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Goldman Sachs -European Economics Analyst


Threat of area-wide, generalised deflation still remote

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									July 11, 2013

Issue No: 13/27

European Economics Analyst
                                                                                                       Economics Research

Threat of area-wide, generalised deflation still remote

Inflation has been surprisingly weak of late …                                    Huw Pill
April’s headline inflation outturn in the Euro area (1.2%pa) surprised to the     Goldman Sachs International
downside, raising concerns in some quarters that a deflationary dynamic –
akin to that seen in Japan over much of the past two decades – was                Kevin Daly
emerging in continental Europe. Subsequent slightly higher inflation              Goldman Sachs International
outturns (June 1.6%pa) have assuaged some of these concerns.
                                                                                  Dirk Schumacher
… but more important to look at longer-term trends                                Goldman Sachs AG
But these very short-term developments in inflation are a poor guide to the
more persistent trends in the price level that are of relevance for               Andrew Benito
macroeconomic developments (and thereby the setting of monetary                   Goldman Sachs International
policy). Nevertheless, the current weakness of the real economy in the Euro
area as a whole augurs for continuing disinflationary pressure.                   Lasse Holboell Nielsen
                                                                                  Goldman Sachs International
As yet, prices are not falling in a generalised manner
ECB President Draghi has defined deflation as a “protracted fall in prices        Natacha Valla
across different commodities, sectors and countries.” The recent data             Goldman Sachs International
suggest that, while inflation rates across countries and commodities are
clearly lower on average than in the pre-crisis period, falling prices remain     Antoine Demongeot
the preserve of specific components of the inflation basket. We therefore         Goldman Sachs International
remain some way from meeting Mr. Draghi’s criterion.
                                                                                  Sebastian Graves
Persistence is what matters                                                       Goldman Sachs International
Mr. Draghi also emphasised that deflation embodies “self-fulfilling
expectations”. Such a process would imply a persistent downward trend in
the price level. Assessing the persistence of price developments in real
time is challenging. Backward-looking statistical measures point to higher
persistence in price dynamics in recent times, but from a starting point
consistent with price stability this may be benign: it can serve to keep
deflation at bay. Forward-looking measures associated with private
inflation expectations are also quite reassuring. But they reflect the
credibility of the ECB, which ultimately depends on effective monetary
policy. In the face of continued weakness in Euro area aggregate activity –
and consistent with Mr. Draghi’s message at his July press conference –
we expect the ECB to maintain its accommodative monetary policy stance
for some time and – absent further shocks – see this as sufficient to ward
off deflation on his definition.

Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification
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The Goldman Sachs Group, Inc.                                        Goldman Sachs Global Economics, Commodities and Strategy Research
July 11, 2013                                                                                                                 European Economics Analyst

Threat of area-wide, generalised deflation still remote
                                         April’s headline inflation outturn in the Euro area (1.2%pa, Exhibit 1) surprised to the
                                         downside, raising concerns in some quarters that a deflationary dynamic – akin to that
                                         seen in Japan over much of the past two decades – was emerging in continental Europe.

                                         The very short-term evolution of inflation is a poor guide to the more persistent trends in
                                         the price level that are of relevance for macroeconomic developments (and thereby the
                                         setting of monetary policy). But the current weakness of the real economy in the Euro area
                                         as a whole augurs for a continuance of disinflationary pressures, even if some constituent
                                         countries are running at high levels of capacity utilisation and employment. As we have
                                         heard from several important European policymakers in recent weeks, assessing the risk of
                                         deflation remains an important element of policy analysis.

                                         At his June press conference, ECB President Draghi offered a definition of deflation. In this
                                         week’s European Economics Analyst, we evaluate recent price developments in the Euro
                                         area against elements of this definition. We conclude that:

                                                  Over recent months, inflation in the Euro area has been lower than in the past,
                                                   owing to weaker than expected inflation in the periphery and an erosion of
                                                   German corporate margins that has dampened the inflationary impact of stronger
                                                   wage growth there. However, as yet, the observed fall in the inflation rate does not
                                                   portend deflationary dynamics.

                                                  Falling prices (or very low rates of inflation) remain the preserve of specific
                                                   components of the inflation goods and services basket. Price dynamics are
                                                   persistent in the Euro area. In evaluating changes in such persistence since 2008,
                                                   we find that persistence has risen in some countries (including a number of the
                                                   largest), whereas looking across goods and services there has been little change.

