Markets Research, ONS, Haver Analytics

1500                                                                         270   Q2 GDP and beyond
                                                                             250   The economy slipped into a second recession in Q4 and
                                                                             230   Q1, revised in this week’s data to be slightly worse than
1200                                                                               originally published (Q4 GDP is now down by 0.4% qoq
                                                                             210   rather than 0.3%, followed by an unrevised 0.3% print for
                                                           % profits (lhs)   190   Q1 this year). The previous recession, however, has been
                                                           % GDP (rhs)
                                                                                   revised to show a smaller peak to trough in GDP of 6.3%
  900                                                                        170
                                                                                   which compares to the previous estimate of -7.1%.
  800                                                                        150
     1990 1993 1996 1999 2002 2005 2008 2011                                       UK and euro area growth are closely correlated
Source: DB Global Markets Research, ONS, Haver Analytics
                                                                                    6                                    GDP growth, % yoy
11. The credit impulse                                                              5
The update of the National Accounts gives us an                                     4
opportunity to refresh our credit impulse. Recall that the                          3
credit impulse is defined as the annual change, as a
percentage of GDP, in net borrowing flows (as opposed
to stocks) by private non-financial corporates and                                 -1
households. In the following chart, we assume that net                             -2
borrowing remains unchanged until the end of 2013 and                              -3                              Euro area
plot the credit impulse against real GDP growth.                                   -4
Real domestic demand growth has been weaker than the                               -6
credit impulse would have suggested over the past year.                            -7
The improvement in the credit impulse in the first quarter                              1999        2001         2003          2005           2007      2009   2011
                                                                                   Source: DB Global Markets Research, ONS, Eurostat, Haver Analytics
is the result of combined less deleveraging by the private
sector – particularly non-financial firms – between Q4 and                         We recently revised our euro area GDP forecasts
Q1. If deleveraging were to remain the same as in Q1                               downwards to -0.4% for 2012, which raises the risk of a
going forward, that would push the credit impulse into                             further slowing in UK GDP going forward (see chart
negative territory during the remainder of this year,                              above). Indeed, in our new UK forecasts published in this
suggesting that growth could take time to recover going                            week’s Focus Europe (see page 2 of this publication) we
forward. While the headline balances of the credit                                 now see zero growth this year followed by 1.8% next year
conditions survey held up better than we had expected in                           (down from 0.3% and 2% respectively). The risks are
this week’s Q2 survey, some of the other balances                                  arguably on the downside, particularly to next year’s
measuring the terms and conditions of lending                                      forecast.

Page 18                                                                                                                                       Deutsche Bank AG/London
29 June 2012                Focus Europe

PMI suggests zero growth but should be weaker in Q2                              While production may have been negatively impacted by
60                                                                        1.5    the Jubilee, consumer spending could be supported by
                                                                                 both the Jubilee in June and the Olympics thereafter. This
                                                                                 week’s CBI retail sales indicator rose to +42 in June, its
55                                                                        0.5
                                                                                 highest since the end of 2010, while the expectations
                                                                          0.0    balance for July also improved.
                                                                                 The next installments of the PMI surveys are due over the
45                                                                               coming week – these will be important inputs into the
                                                                          -1.5   Bank of England’s decision on QE on Thursday 5 July –
                                                                          -2.0   we expect a further GBP50bn of gilt-based QE to be
40                   PMI composite (lhs)
                                                                                 undertaken over the coming three months, and while not
                     GDP growth, % qoq (rhs)                              -2.5
                                                                                 our forecast we do think there is a not-insignificant risk of
35                                                                        -3.0   a small cut in interest rates. In support of more QE this
     2002                           2006                           2010          week’s Treasury Committee testimony saw the Governor
Source: DB Global Markets Research, ONS, Markit, Haver Analytics
                                                                                 point to the continued efficacy of QE, although it is worth
The current level of the composite PMI is consistent with                        noting that Spencer Dale and Ben Broadbent argued that
roughly zero economic growth, as the chart above shows.                          additional stimulus measures (funding for lending) may
However, official growth prints are likely to be highly                          potentially impact decisions on QE – recall they both
volatile over the course of this year – more volatile than                       voted for no more QE this month.
that of the business surveys for example, given the
impact of the Queen’s Silver Jubilee in particular. The
                                                                                 Credit conditions and house prices
PMIs have tended to cut through such temporary volatility
in the past, so they are likely to suggest a stronger rate of                    We discussed above the fact that the headline balances of
growth in Q2 than the official figures record, and a slower                      the credit conditions survey were not as bad as might
rate of growth in Q3 than the bounce back should imply.                          have been expected given developments in the euro area
                                                                                 over recent months. Indeed, this week’s survey showed
As a result, we are forecasting a 0.2% qoq contraction in                        the headline availability of credit balances improving over
GDP in the second quarter, which will be published on 25                         the next three months for both corporate and households.
July. The breakdown of our forecast from the output side
of the National Accounts is as follows:                                          However, there was a notable deterioration in the terms
                                                                                 and conditions on lending according to the BoE’s survey.
       We assume flat industrial production in May followed                      Spreads on secured lending to households had “widened
       by c.4% fall in June – the latter similar to what                         markedly” in Q2 and lenders were expecting that to
       happened in June 2002 (the Queen’s Golden Jubilee).                       continue into Q3. The same was true for both small and
       That would mean a 1.3% qoq fall in industrial output                      medium-sized firms too. Indeed, the Bank of England’s
       during the second quarter as a whole;                                     quoted interest rate series shows 2-year fixed mortgage
                                                                                 rates having risen by 75bps since last autumn, 3-year
       A 0.2% rise in services output, similar to that of the
                                                                                 rates by 50bps, 5-year rates by 30bps, Bank Rate tracker
       first quarter.  The risks might even be on the
                                                                                 mortgages by 50bps and 2-year discounted rates by some
       downside here given the 2.5% fall in output that we
                                                                                 90bps. The rise in standard variable rates had been less
       saw back in June 2002;
                                                                                 sharp (just 10bps) but the level of SVR rates is generally
       Construction output once again looks likely to have                       higher than most other mortgage types.
       fallen notably in the second quarter, particularly if the
       Jubilee celebrations mean a sharp fall in output in                       Moreover, the British Bankers’ Association reported that
       June.                                                                     net mortgage lending turned negative in May for the first
                                                                                 time since their records began (see chart below). As MPC
As can be seen from the above commentary, the scale of
                                                                                 member David Miles pointed out in a speech some time
the impact of the Jubilee on output in June will have a
                                                                                 ago, if it takes x years for an average first time buyer to
huge impact on the final outturn for Q2 economic growth.
                                                                                 save for a deposit when maximum loan-to-value ratios are
But a 0.2% qoq fall followed by a 0.6% bounce back in
                                                                                 say 90%, then it will take 2x years to save the deposit for
Q3 and settling at 0.4% in the final quarter of the year
                                                                                 a house when maximum loan-to-value ratios are 80%.
would produce roughly zero economic growth for the full
                                                                                 This means that housing transactions – and therefore
year. Our forecast of 1.8% for next year is based on
                                                                                 mortgage lending – are likely to remain depressed for a
quarterly growth of between 0.4% and 0.5%; the risks
                                                                                 number of years. And indeed that is pretty much what
here seem to be weighted to the downside.

