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Credit-Suisse - €uro back in fashion

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					                                                                                                                      31 January 2013
                                                                                                                  Economics Research
                                                                                            http://www.credit-suisse.com/researchandanalytics




                                                     European Economics

                         Research Analysts           €uro back in fashion
                         Yiagos Alexopoulos
                           +44 20 7888 7536           A strengthening euro is a risk for the euro area’s subdued recovery but
           yiagos.alexopoulos@credit-suisse.com
                                                       this risk could be limited as long as global demand does not falter.
                       Christel Aranda-Hassel
                                                      Global demand has become more important than the price effect for core
                                        Director
                            +44 20 7888 1383           northern European economies, specifically Germany and the countries
         christel.aranda-hassel@credit-suisse.com      closely linked to its production chain, the Netherlands and Austria. Southern
                                                       periphery countries have become more dependent on exporting outside the
                               Steven Bryce
                           +44 20 7883 7360            euro area in recent years. That and the make-up of their export products
                 steven.bryce@credit-suisse.com        render them more vulnerable to a stronger euro.
                          Violante Di Canossa         It is important to note at this point that as long as core Europe and especially
                                Vice President
                                                       Germany do not contribute more to rebalancing the euro area through
                            +44 20 7883 4192
            violante.dicanossa@credit-suisse.com       stronger internal demand satisfied partly through goods from the periphery,
                                                       the latter remains particularly vulnerable to a slowdown in global trade and/or
                                      Neville Hill
                                                       a strengthening of the euro.
                                         Director
                            +44 20 7888 1334
                                                      This year, the euro area economy will continue enjoying the tailwinds
                    neville.hill@credit-suisse.com
                                                       stemming from last year’s currency weakness. But a trade-weighted
                                     Axel Lang         appreciation of 5% from current levels, equivalent to just over EURUSD 1.40,
                            +44 20 7883 3738
                                                       undoes the positive impact the euro area is still enjoying from past weakness.
                     axel.lang@credit-suisse.com
                                                       A EURUSD above 1.45 would have significantly negative repercussions
                               Giovanni Zanni          on economic activity.
                                       Director
                            +44 20 7888 6827          The ECB is unlikely to take action before the EURUSD gets past 1.40.
                giovanni.zanni@credit-suisse.com
                                                       This was the average level prevailing in the first half of 2011 before the
                                                       breakup panic started to spread. But strengthening beyond that level starts
                                                       having significant economic costs and is likely to see the ECB responding.
                                                      The initial ECB response is likely to be cutting the repo rate further.
                                                       Verbal intervention of the currency is also an option although traditionally the
                                                       effect of this is not long lasting. Finally, there is always going back to
                                                       expanding the balance sheet further, which could be taken care of if the
                                                       OMT gets triggered.
                                                      The latter cannot be excluded in the event of the euro appreciating
                                                       further. The strain this puts on economic activity, especially in the periphery,
                                                       is likely to bring back periphery debt sustainability worries and result in rising
                                                       periphery yields. This might force periphery authorities to ask for ECB
                                                       assistance. Ultimately, this may prove to be the mechanism by which
                                                       the euro’s appreciation is reversed.




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                                                                                                                                 31 January 2013



                   Christel Aranda-Hassel
                        +44 20 7888 1383
                                                €uro back in fashion
     christel.aranda-hassel@credit-suisse.com
                                                Draghi’s promise to do what it takes last summer countered euro area redenomination
                                 Axel Lang      risks in the periphery. The result was initially a halting and since then a sharp reversal of
                        +44 20 7883 3738
                 axel.lang@credit-suisse.com
                                                the flight out of peripheral European assets. This has resulted in a significant easing of
                                                monetary conditions, to the tune of 350 bp as we pointed out when reviewing European
                                                public finances.
                                                Allaying redenomination fears is also restoring business confidence. Leading economic
                                                indicators, such as the German ifo expectations component, have risen for four
                                                consecutive months. And after stabilizing since last summer, the euro area composite PMI
                                                has also turned in the last two months. This supports our view that euro area growth will
                                                gradually improve from the Q4 trough.