                                                  Even if the emergence of a persistent deflationary trend in the Euro area as a
                                                   whole remains remote, headline HICP inflation is likely to remain at rates below
                                                   those consistent with the ECB’s definition of price stability (“below, but close to,
                                                   2%”) for some time (see our latest forecasts in Exhibit 2). Other things equal, this
                                                   will continue to support the case for an accommodative monetary policy stance, in
                                                   line with the ‘forward guidance’ offered by Mr. Draghi at his July press conference.

Exhibit 1: Inflation has been subdued of late …                              Exhibit 2: … and our short-term forecasts point to
HICP index, annual percentage change                                         inflation below the ECB’s objective, but not a
                                                                             deflationary trend
                                                                             Forecast HICP inflation, %pa




  1.5                                                                          1.50

  1.0                                                                          1.00
                                                                                                90% conf. interval
                                                                                                68% conf. interval
  0.5                                                                          0.50
                   HICP inflation                                                               10% conf. interval
                                                                                                GS macro forecast
  0.0                                                                          0.00
        Jan-12     May-12           Sep-12       Jan-13    May-13                 Jan-13    Mar-13     May-13        Jul-13     Sep-13   Nov-13

Source: Eurostat                                                             Source: Eurostat, GS Global ECS Research

Goldman Sachs Global Economics, Commodities and Strategy Research                                                                                     2
July 11, 2013                                                                                                           European Economics Analyst

                                  Risks of vicious debt / deflation spiral
                                  Low rates of inflation (or even falling prices) are not necessarily a malign influence on the
                                  macroeconomic outlook. As Mr. Draghi pointed out in his recent press conferences, other
                                  things equal, lower or falling prices boost real incomes and thus can help sustain
                                  consumption. Positive supply shocks will also tend to lower prices in the first instance –
                                  and they are clearly favourable from a macroeconomic perspective.

                                  But a persistent deflationary dynamic with its origins in monetary phenomena should be of
                                  considerable concern to policy makers, as the experience of Japan demonstrates.
                                  Countries with large debt overhangs and weak banking systems are particularly at risk,
                                  given the potential for a vicious debt / deflation spiral to emerge. In such a spiral, the real
                                  (inflation-adjusted) burden on debtors rises as prices start to fall, leading them to save
                                  more and spend less. The resulting weaker demand serves to exacerbate economic slack
                                  and thereby further depress prices. Debtors unable to service their debt burden will default,
                                  weakening the banking system, interrupting credit creation and further weakening demand.
                                  The deflationary process becomes self-sustaining, as the financial sector and real economy
                                  both contract.

                                  Given its significant public and private debt overhang, continued fragility of the banking
                                  sector and inability to undertake the challenging structural reforms and deleveraging
                                  needed to address the underlying fundamental problems, the Euro area appears vulnerable
                                  to such a dynamic. Against this background, at his June press conference Mr. Draghi
                                  offered the following definition of deflation: “Deflation is a protracted fall in prices across
                                  different commodities, sectors and countries. In other words, it is a generalised protracted
                                  fall in prices, with self-fulfilling expectations”.1 In the remainder of this note, we assess the
                                  composition of recent price developments in the Euro area against the criteria established
                                  by Mr. Draghi in this definition.

                                  Recent price developments: Weak, but no deflationary trend
                                  April’s area-wide HICP inflation (1.2%pa) came as a downside surprise to us (and others). In
                                  a context where conjunctural indicators were also pointing to weaker economic activity,2
                                  the unexpectedly low outturn relative to forecasts raised concerns in some quarters that a
                                  deflationary dynamic was emerging. Subsequent inflation outturns have assuaged some of
                                  these concerns. Annual inflation in the Euro area harmonised index of consumer prices
                                  (HICP) rose to 1.4% in May, with the latest flash estimate pointing to a further increase to
                                  1.6%pa in June. The April outturn appears to have been influenced by calendar effects
                                  associated with the early timing of Easter this year.

                                  Nonetheless, we had revised down our own inflation forecasts in expectation of these
                                  subdued outturns,3 on the grounds that:

                                             Inflation in the periphery is weaker than we anticipated. Spanish wage growth
                                              has moderated more rapidly than we had expected over the past few quarters,
                                              even as our growth forecasts have come in on track. We think this owes to the
                                              impact of the labour market reform introduced last year on wage determination.
                                              The reforms have served to help unify the labour market and steepen the Phillips

                                      See the ECB press conference of June 6, 2013,
                                      See ‘Tracking Euro area Q1 GDP growth’, European Economics Analyst 13/18.
                                      See ‘Update of Euro area macroeconomic forecasts: Slightly weaker 2013, but overall picture remains intact’,
                                      European Views, March 5, 2013.