Deutsche Bank AG/London                                                                                                               Page 19
29 June 2012               Focus Europe

has happened since the credit crisis – back in 2007 the          finances and the cycle, Treasury Economic Working Paper
average loan-to-value ratio for first time buyers was 90%,       No.5, November 2008) the following equation was stated:
whereas it has been 80% since the end of 2010 (having
fallen to as low as 75% in 2009).                                              CANBt = NBt + 0.5 x OGt + 0.2 x OGt-1

First negative print on net new mortgage lending                 where CANB is the cyclically adjusted or underlying
 7      Net mortgage lending, GBPbn                              deficit, NB is the total deficit and OG is the output gap (all
                                                                 as percentages of GDP/trend GDP).

 5                                                               If we make the following assumptions:
                                                                        That the difference between our forecasts for
 3                                                                      economic growth and those of the Treasury are
                                                                        cyclical, i.e. they show up in the same percentage
                                                                        point differences in the output gap;
                                                                        That the Treasury’s forecast for underlying deficit
 0                                                                      (CANB) reduction remains on track;
-1                                                               then we can use the above equation to estimate the
  1994 1996 1998 2000 2002 2004 2006 2008 2010 2012              difference our GDP forecasts make relative to those of the
Source: DB Global Markets Research, BBA
                                                                 OBR’s. Applying the growth differentials (0.8pp lower this
Also this week we saw a further fall in house prices on the      year, 0.2pp lower next) means total deficit forecasts for
Nationwide measure – down by 0.6% mom and 1.5% yoy               fiscal years 2012 and 2013 of 6.3% and 6.1% (note these
in June. In the first half of this year, prices have fallen in   numbers include the impact of the Royal Mail pension
four out of the six months, the annual rate now at its           transfer this year). These are 0.5pp and 0.2pp higher for
weakest for three years. We expect to see further falls in       the two years, respectively. Taking the analysis further
national house prices although we expect the adjustment          forward, our growth forecasts imply a deficit of 1.6% by
in real house prices to continue thereafter with inflation-      2016-17 (the end of the OBR’s projection period), 0.5pp
erosion.                                                         higher than the 1.1% OBR forecast.

Budget deficit deterioration                                     Income tax receipts growth turning negative
                                                                  16                       Central government income tax
We discussed in the section on the key indicators in the          14                       receipts, 6m on 6m a year ago, %
National Accounts that government borrowing had risen in          12
the first quarter of the year, the result of higher spending      10
and lower receipts growth. This week’s May public                   8
finance figures reported a further deterioration in the             6
deficit.                                                            4
The PSNB (excluding financial interventions) rose to nearly
GBP18bn in May, about GBP3bn higher than expectations.             -4
This follows on from the GBP1bn upwardly revised                   -6
surplus of GBP17.6bn in April, which itself was largely due        -8
to the transfer of the Royal Mail pension fund to the public     -10
sector balance sheet.                                                2005        2006       2007       2008   2009   2010   2011   2012
                                                                 Source: DB Global Markets Research, ONS

Looking forward, downside risks to economic growth               For this year, using the above analysis, the deficit
suggest the deficit could be above the forecasts                 overshoot in nominal terms would be about GBP7.5bn.
published by the Office for Budget Responsibility at the         However, this week’s borrowing figures for May were
end of last year. We can crudely estimate the impact of          already above expectations by GBP3bn. Of course, being
our weaker economic growth view (flat in 2012, 1.8% in           the difference between two large numbers (spending and
2013) relative to that of the OBR (0.8% and 2.0%                 receipts) these figures can be volatile on a month-to-
respectively) on the deficit as follows. In an article           month basis.       But were the deficit to overshoot
published by the Treasury back in 2008 (see Public               expectations as much in the remaining 10 months of the
                                                                 fiscal year as it has done in the first 2 months, then we

Page 20                                                                                                          Deutsche Bank AG/London
29 June 2012     Focus Europe

could be looking at a deficit up to GBP30bn higher than            Further falls in petrol prices may yet be forthcoming
the OBR is currently forecasting. We should reiterate at           90                                                                                    1.6
this point that we are not so bearish: our current forecast
                                                                   80                                                                                    1.5
for 2012-13 is for a deficit of about GBP100bn, compared
to the OBR’s forecast of GBP92bn.                                  70                                                                                    1.4