                                                Exhibit 1: Euro area composite PMI and GDP growth


                                                   60                                                                                   1.0

                                                   55                                                                                   0.5

                                                   50                                                                                   0.0

                                                   45                                                                                   -0.5
                                                              Euro area composite PMI, lhs
                                                   40                                                                                   -1.0

                                                   35                                                                                   -1.5

                                                   30                                               Euro area GDP, q/q, rhs             -2.0

                                                   25                                                                                   -2.5
                                                     1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
                                                Source: Thomson Reuters Datastream, Credit Suisse



                                                Diminished fears of periphery redenomination risks have been accompanied by a
                                                significant increase in appetite for higher yielding European assets. This appetite is being
                                                reflected in the euro. In their FX Compass: The Slow Demise of the Fear Trade, our FX
                                                strategists expect the gradual normalization of investment flows out of safe havens and
                                                back to the euro area to take the EURUSD back to 1.40. This was the average EURUSD
                                                level prevailing in the first half of 2011, before the euro breakup panic started to spread.
                                                A strengthening euro is a risk to the economic outlook. As the composite PMI shows,
                                                although the indicator has turned, any recovery remains fragile. Fiscal headwinds,
                                                although not as strong as in the preceding two years, persist and structural adjustment will
                                                take time to bear fruit. Against this backdrop, an undue strengthening of the currency is
                                                bound to be viewed with trepidation since it puts the modest recovery at risk. Economic
                                                activity is also key to debt sustainability in periphery countries and a renewed faltering of
                                                activity is bound to increase the fear factor.
                                                But it is important to put the strengthening euro into perspective. First, although off the low
                                                seen last summer, the EURUSD would need to rise above 1.45 to have a significantly
                                                negative effect on economic activity. And the impact on economic activity only comes with
                                                a lag. This year, the economy will continue enjoying the tailwinds stemming from last
                                                year’s currency weakness.
                                                A second point to keep in mind is that while the ECB dislikes targeting the exchange rate,
                                                it has in the past stated that sharp and abrupt currency moves are not welcome. There is
                                                no reason to think that the ECB would stand idle if the euro strengthens rapidly beyond
                                                1.45.


European Economics                                                                                                                             2
                                                                                                                                                  31 January 2013



                                             A final point is that while the euro matters, nowadays it is global demand rather than price
                                             which is more important to exports. This is especially true for northern European core
                                             countries with the exception of France, but also Spain has become more resilient to the
                                             exchange rate over the last decade. For the euro area, it is thus crucial that the global
                                             recovery continues and if that is the case, some euro appreciation can be weathered.

                                             1.       Estimating the euro pain threshold
                                             The euro is not in the stratosphere yet. The trade-weighted euro has strengthened by
                                             8% from the low last summer, when all revolved around the break-up scare. But compared
                                             to last year’s average, the trade-weighted increase amounts to half of that at 4%, and is
                                             still below its long-term average. Although it only accounts for 7% of the trade-weighted
                                             euro, the yen is the main culprit of the effective exchange rate appreciation, having
                                             weakened by 20% from last year’s average. This contrasts with the more modest
                                             weakening of around 5% of both the US dollar and sterling over the same period.
                                             Excluding the US dollar, sterling and yen from the trade-weighted euro shows that the
                                             euro has only strengthened by 2% from last year’s average.

Exhibit 2: Trade-weighted euro                                                   Exhibit 3: Broad-based strengthening
                                                                                 Average 2012 = 100

                                                                                 108
  116                                                                                             USD, GBP and JPY
  112                                                                            106              EUR trade weighted x-USD, GBP and JPY
  108
                                                                                 104
  104
                                                                                 102
  100
   96                                                                            100
   92
                                                                                  98
   88                                               EUR trade weighted
                                                    EUR trade weighted, 5yr ma    96
   84
   80                                                                             94
     1999      2001     2003      2005      2007       2009    2011      2013     Jan-2012           Apr-2012     Jul-2012       Oct-2012      Jan-2013
Source: Thomson Reuters Datastream, Credit Suisse                                Source: Thomson Reuters Datastream , Credit Suisse