Goldman Sachs Global Economics, Commodities and Strategy Research                                                                                    3
July 11, 2013                                                                                                                                              European Economics Analyst

Exhibit 3: While inflation is lower on average than before the financial crisis, as yet we do not observe a generalised
decline in prices across countries and goods
Annual HICP inflation (%) by component and country

May 2013

                   n io

                io at


              at ic




           uc un






        Ed m




















 FRA 5.3        1.4                 1.7                    1.4      -1                 2.4                       1.5                  -0.4           1.9                0

 GER 0.9        0.2    -1         4.8            0.8         -4                       2.6                         1.4                    0.7            7.2           -0.1


  ITA 1          0.4         -2               2.8                   0.9           1               1.7                 1.7             0.2            1.7                0.1
                                                                                            1.8                        1. 5


 ESP            0.5         -4             3.4                     1.4       14          0.2                  3.2               1.6                0.6                  0.7

Average over Jan 1999 – Dec 2006











        C th l
         om in
         lo o



        C oh
















AUT                                                                                                                                               R
BEL                                                                                                                                                                           1.9

FRA                                     1.9                   1.1                           2.5                       2                  -0.4           2.5             2.5

GER                               0.7               0.3                                2.6                            1.8                  -0.2                        2.8


ITA               1.8                         2.1                      1.8                        3.4             3.0                1.5            3.2                 2.9


ESP              2.1                                3.6                                            3.7                          1.3                 4.4                  3.7

                                                                                                   Below 0                                                      Between 2 and 2.5
                                                                                                   Between 0 and 1                                              Between 2 and 3
                                                                                                   Between 1 and 1.5                                            Between 3 and 4
                                                                                                   Inflation in line with target                                Above 4

Source: Eurostat, GS Global ECS Research

Goldman Sachs Global Economics, Commodities and Strategy Research                                                                                                                   4
July 11, 2013                                                                                                              European Economics Analyst

                                              An erosion of German corporate margins, which has absorbed the anticipated
                                               inflationary impact of stronger German wage growth. German wages are rising
                                               more rapidly than elsewhere (and have reached a growth plateau of slightly above
                                               3%pa), as one would expect given the relative tightness of the labour market. But
                                               the long period of wage moderation in the first decade of Monetary Union has
                                               widened corporate margins, creating a buffer for the absorption of higher labour

                                  While these revisions lead to short-term forecasts of inflation at rates below those deemed
                                  by the ECB to be compatible with its price stability objective, they do not portend persistent
                                  deflationary dynamics. This view is supported by a cross-check of our short-term inflation
                                  outlook constructed using a Bayesian VAR model that summarises the information in 30
                                  macro time series (Exhibit 2). Although it points to some downside risks to our short-term
                                  macroeconomic forecast in the autumn, this model is consistent with the view that inflation
                                  will remain weak in the coming quarters, but that persistent deflation dynamics appear

                                  No generalised deflation across countries, across sectors …
                                  In line with Mr. Draghi’s definition of deflation, we can further cross-check our
                                  macroeconomic forecasts by looking at the cross-country and cross-sectoral variation in
                                  price developments.

                                  To do so, we illustrate this variation in the form of a heat map. Exhibit 3 shows the annual
                                  inflation rate of the various components of the HICP index by country. To show the extent
                                  of deflationary dynamics across countries and across sectors, we colour-code elements of
                                  the matrix according to price developments: falling prices are black, low inflation (between
                                  0 and 1.5%) grey, etc. Moreover, the size of each cell in the chart is proportional to its
                                  weight in the construction of the area-wide index, reflecting both the country weight
                                  (captured by the height of the cell) and the sector weight (captured by the width).

                                  As a basis for comparison, we build two matrices: one capturing average behaviour in the
                                  pre-crisis period (i.e., 1999 - 2007) and the other showing the most recent data release (for
                                  the year ending in May 2013). The resulting charts give a visual impression of whether
                                  deflationary dynamics are widespread (as Mr. Draghi’s definition of deflation demands), or
                                  rather concentrated in a small number of the overall index’s components.