                                                                   60                                                                                    1.3
Financial stability
                                                                   50                                                                                    1.2
The Governor of the Bank of England presented the
                                                                   40                                                            Oil price per           1.1
Bank’s latest Financial Stability Report this week. Mr King
                                                                                                                                 barrel, £ (lhs)
talked of how tighter credit conditions had stifled the            30                                                                                    1.0
recovery (see section on credit conditions above). The                                                                           Petrol price per
                                                                   20                                                            litre (rhs)             0.9
Financial Policy Committee’s (FPC) recommendations to
the Financial Services Authority (FSA) include a temporary         10                                                                                    0.8
rise in banks’ capital (which, it is argued, would reduce            2008                2009              2010               2011            2012
                                                                   Source: DB Global Markets Research, European Commission, Haver Analytics
bank funding costs and thereby support lending), a
reduction in banks’ balance sheet exposure to areas of             Impact on inflation
potential euro area stress, and to encourage banks to use          Petrol is worth around 4.5% of the total CPI index. Thus
their regulatory liquid asset buffers if a liquidity crisis were   the 7.3% fall since the peak should reduce CPI inflation by
to emerge.                                                         around 0.3pp. The decline should be even greater
                                                                   assuming the fall in petrol prices catches up with
                                                                   movements in sterling oil prices (see preceding chart).
Oil and petrol prices
There have been two important developments on oil and              The cancellation of the 2.2% rise in petrol prices in August
petrol prices over recent weeks. First, there has been a           should take a further 0.1pp off the headline rate of CPI
sizable fall in oil prices. In sterling terms, oil prices are      inflation, although if the government sticks to its plans to
down by around 25% since their peak in mid-March. This             delay this until January, then the rise will eventually come
has had a clear impact on UK petrol prices, which have             through at that point instead.
fallen from their peak of about GBP1.48 per litre in early
April to GBP1.37 currently. Secondly, the government has           Impact on activity
decided to postpone the 3p (2.2%) rise in fuel duty which          Assume 30bn litres of vehicle fuel is sold to households in
was due to take effect in August until January next year.          the UK each year. With petrol prices having fallen by 11p
What impact should these have on inflation and economic            since their peak, this means that, assuming the demand
consumer spending?                                                 for fuel is price insensitive, the total amount of money
                                                                   spent on fuel will decline by a little over GBP3bn. Some
                                                                   of this money will be channeled into other spending,
                                                                   which could raise overall consumer spending growth, and
                                                                   some may be channeled into savings, which could have
                                                                   the effect of raising the saving ratio.

                                                                                                       George Buckley, (44) 20 7545 1372

Deutsche Bank AG/London                                                                                                                              Page 21
29 June 2012    Focus Europe

Hungary: NBH inflation scenarios
    The release of the June Inflation Report saw GDP            NBH baseline: The overall message from the June
    growth forecasts revised lower and the 2013                 Inflation Report is that core inflation is expected to remain
    inflation forecast revised higher. The NBH                  low due to very weak domestic demand. This allows for
    baseline expects a gradual reduction in Hungary’s           lower rates provided improved risk perceptions and forint
    risk premium and rate cuts only from early 2014             strength are sustained. More specifically the report notes
    once the forthcoming tax adjustments drop out of            that “real economy considerations and the developments
    YoY inflation comparisons.                                  in underlying inflation point to monetary easing”, but that
    The NBH present 3 alternative scenarios of i) a             “in the near term, the factors calling for interest rate
    smaller output gap, ii) lower risk premium and iii)         increases and cuts more of less offset one another”. The
    a deepening of the Eurozone crisis. The second              NBH model calibrates the interest rate needed to ensure
    scenario should become the baseline on the                  inflation returns to target during the forecast period but
    assumption that an IMF/EU agreement is signed               does not detail explicitly the interest rate path (the NBH
    and would allow rate cuts to come sooner.                   model is different to Poland where the NBP use a
                                                                constant interest rate assumption). The report says only
    The NBH reiterated the need for a cautious policy           that “with the expected improvement in risk assessment
    stance at the June 26th MPC meeting but with the            and the fading of administrative cost shocks, the base rate
    statement explicitly discussing the possibility of          may gradually decline”. At face value this would suggest
    rate cuts. The necessary conditions for rate cuts           cuts starting in Q1 2014 but on the assumption of no
    were stated as a sustained fall in risk perceptions         IMF/EU program. In such a scenario the near-term outlook
    and an improved outlook for inflation - both of             for the forint and risk perceptions would be very
    which are again linked to an IMF/EU deal.                   unfavourable in our view and overall we do not view this
    The recent confirmation from the IMF that the               scenario as very likely.
    latest amendments to the NBH law, once passed
    into Parliament, are sufficient to open                     The June Inflation Report saw growth forecasts
    negotiations takes us a step closer to scenario 2.          revised down and inflation up
    But opening negotiations is only the first step in             Inflation forecasts (% YoY)           GDP forecasts (%)
    what is expected to be a bumpy road to signing a                          Previous Latest Change   Previous Latest Change
    deal. Near-term rate cuts are therefore unlikely              2012          5.6     5.3    -0.3      0.1     -0.8   -0.9
    and we retain our call for 2x 50bps in rate cuts              2013          3.0     3.5    0.4       1.6     0.8    -0.8
    towards year end.
                                                                Source: NBH

Updated NBH projections see lower                               Despite three higher-than-expected inflation readings
growth and higher inflation                                     through the start of the year the NBH revised down its
                                                                2012 CPI forecast by 0.3pp to 5.3%. The better-than-
The National Bank of Hungary (NBH) this week revised its
                                                                expected May reading, a lower oil price assumption and
forecasts for growth and inflation in its quarterly Inflation
                                                                recent forint strength will all have been factors here and
Report. Governor Simor had already pointed to lower
                                                                have offset the expected impact from the forthcoming
growth and higher inflation versus the March Inflation
                                                                telecoms tax. The oil price assumption in the June
Report due to the latest round of fiscal measures
                                                                Inflation Report is 17.3% lower than in March for H2
announced in April, and as such the forecast adjustments
                                                                2012, with the year end projection now at $97.9/barrel
did not come as too much of a surprise. The report
                                                                versus $117.4/barrel in March. The downward revision to
presents a baseline where the government remains
                                                                inflation came across all components with core inflation
committed to the fiscal targets despite very weak
                                                                revised lower (to 4.9% versus 5.3% in March) and the
domestic demand and assumes only a gradual
                                                                non-core components of unprocessed food, energy and
improvement in Hungary’s risk premia. Inflation is no
                                                                regulated prices also revised lower to 2.9%, 10.3% and
longer expected to return to the 3% target next year
                                                                5.2% from 3.7%, 11.3% and 4.5% respectively in March.
(versus the expectation of H1 2013 in the last report) with
                                                                The average 2013 oil price assumption is also 14.6%
the target now expected to be achieved by early 2014.
                                                                lower than in March (at $96.7/barrel versus $113.3/barrel
The report also presents three alternative scenarios of i)
                                                                previously) but this is not significant enough to offset the
an output gap that is smaller than the forecast, ii) a lower
                                                                larger tax increases with the 2013 headline CPI forecasts
risk premium and iii) a deepening of the European debt
                                                                revised upwards by 0.4pp to 3.5%, and core revised up to
crisis. Only in the second scenario is there an explicit
                                                                0.1pp to 3.0%.
mention of an IMF/EU program.