                                             The rising importance of emerging                Exhibit 4: Trade weights in the euro’s
                                             markets and, in particular Asia, means           effective exchange rate
                                             that the latter now accounts for one-            %
                                             quarter of the weight in the effective            25                                                1995-97
                                             euro exchange rate. Asia accounted for
                                                                                                                                                 2007-09
                                             only one-tenth nearly two decades ago.
                                                                                               20
                                             Over the same time frame, the
                                             importance of the US, UK and Japan
                                             has fallen from nearly 60% of the trade           15
                                             weight to only 40%. But this is still a
                                             sizeable share of euro area trade.                10
                                             It is also likely that at 17%, the weight
                                             of the US dollar is understated.                    5
                                             Although the ECB takes third-market
                                             effects into account, many emerging                 0
                                             market currencies use the US dollar as                        UK             US           Japan       China
                                             a reference, including China and its
                                                                                              Source: European Central Bank, Credit Suisse
                                             managed floating regime.


European Economics                                                                                                                                              3
                                                                                                                                                                                      31 January 2013



                                                              The impact of a stronger euro can be assessed using a global growth model. We
                                                              have quantified the impact using the OECD global model, which takes into account past
                                                              changes of the euro. This year, the euro area enjoys a significant positive impact on
                                                              growth of nearly 1 pp as a result of the sharp decline in the trade-weighted euro last year.
                                                              And last year’s decline came on top of weaker euro averages in the preceding two years.
                                                              The positive impact, although only worth 0.1 pp, persists into next year if the trade-
                                                              weighted euro remains at its current level throughout the remainder of the year.
                                                              Next year’s positive impact is only undone if we estimate a broad-based strengthening of
                                                              the trade-weighted euro of 5% from its current level by the end of Q2. This would take the
                                                              EURUSD to just above 1.40 and is in line with the three-month forecast of our FX strategy
                                                              team. Assuming the euro stays at that level detracts 0.2pp from GDP growth next year and
                                                              half a point in 2015.
                                                              Increasing the trade-weighted euro by 10% in Q2 and assuming a broad-based
                                                              appreciation would translate into the EURUSD increasing nearer to 1.50. Next year, this
                                                              would detract nearly half a point from growth and nearly 1 point in 2015.

Exhibit 5: Estimated impact of past euro trade-                                                                        Exhibit 6: Factoring in a stronger trade-weighted
weighted changes on euro area real GDP growth                                                                          euro
Trade-weighted euro remains unchanged from current level, pp                                                           Pp

  1.0                0.9                                                                                                 1.0
                                                                                                    0.7                                5% trade-weighted appreciation
               0.5         0.5                                                                                                         10% trade-weighted appreciation          0.7
  0.5                                                                                        0.4
         0.2                     0.2                                                   0.2                               0.5                                             0.4
                                                                                                          0.1
                                                                   0.0                                                                                         0.2
  0.0
                                                                                                                                         0.0
                                                            -0.1                                                -0.1     0.0
  -0.5                                                                   -0.3
                                                                                -0.4                                            -0.1                                                  -0.2
                                                     -0.6                                                                                       -0.3
                                                                                                                        -0.5                            -0.4
  -1.0                                                                                                                                                                                  -0.5 -0.4
                                       -1.0
                                                                                                                                                                                                -0.7
  -1.5                                        -1.3
                                                                                                                        -1.0
         1999        2001        2003         2005          2007         2009          2011        2013     2015                 2007            2009           2011           2013           2015
Source: Thomson Reuters Datastream, Credit Suisse                                                                      Source: Credit Suisse




                                                              2.         Sharp and abrupt currency changes are not welcome
                                                              A level near to EURUSD 1.50 was last seen in spring 2011 when the ECB had embarked
                                                              on tightening monetary policy by increasing its key repo rate. In retrospect, this was
                                                              premature and more than reversed as the sovereign debt crisis unfolded.
                                                              Once again, the perception is that the ECB is taking a different path from other key
                                                              central banks. A shrinking ECB balance sheet is being contrasted with those expanding
                                                              in the US and Japan while the BoE has not closed the door to adding further to its balance
                                                              sheet if needed.
                                                              Part of the problem is that the ECB has left banks to decide the size of its balance sheet
                                                              rather than steering the supply as do the other major central banks. A shrinking balance
                                                              sheet as excess liquidity is returned thus conveys a money market that is becoming
                                                              healthier. In the absence of another longer-term LTRO or triggering the OMT, the ECB
                                                              will need to convince financial markets that a shrinking balance sheet is not
                                                              analogous to preparing the ground for exiting non-conventional measures.