                                  Speaking in June, Mr. Draghi said “when we look at which prices are falling, we see that
                                  the fall in prices is actually limited to certain categories of goods.” This conclusion is
                                  confirmed by Exhibit 3.

                                  Although (through a comparison of the two matrices) we confirm that the most recent
                                  annual inflation rates are lower than the historical pre-crisis average, we also see that
                                  deflationary (or low inflation) dynamics are confined to specific sectors and, albeit to a less
                                  obvious extent, specific countries: black cells are not all pervasive (they cover less than half
                                  of the matrix). In particular, price falls are limited to certain goods and services, mainly
                                  those that either continue to benefit from technological innovation (e.g., communication)
                                  and/or greater competition via regulatory change (e.g., transport). Developments are
                                  therefore consistent with relative price changes – and thus market-based sectoral and
                                  country adjustment – rather than a generalised and toxic deflationary dynamic.

                                      See ’The Euro area short-term inflation outlook: Weak, but no persistent deflationary trend’, European Economics
                                      Daily, June 20, 2013.

Goldman Sachs Global Economics, Commodities and Strategy Research                                                                                        5
July 11, 2013                                                                                                                                                              European Economics Analyst

                                       … but it is persistence that matters
                                       The preceding assessment has been descriptive: we have simply used the available data to
                                       present how widespread deflationary dynamics are across countries and sectors. But the
                                       third element of Mr. Draghi’s definition of deflation – that price falls be self-sustaining, and
                                       thus persistent in nature – requires something more.

                                       One approach to thinking about the persistence of price dynamics is to analyse measures
                                       of core inflation (Exhibit 4). These are constructed by excluding the most volatile
                                       components of the HICP basket from the construction of the core index. But that does not
                                       necessarily mean that they are better at picking up persistent price developments. Should
                                       innovations in the excluded items be themselves persistent and/or entail persistent indirect
                                       or second-round effects on other components, then excluding these items may obscure
                                       price trends or at least complicate their timely identification.

                                       We therefore complement an assessment of core inflation measures with more direct
                                       statistical analysis of inflation persistence. In previous work, we have argued that the
                                       persistence of inflation in the Euro area is high and has been rising.5 This evidence cuts two
                                       ways. On the one hand, from a starting point of inflation at or above the ECB’s objective,
                                       greater inflation persistence makes the prospect of a painful deflation more remote. On the
                                       other hand, should macroeconomic weakness reach an extent where deflation takes hold, it
                                       is more likely to be self-sustaining.

                                       We extend our analysis here to specific countries and sectors. Prices that have proved to
                                       show persistent developments in the past may be given greater weight in the assessment
                                       of deflationary risks, since – other things equal – these are the ones most vulnerable to
                                       generating the self-sustaining dynamics that Mr. Draghi has expressed concern about.

                                       On the basis of our analysis, we conclude that:

                                                  In the past, inflation has demonstrated greater persistence in some countries
                                                   than in others. Exhibit 5 shows the first 12 countries that joined the Euro, ranked
                                                   according to the degree of inflation persistence in decreasing order. In the past,
                                                   inflation persistence was more heterogeneous than it is now, with the Netherlands
                                                   and Finland exhibiting the most stable price level up to 2007.

Exhibit 4: Core inflation measures are smoother, but do                            Exhibit 5: We see cross-country variation in the degree of
not necessarily better identify persistent price trends                            inflation persistence
Annual percentage change                                                           Rolling estimates of first order inflation autocorrelation

 5                                                                                   1.00

                                                                                     0.95                                                                                          Inflation persistence

 3                                                                                   0.85


 1                                                                                   0.70

                HICP Inflation









                Core Inflation
     05    06       07      08    09         10     11      12     13

Source: Eurostat, GS Global ECS Research                                           Source: Eurostat, GS Global ECS Research

                                           See ‘Changing inflation dynamics in the Euro area’, European Economics Analyst 13/04.