Page 22                                                                                                Deutsche Bank AG/London
29 June 2012     Focus Europe

The revisions to the GDP growth forecasts were larger            associated inflation projections (shown in the final chart)
than those to inflation with a 0.9pp and 0.8pp downward          see inflation close to target in Q1 2014 (3.01% versus
revision for 2012 and 2013 respectively. Alongside the           2.88% in the baseline scenario) with this scenario having a
revised energy assumption mentioned above the dismal             smaller impact over the forecast period that the others.
Q1 reading, the revisions to the 2011 GDP data and the           The longer-term impact of this scenario could, however,
additional fiscal measures for both 2012 and 2013 (at            be more protracted.
0.3% and 2.0% of GDP respectively) will all have been
incorporated. The forecasts also see weaker export               Persistently negative investment growth could mean
growth in line with the deterioration in the external            a smaller output gap and higher inflation
environment while investment growth has also been
revised down fairly substantially for both this year and                10                                                             88
next. High unemployment, falling real incomes and tight                                                                                86
credit conditions are all expected to continue. At -0.8% for             5                                                             84
this year the Bank’s 2012 projections is higher than our                                                                               82
own -1.3% while the +0.8% for next year is slightly better               0                                                             80
than our 1.0% projection. Nevertheless, both forecasts
                                                                        -5                                                             76
expect a drop back into recession and leave the economy
several years away from returning to pre-crisis levels of
                                                                      -10                                                              72
output.                                                                                    Investment (% YoY)
                                                                                           Capacity utilisation (rhs, %, sa)
                                                                      -15                                                              68
The Bank’s fiscal projections now see a sub 3% deficit for
                                                                         Q1-06               Q3-07        Q1-09        Q3-10   Q1-12
both this year and next (assuming the extra reserves in
the budget are used) with the previous projections of            Source: Haver Analytics

3.1% and 3.4% for 2012 and 2013 revised to 2.7% and              Scenario 2: Lower risk premium. The baseline scenario
2.4%. This is in line with the recent decision by the EC to      from the June Inflation Report assumes a “gradual”
remove the threatened suspension of the 2013 cohesion            decline in risk premium. A scenario of lower risk premium
funding due to an earlier expectation of a >3% fiscal            is assumed to occur where an IMF/EU deal is finalized
deficit next year. On the C/A, the surplus was revised           before the end of the summer and government financing
slightly smaller for this year and wider for next year but       risk are reduced. An alternative situation which leads to a
would still see highest ever surpluses in Hungary.               lower risk premium in the NBH’s view is a shift in focus
                                                                 away from the implications of low growth of debt
We now assess the three scenarios in the inflation report
                                                                 sustainability and a focus instead on the positives
and the expected policy response for each.
                                                                 associated with the actual fiscal consolidation efforts.
Scenario 1: A smaller output gap. The higher-than-               While our baseline is that an IMF/EU deal is signed in late
expected pass through from the January VAT increase              Q3 we expect scenario 2 has some flexibility on timing
combined with the very poor performance on private               and see it as becoming the baseline.
sector investment leases a risk that very weak domestic
                                                                 The Inflation Report was published before the June 26th
demand may not have the same downward pressure on
                                                                 confirmation from the IMF that the latest amendments to
prices as assumed in the NBH baseline according to the
                                                                 the NBH law, once passed into Parliament, are sufficient
report. The persistently negative investment growth (with
                                                                 to open negotiations. This takes us a step closer to
fixed investment down 28% since the pre-crisis peak), the
                                                                 scenario 2 but we recognize this is still only the start of
recent closure of large firms such as Malev and Nokia and
                                                                 the process. We expect several sticking points, most
the high proportion of long-term unemployed are all
                                                                 notably the structure of fiscal adjustment, and expect the
factors which are cited as potentially lowering medium-
                                                                 road to signing negotiations to be bumpy. In particular, the
term growth prospects, and therefore contributing to
                                                                 minimal compromise by the authorities to meet the
higher inflation. The NBH can track investment and
                                                                 necessary pre-conditions does not bode for the flexibility
capacity utilization on a quarterly frequency but with so
                                                                 that will be needed to get a deal signed. And the recent
many distortions in the inflation data it will be difficult to
                                                                 announcement from the government that the financial
disentangle the impact of a smaller output gap in the near
                                                                 transactions levy will be applicable on the central bank is
term. The NBH measure of tax-adjusted core inflation is
                                                                 yet another example of Hungary’s unpredictable policy
probably the best way to monitor this but NBH comfort
                                                                 making. Given the likely negative market reaction from
levels on this measure are unclear.
                                                                 further foot dragging, we do expect that a deal will be
The policy response in this scenario is maintaining current      signed despite these hurdles.
monetary conditions for a longer period of time. The

Deutsche Bank AG/London                                                                                                           Page 23
29 June 2012                 Focus Europe

The policy response in this scenario is unsurprisingly an                                             Such a scenario is possible in the short term but in our
earlier start to the easing cycle than in the baseline and is                                         view would most likely be accompanied by an IMF/EU
therefore broadly in line with our current projections of 2x                                          deal. A combination of scenario 2 and 3 would probably
50bps in rate cuts towards year end. We see a risk that                                               mean rates remain at 7% for longer than in our baseline
rate cuts come in clips of 25bps rather than 50bps in this                                            and rate cuts come more gradually.
scenario particularly with the IMF and EU likely to push for
a conservative monetary policy stance.                                                                Overall we view scenario 2 as the most likely baseline for
                                                                                                      Hungary in the coming months with rate cuts once an
Hungary’s risk premia remains elevated versus the                                                     IMF/EU deal is signed. A combination of scenario 2 and 3
rest of the region                                                                                    cannot, however, be ruled out.
               5-year CDS
    800                  Hungary                       Poland
    700                  Romania                       Czech
                                                                                                                            Caroline Grady, (44) 207 545 9913
       Jan-11             May-11              Sep-11              Jan-12             May-12

Source: DB Global Markets Research

Scenario 3: Worsening Eurozone crisis. The third
scenario has the opposite effect from scenario 2 with a
deepening of the debt crisis in Europe and a resulting rise
in risk premium and a weaker forint. Weaker European
growth also means lower growth in Hungary but
ultimately higher rates according the the NBH given the
still-high fx mismatches on corporate and household
balance sheets. This scenario has the largest impact on
the inflation forecasts of the three with CPI still above
target at the end of the forecast period (3.22%).