European Economics                                                                                                                                                                                   4
                                                                                                                                   31 January 2013



                     An appreciation of 5% from current levels in coming months would result in the trade-
                     weighted euro strengthening by over 8% from last year’s average (and a 10% appreciation
                     would lead to a strengthening of over 13%). This is equivalent to a monetary tightening of
                     more than 130 bp up to 220 bp. A tightening of this magnitude would have serious
                     repercussions on the nascent euro area recovery.
                     Our view is that the ECB is unlikely to take action below and up to the EURUSD 1.40
                     level. On average, this was the prevalent level in the first half of 2011 before the euro
                     breakup scare started to take hold. But a rapid appreciation towards 1.45 is unlikely to
                     be tolerated without some form of response.
                     The question is what to do. In the short term, the repo rate could be cut further from its
                     current 0.75 bp. We continue to expect another 25 bp cut in Q2 and the rate might have to
                     go even lower.
                     Intervening with the currency is also an option, although the ECB has hinted in the past
                     that this only works if it is coordinated. With other central banks endorsing weaker
                     currencies at home, support for coordinated intervention is unlikely to be
                     forthcoming.
                     Verbal intervention is likely if a lower rate has not taken care of the strengthening
                     exchange rate. Verbal intervention has been used in the past - at the end of 2007, the
                     ECB stated that sharp and abrupt currency movements are never welcome – but the life-
                     span of intervening verbally is traditionally limited.
                     And finally, there is always going back to expanding the balance sheet further. This
                     could be taken care of if the OMT gets triggered. The latter cannot be excluded in the
                     event of the euro appreciating further. The strain this puts on economic activity, especially
                     in the periphery, is likely to bring back periphery debt sustainability worries and result in
                     rising periphery yields. This might force periphery authorities to ask for ECB assistance.
                     Ultimately, this may prove to be the mechanism by which the euro’s appreciation is
                     reversed.


                     3.      FX sensitivities and the importance of global demand
                     The impact of the stronger trade-weighted euro using the OECD model provides results for
                     the euro area aggregate. But the impact differs depending on how exposed a country is to
                     trade outside the euro area and also how price sensitive the exports of particular countries
                     are. The latter, in turn, depends on the degree of outsourcing lower added value elements
                     in the production chain or on the degree of product specialization.
                     A key point is the importance of global demand. In the case of Germany, studies1 have
                     shown that over the last two decades, the influence of trading partners’ economic activity
                     on German exports has outweighed the effects of price competitiveness.
                     Comparing the average growth of extra- euro area exports with global export market
                     growth in two previous episodes of strong trade-weighted euro appreciation shows that
                     this has not only been true for Germany, but to a lesser extent, also for core countries
                     closely linked to the German production chain, the Netherlands and Austria.
                     We looked at two previous episodes of sharp euro appreciation. From January 2001 to
                     December 2003, the trade-weighted euro increased by slightly more than 20% and from
                     January 2006 to March 2008, the currency strengthened by over 10%. Using a lag of two
                     quarters, which is the commonly accepted period before exchange rate changes start
                     feeding through, we look at average extra-euro area export growth and compare this to the

                     1   See Deutsche Bundesbank, Monthly Report March 2008 "Macroeconomic effects of changes in real exchange rates" and K.
                          Stahn "Has the impact of key determinants of German exports changed? Results from estimations of Germany's intra euro-area
                          and extra euro-area exports" in Deutsche Bundesbank, Discussion Paper No 07/2006.