Goldman Sachs Global Economics, Commodities and Strategy Research                                                                                                                                                       6
July 11, 2013                                                                                                                         European Economics Analyst

Exhibit 6: While there has been less cross-sectoral                                       Exhibit 7: … we have seen increased inflation persistence
variation in inflation persistence …                                                      in some countries over the past few years
Rolling estimates of first order inflation autocorrelation                                Rolling estimates of first order inflation autocorrelation

1.0                                                                                         1.0
                                                                                                            Interval band for
                                                                                                            selected countries
0.9                                                                                                         Median



0.5              Interval band for sectors                                                  0.8

0.4                                                                                         0.8
      05    06        07       08      09          10      11     12      13                      05   06       07      08       09   10    11     12      13

Source: Eurostat, GS Global ECS Research                                                  Source: Eurostat, GS Global ECS Research

                                                        Cross-sectoral variation in the persistence of inflation has been limited over
                                                         the period since 2005. Exhibit 6 shows the first-order autocorrelation coefficient of
                                                         annual headline HICP inflation computed using rolling samples: this represents a
                                                         simple time-varying measure of inflation persistence. While inflation persistence is
                                                         uniformly high, apart from in the transport sector (where regulatory change may
                                                         have played a role), there is little evidence of an increase in the persistence of price
                                                         dynamics since the onset of financial crisis.

                                                         Over the same period, there is evidence that the persistence of inflation has
                                                          increased in some countries. Exhibit 7 shows the increase in persistence in
                                                          annual headline HICP inflation by country (again measured by a rolling estimate of
                                                          the first-order autocorrelation coefficient). In some countries (France, the
                                                          Netherlands) inflation has become more persistent since 2008.

                                             Inflation expectations remain well-anchored …
                                             Policy makers need to make an assessment of the persistence of price dynamics in real
                                             time. But, by the nature of the problem, it is difficult to do so. The statistical analysis in the
                                             preceding section is, of necessity, a backward-looking exercise. This type of analysis faces
                                             an ‘end-sample’ problem: a persistent process is, by definition, long-lasting. But in real
                                             time we only observe the start of this process – we cannot know for certain whether or not
                                             it will be long-lasting, simply because we do not know the future (and predictions of it are

                                             In this context, one approach is to look at expectations of future inflation. And the message
                                             from such measures is fairly reassuring. Exhibit 8 shows inflation expectations at different
                                             horizons derived from inflation-indexed swaps.6 While inflation expectations at shorter
                                             horizons have fallen recently and proved quite volatile (reflecting an (over)reaction to the
                                             low inflation outturns and downside surprises seen in recent monthly data), expected
                                             inflation at longer horizons has proved more stable and (allowing for the impact of inflation
                                             risk premia) broadly consistent with the ECB’s price stability objective.

                                                 For a more thorough analysis, see ’Market inflation expectations: Evolution and determinants’, European
                                                 Economics Analyst 13/14.

Goldman Sachs Global Economics, Commodities and Strategy Research                                                                                               7
July 11, 2013                                                                                                                  European Economics Analyst

Exhibit 8: Longer-term market inflation expectations                            Exhibit 9: … a view supported by survey-based inflation
have remained stable and in line with price stability …                         expectations
%pa                                                                             %pa, one year ahead

 3.50                                                                           3.5

 3.00                                                                           3.0

 0.50           Inflation swaps 1y
                Inflation swaps 5y                                              0.5             Consensus Economics survey
 0.00           Inflation swaps 10y
                                                                                                ECB survey of Professional Forecasters
                Inflation swaps 5y5y                                            0.0
-0.50                                                                                 05   06       07     08      09     10      11     12    13
        05   06       07      08       09     10   11    12    13

Source: Bloomberg, GS Global ECS Research                                       Source: ECB, European Commission, Consensus Economics

                                            This conclusion is supported by the various survey-based measures of inflation
                                            expectations, shown in Exhibit 9. Unsurprisingly, central bank communication has
                                            emphasised the stability of longer-term inflation expectations. And while inflation
                                            expectations remain well-anchored in this manner, the prospect of the ‘self-fulfilling’
                                            dynamics that Mr. Draghi embodied in his definition of deflation seems remote.

                                            … but such expectations embody the monetary policy response
                                            Yet there is no room for complacency. Crucially, private-sector inflation expectations
                                            embody the monetary policy response to inflationary and/or deflationary shocks. Stable
                                            longer-term inflation expectations at levels consistent with price stability reflect the
                                            credibility of the ECB in its pursuit of its mandate. That credibility remains strong – and this,
                                            in turn, helps the ECB achieve its goal, since forward-looking price-setters discount
                                            prolonged trends in the price level.