We expect the scenario of a lower risk premium to
become the baseline
       Per cent                                                                      Per cent
 6,0                                                                                            6,0
 5,5                                                                                            5,5
 5,0                                                                                            5,0
 4,5                                                                                            4,5
 4,0                                                                                            4,0
 3,5                                                                                            3,5
 3,0                                                                                            3,0
 2,5                                                                                            2,5
 2,0                                                                                            2,0
       2010               2011                 2012                2013               2014

           Smaller output gap                                   Lower risk premium
           Worsening Eurozone crisis                            Baseline scenario
Source: NBH (chart shows the effect of the alternative scenarios on CPI forecasts)

Page 24                                                                                                                                 Deutsche Bank AG/London
29 June 2012     Focus Europe

Rate Views
Euro Area                                                       Switzerland
                                                                EUR/CHF remains close to the level at which the SNB has
We expect the refi rate to fall by 25bp to 0.75% but, on
                                                                promised to keep it below (1.20). Next meeting: 13 Sep.
balance, we expect the deposit rate to be cut by a smaller                     Current     Sep12    Dec12      Jun13
amount, possibly 15bp to a level of 0.10%. There are            3M Libor tgt     0.00       0.00      0.00      0.00
grounds to cut rates. The economic cycle has faltered,
price expectations are declining and the signals from
money and credit are not positive. We do not expect new         Sweden
liquidity and non-standard monetary policies to be              The Riksbank left rates unchanged in April despite cutting
announced on 5 July. The ECB has already recently               its inflation & growth forecasts. Next meeting: 4 July.
announced ABS collateral rule changes, which are positive                         Current    Sep12     Dec12     Jun13
at the margin, and the ECB will be pleased by the euro          Repo rate           1.50      1.50      1.50      1.50
area leaders’ agreement to introduce common supervision
of euro area banks (under the ECB) and to eventually
create a direct bank recapitalization capability. This ought
                                                                Norges Bank has cut rates by a total of 75bps since
to contribute to relieving the negative feedback loop
                                                                December. We expect rates to remain on hold for the
between sovereigns and banks.
                                                                next year. Next meeting: 29 August.
                                                                                Current    Sep12    Dec12 Jun13
                Current     Sep12      Dec12      Jun13
                                                                Deposit rate      1.50      1.50     1.50  1.75
3m Libor projections
Mkt               0.56          0.50    0.49       0.53
DB                   ---        0.50    0.50       0.50         Denmark
                                                                The Danish central bank cut rates by 25bps in total in May.
refi rate forecast
                                                                Our forecast sees the spread to the ECB narrowing very
DB                 1.00         0.75    0.75       0.75
                                                                slightly by 5bps assuming the ECB cuts rates in July.
10-year government yields                                                       Current    Sep12      Dec12      Jun13
DB              1.59      1.60          1.70       1.90         Lending rate       0.45     0.20       0.20       0.30

UK                                                              Poland
                                                                Another rate hike later in the summer is no longer our
Over the past few weeks speeches by the Chancellor
                                                                base case but cannot be completely ruled out.
George Osborne and the BoE Governor Mervyn King at
                                                                Increasingly weak domestic data argue against it.
Mansion House, along with the more dovish voting
                                                                               Current     Sep12    Dec12       Jun13
pattern at the June MPC meeting, have raised the
                                                                2-week repo      4.75       4.75     4.75         4.25
prospect of further QE at the forthcoming July meeting
(as we had argued might happen at this month's meeting).
Indeed, we expect GBP50bn of additional gilt sales to be        Hungary
announced on July 5. While the risks have risen of a small      Improvement in the forint and in risk perceptions versus
rate cut at the same time, our official call is currently for   early Jan point to no further hikes from the NBH. Rate
no change.                                                      cuts should come once an IMF/EU program is under way.
                Current     Sep12      Dec12      Jun13                        Current    Sep12     Dec12      Jun13
                                                                Base Rate         7.00     7.00       6.00      6.00
3m Libor projections
Mkt               0.91          0.77    0.73       0.69
DB                   ---        0.85    0.85       0.85         Czech Republic
                                                                Another rate cut from the CNB looks unlikely give the very
Bank Rate forecast
                 0.50           0.50    0.50       0.50         low level of the policy rate.
                                                                                 Current      Sep12 Dec12       Jun13
10-year government yields                                       Repo rate          0.50        0.50  0.50        0.50
DB              1.73      1.80          1.90       2.10
                                                                Source for all tables: DB Global Markets Research

Deutsche Bank AG/London                                                                                             Page 25
29 June 2012                Focus Europe