European Economics                                                                                                                                 5
                                                                                                                                31 January 2013



                                             growth in global export markets over the two periods of currency appreciation. In the 2001-
                                             03 period, global export market growth amounted to 3% and had accelerated sharply to
                                             around 8% from 2006 until the full break-out of the financial crisis in the autumn of 2008.
                                             On average, and in spite of sharp currency appreciations, German export growth outpaced
                                             the strength of the global market by nearly 1 pp over the two episodes, joined by both the
                                             Netherlands and Austria. In fact, the latter saw its exports growing more than 1 pp faster.
                                             Despite the currency appreciation, and helped by strong increases in global demand
                                             especially in the 2006-08 period, average export growth increased in all of the euro area
                                             countries apart from France and Greece. With the exception of Germany, the Netherlands
                                             and Austria, however, all countries suffered export share losses as the euro appreciated.
                                             But the loss of export share varies, with Spain suffering relatively little compared to the
                                             other periphery countries. Among core European countries, France stands out as suffering
                                             the largest loss of market share, indicative of structural competitiveness problems which
                                             go beyond the exchange rate.

Exhibit 7: Average extra-EA export vs global export                         Exhibit 8: Average extra-EA export growth in
growth in periods of sharp € appreciation                                   periods of sharp € appreciation
Average annual growth rate differential to global export growth, pp         Average annual growth rates, %
Periods 2001 Q3- 2003 Q2 and 2006 Q3-2008 Q3                                Periods 2001 Q3- 2003 Q2 and 2006 Q3-2008 Q3

                                                                              7
  1
                                                                              6
  0
                                                                              5
  -1
                                                                              4
  -2
                                                                              3
  -3                                                                          2
  -4                                                                          1
  -5                                                                          0
  -6                                                                         -1
  -7                                                                         -2
  -8                                                                         -3
       GER FRA          ITA    SPA NET BEL AUT GRE POR IRE                         GER FRA          ITA    SPA NET BEL AUT GRE POR IRE
Source: Thomson Reuters Datastream, Credit Suisse                           Source: Thomson Reuters Datastream, Credit Suisse



                                             There are a series of factors which determine the sensitivity of exports to the exchange
                                             rate. The destination of exports is one of them.
                                             It is commonly assessed that countries which send a larger share of their total
                                             exports outside the euro area will suffer relatively more from the strength of the
                                             euro. With the exception of Ireland, the other periphery countries seem relatively more
                                             shielded on this account while northern European core countries are more exposed.
                                             Exports have a smaller share of GDP in southern periphery countries, but all those
                                             countries have registered dynamic export growth over the last 12 months and it has been
                                             extra-euro area destinations which have almost entirely contributed to countries’ export
                                             growth.




European Economics                                                                                                                            6
                                                                                                                                             31 January 2013




Exhibit 9: Exports by destination (EA vs extra-EA)                           Exhibit 10: Dynamic export growth
% of GDP, 2011                                                               Average annual growth of exports in the last 12 months

  60                                                                          16
                                                                                                                                           EA
                                                                              14
  50                                                                                                                                       Extra-EA
                                                    Extra-EA     EA           12
                                                                                                                                           Total
  40                                                                          10

                                                                                8
  30
                                                                                6
  20                                                                            4

                                                                                2
  10
                                                                                0
   0                                                                           -2
         BEL IRE NET GER AUT ITA FRA SPA POR GRE                                     GRE POR NET GER FRA ITA SPA AUT BEL IRE
Source: Credit Suisse, Eurostat                                              Source: Credit Suisse, Eurostat



                                             This is because periphery countries have increased efforts to diversify outside the euro
                                             area, which has been helped by an improvement in competitiveness as wages have
                                             declined relative to the euro area average. This is true for both Spain and Portugal. For the
                                             latter, Spain is the main trading partner but Portuguese exporters are trying to reduce this
                                             dependence, targeting destinations outside the euro area instead. As a result, these
                                             countries will be more vulnerable to an appreciating euro.