                                            But that credibility rests on the appropriate and effective implementation of monetary policy.
                                            In line with the message given by Mr. Draghi at his July press conference, we expect the
                                            ECB to maintain its very accommodative monetary policy stance for a prolonged period, in
                                            the face of a large output gap at the area-wide level. Moreover, in the face of further
                                            weakening in the economic situation and/or a downward shock to price dynamics – neither
                                            of which are part of our baseline scenario at present – we would expect the ECB to ease
                                            further. We believe that such a stance will be sufficient to ward off the threat of generalised
                                            and self-sustaining deflation (as Mr. Draghi has defined it) on an area-wide basis.

                                            Nevertheless, financial market fragmentation and impairment of monetary policy
                                            transmission to the periphery remain significant problems. Disinflationary (and incipient
                                            deflationary) pressures are acute in many peripheral countries, which are already
                                            vulnerable given, in many cases, large debt overhangs and still weak financial sectors. As
                                            on other dimensions, it is the ‘one size fits all’ problem, with a single monetary policy but a
                                            fragmented economic and financial landscape that can create deflationary risks in some
                                            parts of the Euro area.

                                            Lorenzo Pessina* and Huw Pill
                                            * Lorenzo Pessina is an intern with our Global ECS European Economics Team.

Goldman Sachs Global Economics, Commodities and Strategy Research                                                                                      8
July 11, 2013                                                                                                                                          European Economics Analyst

Key European Indicators
European financial conditions are easy, with the                                             Business sentiment showing signs of stabilising
exception of Switzerland                                                                     European business sentiment
European financial conditions
112                                                                                            70
           Index                                                                                     Index
110                                        Tighter                                             65
                     Euro area             Conditions
108                  UK                                                                        60
106                  Switzerland
                     Sweden                                                                    55
104                  Norway
102                                                                                            50
100                                                                                            45
 98                                                                                                                                               Euro area Com. PMI
                                                                                                                                                  UK Comp. PMI
                                                                                               35                                                 Swiss Manuf. PMI
 94                                                                                                                                               Sweden Manuf. PMI
 92                                                                                            30
  Jul-08            Jul-09          Jul-10           Jul-11           Jul-12        Jul-13          07           08         09          10             11         12        13

Source: GS Global ECS Research.                                                              Source: Markit, SVME, Swedbank, GS Global ECS Research.

Our Euro area Current Activity Indicator points to a                                         ...and our UK Current Activity Indicator is consistent with
contraction of 0.4%qoq annualised...                                                         growth of 1.0%-1.6%qoq annualised
Euro area GDP and Current Activity Indicator                                                 UK GDP and Current Activity Indicator
  4.0                                                                                          4.0

  2.0                                                                                          2.0

  0.0                                                                                          0.0

 -2.0        % qoq                                                                            -2.0       % qoq
             annl.                                                                                       annl.
 -4.0                                                                                         -4.0

 -6.0                                                                                         -6.0
                                                                                                                                                             UK CAI
 -8.0                                                          Euro area CAI                  -8.0                                                           UK GDP growth
-10.0                                                          Euro area GDP growth          -10.0

-12.0                                                                                        -12.0
        06          07        08           09        10          11        12         13             06          07        08      09             10        11         12    13

Source: GS Global ECS Research.                                                              Source: GS Global ECS Research.

Bank lending rates to companies remain divergent                                             We expect inflation to remain higher in the UK than in
% pa, interest rates on business loans up to €1mn with                                       the Euro area throughout 2013
maturity between 1 and 5 years                                                               Inflation forecasts
        %                                                                                            % yoy                       Euro area Headline CPI
                                                                                                                                 UK Headline CPI

6.0                                                                                                                                                                GS Forecast

5.0                                                                                           3.0

                                   Germany                                                    2.0
4.0                                                                                           1.0
                                   Spain                                                      0.0

3.0                                                                                          -1.0
      05       06        07         08          09        10      11           12     13            06     07         08   09     10         11        12    13        14   15    16

Source: GS Global ECS Research.                                                              Source: Eurostat, ONS, GS Global ECS Research.