Euroland Data Monitor
                                                B’berg                  Q3             Q4             Q1              Q2      Jan     Feb    Mar         Apr     May      Jun
                                                 code                 2011          2011           2012              2012    2012    2012    2012       2012     2012    2012
Business surveys and output
  PMI composite                                                        50.3           47.2           49.6             46.3    50.4    49.3    49.1       46.7     46.0
    EC industrial conf.                    EUICEMU                      -2.8           -7.0           -6.6           -11.0    -7.0    -5.7    -7.1        -9.0   -11.4   -12.7
    PMI manufacturing                                                  49.3           46.8           48.5             45.5    48.8    49.0    47.7       45.9     45.1
    Headline IP (% pop1)                   EUITEMUM                      3.0           -7.9           -1.5                    -0.2     0.7    -0.1        -1.1
    Capacity Utilisation                   EUUCEMU                     80.5           79.6           79.8             79.7
    EC construction conf.                  EUCOEMU                    -27.7          -27.3          -26.7            -28.7   -28.0   -25.0   -27.0       -28.0   -30.0   -28.0
    EC services conf.                      EUSCEMU                       3.5           -1.6           -0.6            -5.0    -0.7    -0.9    -0.3        -2.4    -5.2    -7.4
    PMI services                                                       50.6           47.6           49.5             46.8    50.4    48.8    49.2       46.9     46.7
 National Sentiment
    Ifo                                    GRIFPBUS                  109.7          106.9          109.2             107.3   108.3   109.6   109.8      109.8    106.9   105.3
    INSEE                                  INSESYNT                  102.0            95.7           94.3             93.3    92.0    93.0    98.0       95.0     93.0    92.0
Consumer demand
 EC consumer survey                        EUCCEMU                    -15.9          -20.6          -20.0            -19.7   -20.7   -20.3   -19.1       -19.9   -19.3   -19.8
 Retail sales (% pop)                      RSSAEMUM                      1.2           -4.8            0.6                     1.2    -0.2     0.4        -1.2
 New car reg. (sa, % yoy)                                                2.8           -1.1         -11.4             -7.0   -12.8   -14.2    -7.3        -7.6    -6.4
Foreign sector
 Foreign orders                            EUI3EMU                      -8.8         -14.4          -16.9            -20.0   -13.9   -14.3   -13.3       -17.3   -20.2   -22.4
 Exports (sa val. % pop)                                                 6.4            7.1          18.8                      1.2     2.0    -1.0        -1.3
 Imports (sa val. % pop)                                                 3.3           -7.6          18.3                      2.4     3.0    -0.9        -3.0
 Net trade (nsa EUR bn)                    XTTBEZ                       -1.8          14.4             0.8                    -8.7     2.0     7.5        5.2
Labour market
 Unemployment rate (%)      UMRTEMU                                    10.2           10.6           10.9                     10.8    10.9    11.0       11.0
 Change in unemployment (k)                                          430.0          563.3          436.0                     164.0   141.0   133.0      110.0
 Employment (% yoy)                                                      0.2           -0.2
Prices, wages and costs
 Prices (% yoy)
    Harmonised CPI                         ECCPEMUY                      2.7            2.9            2.7             2.5     2.7     2.7     2.7        2.6      2.4     2.0
    Core HICP (Eurostat))                  CPEXEMUY                      1.3            1.6            1.5             1.5     1.5     1.5     1.6        1.6      1.6     1.4
    Harmonised PPI                         PPTXEMU                       5.4            4.7            3.4                     3.6     3.4     3.1        2.4
    Oil Price (USD)                        EUCRBRDT                  113.3          109.5          118.4             115.2   110.5   119.4   125.4      120.1    110.2
    EUR/USD                                EUR                           1.4            1.3            1.3             1.3     1.3     1.3     1.3        1.3      1.3
 Inflation expectations
    EC household survey                    EUA8EMU                     25.2           25.6           25.7             23.1    26.8    26.4    24.0       27.0     22.6    19.7
    EC industrial survey                   EUI5EMU                       8.8            5.6            7.2             2.5     6.7     7.3     7.6        6.0      2.7    -1.3
 Unit labour cost (% yoy)
    Unit labour cost                                                     1.1            1.4            1.7
    Labour productivity                                                  1.2            0.9            0.4
    Compensation.                                                        2.3            2.3            2.1
    Hourly labour costs (sa)                                             2.6            2.8            2.0
Money (% yoy)
 M3                                        ECMAM3YY                     2.5            2.0            2.8                     2.3     2.7     3.1         2.5
 M3 trend (3m cma)                         ECMA3MTH                                                                           2.2     2.7     2.7
 Credit - private                          ECMSCDXE                     1.7            1.2            0.5                     0.7     0.4     0.5         0.0
 Credit - public                ECMSCDGY             5.4       1.0         5.8                             4.5     5.6        7.5       7.7
 Quarterly data in shaded areas are quarter-to-date. Monthly data in the shaded areas are forecasts.(1) % pop = % change this period over previous period.
 Quarter on quarter growth rates are annualised.
Source: Deutsche Bank forecasts, Eurostat, Ifo, INSEE, Reuters, European Commission, National statistical offices.

Page 26                                                                                                                                              Deutsche Bank AG/London
29 June 2012                 Focus Europe

The Week Ahead: Euro Zone

•       In Euroland, focus will be on the ECB refi rate decision meeting on Thursday. The release of manufacturing (Mon) and
        services (Wed) PMI from across the board will also be in limelight. The area-wide Q1 GDP (Wed), German and Spanish IP
        (Fri) along with German factory orders (Thu) numbers will provide information about the activity level.

•       Besides, area-wide PPI (Tue), retail sales (Wed) and French trade balance (Fri) data are also due this week.
Source: Deutsche Bank

Key Data & Events
Day               Time             Release                                                                    DB Forecast                                Consensus                                  Previous

    Mon           07.15        Spanish PMI manufacturing (Jun)                                                                                                                                          42.0
                  07.45        Italian PMI manufacturing (Jun)                                                                                                44.5                                      44.8
                  07.50        French PMI manufacturing (Jun)                                                                                                 45.3                                      44.7
                  07.55        German PMI manufacturing (Jun)                                                        44.7                                     44.7                                      45.2
                  08.00        Euroland PMI manufacturing (Jun)                                                                                               44.8                                      45.1
                  09.00        Euroland unemployment rate (May)                                                                                             11.1%                                     11.0%

    Tue           07.00        Spanish unemployment change (Jun)                                                                                                                                       -3.0k
                  09.00        Euroland PPI (May)                                                                                                                                                 0.0% (2.6%)

     Wed          07.15        Spanish PMI services (Jun)                                                                                                                                               41.8
                  07.45        Italian PMI services (Jun)                                                                                                     42.5                                      42.8
                  07.50        French PMI services (Jun)                                                                                                      47.3                                      45.1
                  07.55        German PMI services (Jun)                                                             50.3                                     50.3                                      51.8
                  08.00        Euroland PMI services (Jun)                                                                                                    46.8                                      46.7
                  08.00        Euroland PMI composite (Jun)                                                                                                   46.0                                      46.0
                  09.00        Euroland retail sales (May)                                                                                                   0.3%                                -1.0% (-2.5%)
                  09.00        Euroland GDP (Q1)                                                                                                            (0.0%)                               -0.3% (0.8%)

      Thu         10.00        German factory orders (May)                                                          -0.3%                               0.2% (-6.4%)                             -1.9% (-3.8%)
                  10.00        German domestic factory orders (May)                                                                                                                              0.4% (-2.7%)
                  10.00        German foreign factory orders (May)                                                                                                                               -3.6% (-4.7%)

     Fri          06.45        French exports (May)                                                                                                                                                    1.8%
                  06.45        French imports (May)                                                                                                                                                    2.1%
                  06.45        French trade balance (May)                                                                                                 -EUR5.4bn                                -EUR5.8bn
                  07.00        Spanish industrial production (May)                                                                                                                                    (-8.3%)
                  10.00        German industrial production (May)                                                   0.8%                                0.5% (-1.2%)                             -2.2% (-0.7%)
dbCalendar: For more forward-looking calendars of data and events, as well as various tools to analyse data surprises, go to our new online

Mon, 25                                                                                                                Thu, 05
ECB’s Asmussen to speak in Athens – 06.00 GMT                                                                          ECB to hold Governing Council meeting, interest rate
German Chancellor Merkel to speak – 09.00 GMT                                                                          announcement scheduled – 11.45 GMT

Source: Various National Statistical Offices, Bloomberg, Reuters, S&P MMS, DB Global Markets Research. Growth rates in parentheses are year-on-year, while those without parentheses are this period over last period. *
signifies provisional release day (or time if asterisk beside time)

Deutsche Bank AG/London                                                                                                                                                                                           Page 27
29 June 2012               Focus Europe

The Week Ahead: Rest of Europe & the USA1

•      In the US, we are heading towards a quiet data week due to Independence Day holiday on Wednesday. Datawise, the release of June
       labour market report should garner markets attention – we envisage unemployment rate to remain steady at 8.2%. On the survey
       data front, ISM (manuf & non-manuf) indices are likely to show slight moderation. Besides, vehicle sales, construction
       spending and factory orders data are also scheduled for this week.