Exhibit 11: Spain: Diversifying exports…                                     Exhibit 12:Portugal: …outside Europe
Export growth, y/y%, YTD average                                             Export growth, y/y%, YTD average

                                  7%                                         45                                                             5%
 30
                                                                             40
 25
                                                                             35                                          9%
 20
                                            7%                               30
 15                   37%                           8%                                                         11%
       Weight                                                                25                    29%
                                                            4%
 10    in total                                                              20                                                    8%
       exports                                                        100%           Weight
  5                                                                          15      in total
           63%                                                               10      exports
  0                                                                                                                                                   100%
 -5                                                                            5      71%
          EU       Extra-EU Africa       America    Asia   USA     World       0
                                          x-USA                                        EU       Extra EU Africa        OPEP      America    Asia    World
Source: Thomson Reuters Datastream, Credit Suisse                            Source: Thomson Reuters Datastream, Credit Suisse



                                             The degree of outsourcing and product specialization also plays a role when determining
                                             the impact of the exchange rate.
                                             Outsourcing low value-added production in the production chain tends to shield
                                             from exchange rate appreciation. This is because outsourcing low value added
                                             processes tends to increase margins and thus provides a buffer when the exchange rate
                                             appreciates. But this is also true because export goods that contain a high share of non-
                                             euro denominated components benefit from cheaper import prices as the euro strengthens.

European Economics                                                                                                                                           7
                                                                                                                                31 January 2013



                                           We have no data for the extra-euro area share of imported components, but it is probably
                                           fair to conclude that countries whose exports have a large imported component are
                                           relatively more exposed to the global and hence also extra-euro area production chain.
                                           Ireland and the northern European core countries (Germany, Netherlands and Belgium)
                                           are thus likely to suffer less from an appreciating euro.
                                           Higher tech goods are associated with a lower price elasticity of demand. Type and
                                           quality of export goods are other important factors when assessing the effects of the
                                           exchange rate. Studies have shown that the effect of the exchange rate on export growth
                                           becomes smaller the higher the share of high tech exports. This, because high tech goods
                                           are usually associated with relatively low price elasticity of demand meaning that the
                                           demand for those goods remains relatively unaffected if prices increase2. Another reason
                                           is that higher tech goods are traditionally associated with higher margins as a result of less
                                           competition, a lack of substitutes and higher value added. The higher the margin, the
                                           better a firm can withstand the impact of exchange rate appreciation as it is able to buffer
                                           the effect.
                                           Northern euro area countries export a relatively large share of high- and medium-tech
                                           goods. Ireland’s high share is mainly driven by pharmaceutical exports which are relatively
                                           price insensitive. But Spain and Italy are also close to the OECD average and likely to
                                           suffer less from an appreciating currency than Portugal and Greece, which look less
                                           advanced on the product scale.

Exhibit 13: Intermediate inputs that are re-exported                                     Exhibit 14: High and medium-high tech exports
% of total intermediate imports, all sectors including services, 2009                    Share as% total exports, 2010

 70                                                                                       80
                                                                                                                               High
 60                                                                                       70                                   Medium-high

                                                                                          60
 50
                                                                                                                              OECD average
                                                                                          50
 40
                                                                                          40
 30
                                                                                          30
 20
                                                                                          20
 10
                                                                                          10

   0                                                                                       0
         IRE NET BEL GER POR FRA                            ITA     SPA GRE                      IRE GER FRA BEL ESP AUT NET ITA POR GRE
Source: Credit Suisse, OECD                                                              Source: Credit Suisse, OECD



                                           The large high- and medium-high tech share of total German exports should also
                                           allow Germany to buffer yen weakness. The sharp depreciation of the yen against the
                                           euro is often mentioned as a particular problem for German industry since both, Germany
                                           and Japan are higher technology exporters. But throughout the last decade, Germany
                                           increasingly overtook Japan, expanding its share in high-tech good exports. And this
                                           happened while the euro appreciated by 60% (!) against the yen.