Goldman Sachs Global Economics, Commodities and Strategy Research                                                                                                                  9
July 11, 2013                                                                                                                     European Economics Analyst

Main Forecasts

Economic Forecasts
                                           GDP                        Consumer Prices                    Current Account             Budget Balance
                                      (Annual % change)               (Annual % change)                    (% of GDP)                   (% of GDP)
                                   2012   2013(f)   2014(f)        2012   2013(f)  2014(f)           2012    2013(f)  2014(f)    2012(f) 2013(f) 2014(f)

 Euro area                          -0.5         -0.6     0.8        2.5        1.5      1.5          1.0      1.3       1.4       -3.7     -3.0      -2.4
   Germany                           0.9          0.2     1.9        2.1        1.8      2.0          7.0     6.1        5.6        0.2     -0.5      -0.5
   France                            0.0         -0.4     0.4        2.2        1.1      1.5         -2.3     -2.1      -1.2       -4.8     -4.0      -3.7
   Italy                            -2.4         -1.8     0.4        3.3        1.6      1.3         -0.7      0.1       0.1       -3.0     -2.9      -2.1
   Spain                            -1.4         -1.5     0.0       2.4        1.6       0.9         -1.1     1.2        2.1       -7.6     -6.0      -4.3
 UK                                  0.2          1.2     2.0       2.8        2.7       2.4         -3.8     -3.1      -2.3       -7.3     -6.9      -5.9
 Switzerland                         1.0          1.5     1.3       -0.7       -0.3      0.9         14.0     13.8      12.7        0.7     0.8        0.9
 Sweden                              1.1          2.1     3.0        0.9        0.2      1.3          7.1     6.8        6.2       -0.5     -0.9      -0.5
 Denmark                            -0.4          0.0     1.2       2.4        1.1       1.9          5.0     3.8        3.9       -4.0     -1.9      -1.7
 Norway*                             3.3          2.7     3.4        0.7        2.0      1.9         14.2     15.0      14.5         -        -         -
 Poland                              1.9          1.0     2.8       3.7        1.0       2.0         -3.5     -3.2      -2.4       -3.9     -3.5      -3.3
 Czech Republic                     -1.2         -1.0     1.9       3.3        1.5       1.6         -2.5     -1.3      -1.9       -3.3     -3.0      -2.8
 Hungary                            -1.7          0.5     1.4       5.7        2.1       2.4          1.6     0.6        0.4       -2.0     -2.8      -3.0

*Mainland GDP growth
Source: GS Global ECS Research.

Interest Rate Forecasts

  %                                                        3 Month Horizon                      6 Month Horizon                    12 Month Horizon
                                      Current           Forward            Forecast       Forward            Forecast           Forward         Forecast
  Euro area         3M                     0.2            0.4                0.2               0.4              0.2               0.5              0.2
                    10Y                    1.7            1.7                1.7               1.8              1.8               1.9              1.9
  UK                3M                     0.5            0.6                0.5               0.7              0.5               0.9              0.5
                    10Y                    2.4            2.5                2.2               2.6              2.3               2.7              2.4
  Sweden            3M                     1.2            1.2                1.2               1.3              1.2               1.5              1.1
                    10Y                    2.2            2.2                2.0               2.2              2.0               2.3              2.3
  Switzerland       3M                     0.1            0.0                0.0               0.0              0.0               0.1              0.0
                    10Y                    1.0            1.0                0.9               1.0              1.0               1.1              1.3
  US                3M                     0.3            0.3                0.3               0.4              0.3               0.5              0.3
                    10Y                    2.5            2.6                2.4               2.7              2.5               2.8              2.8
  Canada            3M                     1.2            1.3                1.5               1.3              1.8               1.5              1.8
                    10Y                    2.4            2.5                2.3               2.5              2.5               2.6              2.6
  Australia         3M                     2.8            2.8                2.7               2.6              2.7               3.0              2.7
                    10Y                    3.8            3.8                3.8               3.9              3.8               4.0              4.0
  Japan             3M                     0.2            0.2                0.3               0.2              0.3               0.2              0.3
                    10Y                    0.9            0.9                0.9               0.9              1.0               1.0              1.1

Close: July 10, 2013, mid-rates for major markets. We are currently using September 2013, December 2013 and June 2014 contracts for 3-month forward rates.
Source: GS Global ECS Research.