•      In the UK, most interest will be on the BoE rate setting meeting. We will receive PMI survey, M4 money supply and PPI
       reports this week.
Source: Deutsche Bank

Key Data & Events
Day              Time                                    Release                                DB Forecast                           Consensus                                 Previous

    Mon           06.30       Swedish PMI (Jun)                                                                                                                                    49.0
                  07.15       Swiss adjusted real retail sales (May)                                                                                                               0.1%
                  08.00       Norwegian credit indicator k2 (May)                                                                        (6.7%)                                   (6.7%)
                  08.30       UK PMI manufacturing (Jun)                                                                                   46.5                                    45.9
                  12.30       US construction spending (May)                                       0.3%                                   0.2%                                0.3% (6.8%)
                  14.00       US ISM (Jun)                                                         52.0                                    52.0                                    53.5

    Tue           08.30       UK M4 growth (May)                                                                                                                             1.1% (-3.8%)
                  08.30       UK M4 lending (May)                                                                                                                               GBP3.1bn
                  08.30       UK mortgage approvals (May)                                                                                 50.0k                                    51.8k
                  08.30       UK net consumer credit (May)                                                                             GBP0.1bn                                 GBP0.3bn
                  08.30       UK net mortgage lending (May)                                                                                                                     GBP1.1bn
                  14.00       US factory orders (May)                                              0.0%                                   -0.2%                              -0.6% (3.5%)
                  21.00       US total vehicle sales (Jun)                                        14.0m                                   14.0m                                   13.7m

    Wed           07.00       Slovak retail sales (May)                                                                                                                          (-1.9%)
                  08.30       UK PMI services (Jun)                                                                                        52.9                                    53.3

    Thu           12.30       US initial jobless claims (Jun 30)                                                                                                                  386.0k
                  14.00       US ISM non-mfg (Jun)                                                 53.0                                    52.9                                    53.7

    Fri           07.00       Danish industrial production (May)                                                                                                                   0.0%
                  07.15       Swiss CPI (Jun)                                                                                                                                0.0% (-1.0%)
                  08.00       Norwegian industrial production (May)                                                                                                           2.4% (7.5%)
                  08.30       UK input PPI (Jun)                                                                                     -2.1% (-2.2%)                           -2.5% (0.1%)
                  08.30       UK output PPI (Jun)                                                                                    -0.2% (2.4%)                            -0.2% (2.8%)
                  08.30       UK core output PPI (Jun)                                                                                                                        0.0% (2.1%)
                  12.30       US average hourly earning (Jun)                                      0.1%                                   0.2%                                0.1% (1.7%)
                  12.30       US average workweek (Jun)                                          34.4hours                             34.4hours                                34.4hours
                  12.30       US index of aggregate hours (Jun)                                                                                                               0.1% (2.3%)
                  12.30       US payrolls (Jun)                                                    75.0k                                  93.0k                                    69.0k
                  12.30       US unemployment rate (Jun)                                           8.2%                                   8.2%                                     8.2%
dbCalendar: For more forward-looking calendars of data and events, as well as various tools to analyse data surprises, go to our new online
Mon, 02
Fed’s Williams to speak in San Francisco – 17.15 GMT                                                Thu, 05
                                                                                                    BoE to announce interest rate decision – 11.00 GMT
Wed, 04
National Bank of Poland to announce interest rate decision
Riksbank to announce rate decision – 07.30 GMT
Source: National Statistical Offices, Bloomberg, Reuters, S&P MMS, DB Global Markets Research       The list of data and events for the US is not comprehensive. Please see the web-based week ahead for a
                                                                                                    more complete list.

Page 28                                                                                                                                                         Deutsche Bank AG/London
29 June 2012                 Focus Europe

Financial Forecasts
                                                      US          Jpn             Euro              UK          Swiss*               Swe*              Den*              Nor*               Pol*             Hun*              Cze*
3M Interest                    Actual               0.46          0.34             0.65            0.90              0.00              1.50              0.45              1.50             4.75              7.00              0.50
Rates1                        Sep-12                0.50          0.30             0.50            0.85              0.00              1.50              0.20              1.50             4.75              7.00              0.50
DB forecasts                 (futures             (0.47)        (0.33)           (0.51)          (0.78)                  --                --                --                 --               --                --                  --
& Futures,                     Dec-12               0.50          0.30             0.50            0.85              0.00              1.50              0.20              1.50             4.75              6.00              0.50
*Central Bank                (futures             (0.51)        (0.33)           (0.50)          (0.73)                  --                --                --                 --               --                --                  --
Rates                          Jun-13               0.50          0.30             0.50            0.85              0.00              1.50              0.30              1.75             4.25              6.00              0.50
                            (futures)             (0.55)        (0.32)           (0.54)          (0.69)                  --                --                --                 --               --                --                  --
                                                                                                          [ ---------------------------- Spreads ------------------------------] [ --------------------- Rates --------------------]

10Y Gov’t2                     Actual               1.62          0.83             1.51            1.64             -1.00              0.02             -0.17              0.29             5.20              7.99              2.98
Bond                          Sep-12                1.50          0.90             1.75            1.75             -1.10              0.00             -0.10              0.40                  --                --                  --
Yields/                     (futures)             (1.71)        (0.87)           (1.55)          (1.66)                  --                --                --                 --               --                --                  --
Spreads3                       Dec-12               1.50          1.00             2.00            2.00             -1.20              0.00             -0.05              0.40                  --                --                  --
DB forecasts                (futures)             (1.77)        (0.91)           (1.59)          (1.71)                  --                --                --                 --               --                --                  --
& Forwards                     Jun-13               2.50          1.10             2.25            2.50             -1.30              0.00              0.00              0.40                  --                --                  --
                            (futures)             (1.90)        (0.99)           (1.70)          (1.84)                  --                --                --                 --               --                --                  --

