VIEWS: 17 PAGES: 26 POSTED ON: 10/8/2013
Slow Slog, No Growth Spurt
MORGAN STANLEY RESEARCH EUROPE Morgan Stanley & Co. International Elga Bartsch plc Elga.Bartsch@morganstanley.com +44 (0)20 7425 5434 Daniele Antonucci Daniele.Antonucci@morganstanley.com +44 (0)20 7425 8943 Olivier Bizimana September 3, 2013 Olivier.Bizimana@morganstanley.com +44 (0)20 7425 6290 European Economics Tomasz Pietrzak Samar Kazranian Slow Slog, No Growth Spurt Reiterating our forecast for sub-par growth: Despite Staying Below Official Forecasts for 2014 the long-awaited recovery now coming through in the Real GDP Forecast (YoY%) data, we stay cautious on the euro area growth outlook. Morgan Stanley Consensus EC Official govt. In our view, the growth momentum will lag behind that of 2.0 1.5 past recoveries and other major economies and also 1.0 stay below the historical trend. After an upwardly revised 0.5 0.0 contraction of 0.5%Y this year, we continue to expect -0.5 -1.0 GDP to expand by a sub-par 0.9%Y next year. As such, -1.5 euro area growth remains vulnerable to external shocks -2.0 -2.5 and domestic policy mistakes. 2013e 2014e 2013e 2014e 2013e 2014e 2013e 2014e 2013e 2014e Euro Area Germany France Italy Spain More core countries struggle; periphery stabilises: Source: IMF, EC, ECB for the Euro Area govt estimate, Morgan Stanley Research We note that several core countries, notably France, the forecasts Netherlands and Belgium, are still struggling to recover meaningfully. For now only Germany and Austria show European GDP Growth Forecasts at a Glance clear signs of recovery. More encouragingly, there are 2012 2013e 2014e 2015e some signs of a stabilisation in the southern periphery, EU-15 -0.4 -0.1 1.2 1.4 EMU -0.5 -0.5 0.9 1.2 which we expect to pave the way for positive growth Austria 0.8 0.5 1.6 1.6 later this year in Italy and Spain, and in the smaller Belgium -0.3 0.1 1.2 1.7 countries next year. Denmark -0.4 0.0 1.2 1.6 Finland -0.8 -0.2 0.8 1.2 At most, we see one more ECB rate cut: Contrary to France 0.0 0.0 0.6 1.2 our previous call for aggressive monetary easing by the Germany 0.7 0.4 1.8 1.8 ECB, we only see scope for one more refi rate reduction Greece -6.6 -4.0 0.0 0.4 Ireland 0.1 0.4 2.1 2.5 after the German election. But the ECB’s inaction over Italy -2.4 -1.7 0.4 0.7 the summer has dented our conviction on additional Netherlands -1.3 -1.2 0.5 0.8 ECB easing. When it comes to OMT, we can only see Portugal -3.2 -2.0 0.2 0.5 Ireland requesting an ESM credit line that would make it Spain -1.6 -1.3 0.8 1.1 eligible for OMT support. But we are concerned about Sweden 0.7 1.1 2.2 3.0 the legal and political hurdles to OMT activation – some UK 0.2 1.4 2.4 2.1 Source: National Statistics, Morgan Stanley Research forecasts of which might also apply to QE. Plenty of risks to the baseline: The risks to our baseline forecast remain tilted to the downside due to a combination of potential external shocks, possible euro area-wide policy mistakes and a range of country-specific risk factors. Even though it is not our base case, we would not rule out a re-escalation of the euro crisis after the German election, when unresolved issues such as Greek debt sustainability, Portuguese programme targets and Irish bank support are likely to resurface. In addition, the euro area needs to complete several key steps towards a banking union. For important disclosures, refer to the Disclosures Section, located at the end of this report. MORGAN STANLEY RESEARCH September 3, 2013 European Economics Euroland – Slow Slog, No Growth Spurt Morgan Stanley & Co. Elga Bartsch • A policy coordination system that shows serious signs of International plc Elga.Bartsch@morganstanley.com crisis fatigue, having already spent much political capital Key Points on austerity measures, structural reforms, bail-out Despite signs of a timid recovery, euro area growth remains packages and limited institutional reforms of euro area vulnerable to external shocks and domestic policy mistakes. governance; Even though it is not our base