                                           2   See Lucke, Dorothea; Schröder, Philipp J. H.; Schumacher, Dieter
                                            (2004) : "R&D and price elasticity of demand", DIW-Diskussionspapiere


European Economics                                                                                                                            8
                                                                                                               31 January 2013




                     Exhibit 15: High-tech global export share differential vs EURJPY
                     Annual high-tech global export share data up to 2011

                         6                                                                                               170
                                               Global export share differential in high tech
                         4                     goods (GER minus JAP) (lhs)
                                                                                                                         160
                                               EUR/JPY (rhs)
                         2
                                                                                                                         150
                         0
                                                                                                                         140
                        -2
                                                                                                                         130
                        -4
                                                                                                                         120
                        -6

                        -8                                                                                               110

                      -10                                                                                                100
                               1993     1995       1997   1999     2001     2003   2005   2007   2009   2011     2013
                     Source: Credit Suisse, OECD




                     On balance:
                                A strengthening euro is a risk for the euro area’s subdued recovery but this
                                 risk could be limited as long as global demand does not falter.
                                Global demand has become more important than the price effect for core northern
                                 European economies, specifically Germany and the countries closely linked to its
                                 production chain, the Netherlands and Austria. Southern periphery countries have
                                 become more dependent on exporting outside the euro area in recent years. That
                                 and the make-up of their export products render them more vulnerable to a
                                 stronger euro.
                                It is important to note at this point that as long as core Europe and especially
                                 Germany do not contribute more to rebalancing the euro area through stronger
                                 internal demand satisfied partly through goods from the periphery, the latter
                                 remains particularly vulnerable to a slowdown in global trade and/or a
                                 strengthening of the euro.
                                This year, the euro area economy will continue enjoying the tailwinds
                                 stemming from last year’s currency weakness. But a trade-weighted
                                 appreciation of 5% from current levels, equivalent to just over EURUSD 1.40,
                                 undoes the positive impact the euro area is still enjoying from past weakness. A
                                 EURUSD above 1.45 would have significantly negative repercussions on
                                 economic activity.
                                The ECB is unlikely to take action before the EURUSD gets past 1.40. This
                                 was the average level prevailing in the first half of 2011 before the breakup panic
                                 started to spread. But strengthening beyond that level starts having significant
                                 economic costs and is likely to see the ECB responding.
                                The initial ECB response is likely to be cutting the repo rate further. Verbal
                                 intervention of the currency is also an option although traditionally the effect of
                                 this is not long lasting. Finally, there is always going back to expanding the
                                 balance sheet further, which could be taken care of if the OMT gets
                                 triggered.


European Economics                                                                                                           9
                                                                                                31 January 2013



                        The latter cannot be excluded in the event of the euro appreciating further.
                         The strain this puts on economic activity, especially in the periphery, is likely to
                         bring back periphery debt sustainability worries and result in rising periphery
                         yields. This might force periphery authorities to ask for ECB assistance.
                         Ultimately, this may prove to be the mechanism by which the euro’s
                         appreciation is reversed.




European Economics                                                                                          10
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US AND CANADA ECONOMICS
Dr. Neal Soss, Managing Director          Jonathan Basile, Director                    Jay Feldman, Director                           Henry Mo, Director
Head of US Economics                      +1 212 538 1436                              +1 212 325 7634                                 +1 212 538 0327
+1 212 325 3335                           jonathan.basile@credit-suisse.com            jay.feldman@credit-suisse.com                   henry.mo@credit-suisse.com
neal.soss@credit-suisse.com
Dana Saporta, Director                    Jill Brown, Vice President                   Isaac Lebwohl, Associate                        Peggy Riordan, AVP
+1 212 538 3163                           +1 212 325 1578                              +1 212 538 1906                                 +1 212 325 7525
dana.saporta@credit-suisse.com            jill.brown@credit-suisse.com                 isaac.lebwohl@credit-suisse.com                 peggy.riordan@credit-suisse.com