                                                  EUR/          USD/             EUR/            GBP/              EUR/              EUR/              EUR/              EUR/              EUR/              EUR/             EUR/
                                                   USD           JPY              GBP            USD                CHF               SEK               DKK              NOK                PLN               HUF              CZK
Exchange                       Actual               1.26          79.3             0.81            1.56              1.20              8.77              7.43              7.55             4.27             288.3              25.7
Rates                               3M              1.28          80.0             0.83            1.54              1.21              8.50              7.46              7.40             4.11             283.0              25.0
                                    6M              1.30          82.0             0.84            1.55              1.21              8.50              7.46              7.40             4.10             280.7              24.5
                                  12M               1.25          86.0             0.83            1.51              1.21              8.25              7.46              7.30             3.98             280.0              23.8
 (1) Future rates calculated from the, September, December and June 3M contracts. Forecasts are for the same dates. Central bank rates for the CE-4, Scandinavia and Switzerland
 (2) Forecasts in this table are produced by the regional economists, and are not obtained from DByield. 10-year forwards estimated from the asset swap curve.
 (3) Bond yield spreads are versus Euroland . US 10Y Govt. bond yield forecasts has been taken from US Fixed Income Weekly.
 (4) #For Norway: actual is of 9 year bond yield and forecast correspond to 10yr bond yield. .
 Source: Bloomberg Finance LP, DB Global Markets Research. Revised forecasts in bold type. All current rates taken as at Friday 11:00 GMT.

Euro government bonds: yield and slope                                                                            UK government bonds: yield and slope
        6.0              Euro government bond yields, %                                      2.5                               6.0                     UK government bond yields, %                                 3.5

        5.5                                                                                                                    5.5                                                                                  3.0
                                                                                             2.0                               5.0
        5.0                                                                                                                                                                                                         2.5
        4.5                                                                                                                    4.5
                                                                                             1.5                                                                                                                    2.0
        4.0                                                                                                                    4.0
        3.5                                                                                  1.0                               3.5
        3.0                                                                                                                    3.0
                                                                                             0.5                                                                                                                    0.5
        2.5                                                                                                                    2.5
                                                                                                                               2.0                                                                                  0.0
                            10Y                                                                                                1.5               10Y                                                                -0.5
                            2Y/10Y spread (rhs)                                                                                                  2Y/10Y spread (rhs)
        1.0                                                                                  -0.5                              1.0                                                                                  -1.0
           1/1/02        1/1/04        1/1/06       1/1/08     1/1/10       1/1/12                                                1/1/02        1/1/04      1/1/06       1/1/08       1/1/10      1/1/12

Source: Deutsche Bank. Forecasts to right of vertical line.                                                       Source: Deutsche Bank. Forecasts to right of vertical line.

Deutsche Bank AG/London                                                                                                                                                                                                 Page 29
29 June 2012     Focus Europe

Appendix 1
Important Disclosures
Additional information available upon request
For disclosures pertaining to recommendations or estimates made on a security mentioned in this report, please see
the most recently published company report or visit our global disclosure look-up page on our website at

Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition, the
undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in
this report. Mark Wall/Gilles Moec

Deutsche Bank debt rating key

CreditBuy (“C-B”): The total return of the Reference
Credit Instrument (bond or CDS) is expected to
outperform the credit spread of bonds / CDS of other
issuers operating in similar sectors or rating categories
over the next six months.
CreditHold (“C-H”): The credit spread of the
Reference Credit Instrument (bond or CDS) is expected
to perform in line with the credit spread of bonds / CDS
of other issuers operating in similar sectors or rating
categories over the next six months.
CreditSell (“C-S”): The credit spread of the Reference
Credit Instrument (bond or CDS) is expected to
underperform the credit spread of bonds / CDS of other
issuers operating in similar sectors or rating categories
over the next six months.
CreditNoRec (“C-NR”): We have not assigned a
recommendation to this issuer. Any references to
valuation are based on an issuer’s credit rating.

Reference Credit Instrument (“RCI”): The Reference
Credit Instrument for each issuer is selected by the
analyst as the most appropriate valuation benchmark
(whether bonds or Credit Default Swaps) and is detailed
in this report. Recommendations on other credit
instruments of an issuer may differ from the
recommendation on the Reference Credit Instrument
based on an assessment of value relative to the
Reference Credit Instrument which might take into
account other factors such as differing covenant
language, coupon steps, liquidity and maturity. The
Reference Credit Instrument is subject to change, at the
discretion of the analyst.

Page 30                                                                                              Deutsche Bank AG/London
29 June 2012     Focus Europe

Regulatory Disclosures
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Risks to Fixed Income Positions
Macroeconomic fluctuations often account for most of the risks associated with exposures to instruments that promise to pay
fixed or variable interest rates. For an investor that is long fixed rate instruments (thus receiving these cash flows), increases in
interest rates naturally lift the discount factors applied to the expected cash flows and thus cause a loss. The longer the
maturity of a certain cash flow and the higher the move in the discount factor, the higher will be the loss. Upside surprises in
inflation, fiscal funding needs, and FX depreciation rates are among the most common adverse macroeconomic shocks to
receivers. But counterparty exposure, issuer creditworthiness, client segmentation, regulation (including changes in assets
holding limits for different types of investors), changes in tax policies, currency convertibility (which may constrain currency
conversion, repatriation of profits and/or the liquidation of positions), and settlement issues related to local clearing houses are
also important risk factors to be considered. The sensitivity of fixed income instruments to macroeconomic shocks may be
mitigated by indexing the contracted cash flows to inflation, to FX depreciation, or to specified interest rates – these are
common in emerging markets. It is important to note that the index fixings may -- by construction -- lag or mis-measure the
actual move in the underlying variables they are intended to track. The choice of the proper fixing (or metric) is particularly
important in swaps markets, where floating coupon rates (i.e., coupons indexed to a typically short-dated interest rate
reference index) are exchanged for fixed coupons. It is also important to acknowledge that funding in a currency that differs
from the currency in which the coupons to be received are denominated carries FX risk. Naturally, options on swaps
(swaptions) also bear the risks typical to options in addition to the risks related to rates movements.

Deutsche Bank AG/London                                                                                                      Page 31
                                                                David Folkerts-Landau
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