Goldman Sachs Global Economics, Commodities and Strategy Research                                                                                            10
July 11, 2013                                                                                                                                        European Economics Analyst

European Calendar
Focus for the Week Ahead                                                             Euro area HICP inflation ticking up from +1.2%yoy lows
Inflation data for June will be released for the Euro
area and the UK. We expect the release for the Euro                                     3.0          contributions (ppt)
area aggregate to confirm the pick-up in inflation seen
in the flash estimate, from +1.4%yoy in May to                                          2.0
+1.6%yoy in June. In the UK, we expect inflation to rise
from +2.7%yoy to +3.0%yoy.                                                              1.0

Minutes of the MPC Meetings in the UK and Sweden
will both be published on Wednesday. The Riksbank’s                                     0.0
Executive Board left the repo rate unchanged at 1.0% in                                                                             Food, alcohol and tobacco
                                                                                                                                    Non-energy ind. Goods
early July and the Minutes will include the                                           -1.0                                          Services
considerations of newly appointed members Flodén                                                                                    Energy
and Skingsley, who voted for a cut and unchanged                                      -2.0
                                                                                              09               10              11              12                 13
rates, respectively. The BoE Minutes will include the
details of Governor Carney’s first meeting. The BoE                                  Source: Eurostat, GS Global ECS Research

surprised the market by issuing a statement alongside
the interest rate decision (of no change) and the
Minutes will provide further insight into this decision.

Economic Releases and Other Events
  Country                 Time       Economic Statistic/Indicator               Period                    Forecast*                          Previous                    EMEA-MAP
                          (UK)                                                                      mom/qoq         yoy                mom/qoq               yoy         Relevance

  Fri 12th July
 Italy                    08:00      Harmonised CPI                            Jun (Final)              —           +1.4% (Flash)          —                1.3%            —
 Spain                    09:00      Harmonised CPI                            Jun (Final)              —           +2.2% (Flash)          —                1.8%            —
 UK                       09:30      Construction                                 May                   —                —                 —                –1.1%           —
 Euro area                10:00      Industrial Production                        May                   —                —             +0.4%mom             –0.6%           5
  Mon 15th July
 Switzerland              09:15      Producer & Import Prices                     Jun                   —                  —           –0.3%mom             –0.2%           —
  Tue 16th July
 UK                       09:30      House Prices                                 May                   —                —                 —                +2.6%           —
 UK                       09:30      CPI                                          Jun                   —              +3.0%               —                +2.7%           —
 UK                       09:30      CPI - Core (nsa)                             Jun                   —              +2.5%               —                +2.2%           —
 UK                       09:30      RPI                                          Jun                   —              +3.4%               —                +3.1%           —
 Euro area                10:00      Harmonised CPI                               Jun                   —              +1.6%               —                +1.4%           —
  Wed 17th July
 Sweden                   08:30      Minutes of MPC Meeting                       Jul                     —              —                 —                   —            —
 UK                       09:30      Minutes of MPC Meeting                       Jul                     —              —                 —                   —            —
 UK                       09:30      Claimant Unemployment                        Jun                   -5.0k            —               –8.6k                 —            —
 UK                       09:30      Average Weekly Earnings - Headline           May                     —         +1.5% (3m/yr)          —             +1.3% (3m/yr)      —
 UK                       09:30      Average Weekly Earnings - exc. Bonus         May                     —         +1.0% (3m/yr)          —             +0.9% (3m/yr)      —
 UK                       09:30      ILO Unemployment Rate                        May                  +7.7%             —               +7.8%                 —            4
 UK                       09:30      Employment                                   May              60.0k (3m/3m)         —            +24k (3m/3m)             —            —
 Euro area                10:00      Construction                                 May                     —              —               +2.0%               –6.6%          —
  Thu 18th July
 Switzerland              08:00      Trade Balance                                Jun                   —                —                2.2Bn               —              1
 UK                       09:30      Retail Sales - Ex Autos                      Jun               -0.2%mom           -0.5%           +2.1%mom             +2.1%            3
  Fri 19th July
 UK                       09:30      PSNCR (nsa)                                  Jun                                      —            +£3.1bn               —             —
 UK                       09:30      PSNB (nsa)                                   Jun                +£7.7bn               —            +£8.8bn               —             —

Source: Bloomberg, GS Global ECS Research. Economic data releases in calendar are subject to change at short notice. Complete calendar available via GS360 — * In the case of the PMIs, the Forecast is simply the Flash estimate where available (Flash PMIs are published by
Markit for the Euro area, Germany and France 1-2 weeks before the end of the reference month).

Goldman Sachs Global Economics, Commodities and Strategy Research                                                                                                                11
July 11, 2013                                                                                                                  European Economics Analyst

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Goldman Sachs Global Economics, Commodities and Strategy Research                                                                                         12

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