LATIN AMERICA ECONOMICS AND STRATEGY
Alonso Cervera, Managing Director         Casey Reckman, Vice President                Daniel Chodos, Vice President                   Di Fu, Analyst
Head of Non-Brazil Latam Economics        +1 212 325 5570                              +1 212 325 7708                                 +1 212 538 4125
+52 55 5283 3845                          casey.reckman@credit-suisse.com              daniel.chodos@credit-suisse.com                 di.fu@credit-suisse.com
alonso.cervera@credit-suisse.com          Argentina, Venezuela                         Colombia, Latam Strategy
Mexico, Chile
Nilson Teixeira, Managing Director   Daniel Lavarda, Vice President      Tales Rabelo, Vice President       Iana Ferrao, Associate           Leonardo Fonseca, Associate
Head of Brazil Economics             +55 11 3701 6352                    +55 11 3701 6353                   +55 11 3701 6345                 +55 11 3701 6348
+55 11 3701 6288                     daniel.lavarda@credit-suisse.com    tales.rabelo@credit-suisse.com     iana.ferrao@credit-suisse.com    leonardo.fonseca@credit-suisse.com
nilson.teixeira@credit-suisse.com    Brazil                              Brazil                             Brazil                           Brazil

EURO AREA AND UK ECONOMICS
Neville Hill, Managing Director           Christel Aranda-Hassel, Director             Giovanni Zanni, Director                        Violante di Canossa, Vice President
Head of European Economics                +44 20 7888 1383                             +44 20 7888 6827                                +44 20 7883 4192
+44 20 7888 1334                          christel.aranda-hassel@credit-suisse.com     giovanni.zanni@credit-suisse.com                violante.dicanossa@credit-suisse.com
neville.hill@credit-suisse.com
Axel Lang, Associate                      Steven Bryce, Analyst                        Yiagos Alexopoulos, Analyst
+44 20 7883 3738                          +44 20 7883 7360                             +44 20 7888 7536
axel.lang@credit-suisse.com               steven.bryce@credit-suisse.com               yiagos.alexopoulos@credit-suisse.com

EASTERN EUROPE, MIDDLE EAST & AFRICA ECONOMICS AND STRATEGY
Berna Bayazitoglu, Managing Director      Sergei Voloboev, Director                    Carlos Teixeira, Director                       Gergely Hudecz, Vice President
Head of EEMEA Economics                   +44 20 7888 3694                             +27 11 012 8054                                 +33 1 7039 0103
+44 20 7883 3431                          sergei.voloboev@credit-suisse.com            carlos.teixeira@credit-suisse.com               gergely.hudecz@credit-suisse.com
berna.bayazitoglu@credit-suisse.com       Russia, Ukraine, Kazakhstan                  South Africa                                    Czech Republic, Hungary, Poland
Turkey
Alexey Pogorelov, Vice President          Saad Siddiqui, Vice President                Natig Mustafayev, Associate                     Nimrod Mevorach, Associate
+7 495 967 8772                           +44 20 7888 9464                             +44 20 7888 1065                                +44 20 7888 1257
alexey.pogorelov@credit-suisse.com        saad.siddiqui@credit-suisse.com              natig.mustafayev@credit-suisse.com              nimrod.mevorach@credit-suisse.com
Russia, Ukraine, Kazakhstan               EEMEA Strategy                               EM and EEMEA cross-country analysis             EEMEA Strategy, Israel

JAPAN ECONOMICS
Hiromichi Shirakawa, Managing Director                   Takashi Shiono, Associate
+81 3 4550 7117                                          +81 3 4550 7189
hiromichi.shrirakawa@credit-suisse.com                   takashi.shiono@credit-suisse.com

NON-JAPAN ASIA ECONOMICS
Dong Tao. Managing Director               Robert Prior-Wandesforde, Director            Christiaan Tuntono, Vice President             Santitarn Sathirathai, Vice President
Head of NJA Economics                     +65 6212 3707                                 +852 2101 7409                                 +65 6212 5675
+852 2101 7469                            robert.priorwandesforde@credit-suisse.com     christiaan.tuntono@credit-suisse.com           santitarn.sathirathai@credit-suisse.com
dong.tao@credit-suisse.com                Regional, India, Indonesia                    Hong Kong, Korea, Taiwan                       Malaysia, Philippines, Thailand
China
Michael Wan, Analyst                      Weishen Deng, Analyst
+65 6212 3418                             +852 2101 7162
michael.wan@credit-suisse.com             weishen.deng@credit-suisse.com
Singapore
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