case, we cannot rule out a • An ECB that so far has not delivered significant additional re-escalation of the euro crisis after the German election. easing and instead continues to allow its balance sheet to The ECB is unlikely to act aggressively despite low inflationary shrink materially. Hence, we are concerned that the ECB pressures, we think, in the face of legal and political debates. might not be able to fend off spillovers from Fed tapering. Despite the recovery arriving one quarter earlier than expected, To these domestic policy concerns at the euro area level, we we stay cautious and reiterate our long-standing call for a would add a list of worries about the global economy, which is sub-par recovery in the euro area. We continue to expect preparing to digest monetary policy normalisation in the US, that this timid recovery will eventually also extend to the the financial market dislocations this might cause (e.g., in EM) periphery. After a stronger-than-expected 2Q GDP outturn of a and potential flare-ups in individual euro area countries (please non-annualised 0.3%Q, we expect a slight moderation in see our bull-bear scenarios on page 6 for details). Over the momentum in 2H as the only large economy that shows some next 12 months, the euro area needs to complete key steps clear signs of recovery at the moment is Germany. Away from towards a banking union. Some of these steps have the the core, where a number of countries including France, the potential to create a rise in uncertainty, we think. Netherlands and Belgium are struggling, the stabilisation in the periphery is encouraging. It should pave the way to a return to Exhibit 2 positive growth rates in Spain and Italy later this year. Most Euro Economies Have Troughed Now Exhibit 1 108 Real GDP (1Q 2008 = 100) Euro Area Recovery to Stay Below Historical Trend GER FRA ITA SPA IRE POR 1.5 6.0 104 5.0 1.0 4.0 3.0 100 0.5 2.0 1.0 96 0.0 0.0 -1.0 Quarterly GDP (QoQ%) 92 -0.5 -2.0 IP-based GDP Indicator (QoQ%) -3.0 3Q13-4Q14: Morgan Stanley 88 -1.0 Full Year GDP estimate (YoY%- RHS) -4.0 estimates 2008 2009 2010 2011 2012 2013 2014 2015 -5.0 Source: Eurostat, Morgan Stanley Research forecasts -1.5 -6.0 1999 2000 2001 2002 2004 2005 2006 2007 2009 2010 2011 2012 2014 Euro area growth to be at or a touch below its potential, at Source: Eurostat, EC, Morgan Stanley Research forecasts an unchanged forecast of 0.9%Y for next year, following an The main reason for us to remain cautious is that we fail to upwardly revised -0.5%Y for this year, from -0.7%Y before, see a sustainable engine for growth in the euro area. brining us back to where we were before our spring outlook Instead, we see multiple homemade headwinds in the quarters (see Cutting GDP Forecasts Due to Concerns on Italy & ahead from: France, March 13, 2013). As a result of such tepid growth • An undercapitalised banking system that still needs to momentum, we think that the rate of capacity utilisation will deleverage further (echoing similar deleveraging needs stay rather subdued and the rate of unemployment high by across most sectors in most of the euro area economies) historical standards, and there will likely be no meaningful and that faces several key stress tests in 1H14 as well as a improvement in pricing power. Hence, if anything, change in its resolution regime; disinflationary, if not deflationary, pressures should still 2 MORGAN STANLEY RESEARCH September 3, 2013 European Economics dominate, especially once one-off effects from indirect taxes Exhibit 4 and administrative prices are taken into account, as well as Indirect Taxes Boost HICP Inflation by 0.5pp food and, possibly soon, energy prices. 5.0 Euro Area F'cast Exhibit 3 4.0 Capacity Utilisation Still Subdued, Unemployment Rate Elevated 3.0 88 Capacity Utilisation Rate, LHS Unemployment Rate, RHS 13% 2.0 86 12% 84 1.0 HICP 82 11% HICP at Constant Tax Rates 0.0 80 LT averages 10% 78 -1.0 9% 2003 2004 2005 2006 2007 2008 2008 2009 2010 2011 2012 2013 2013 2014 2015 76 74 8% Source: Eurostat, Morgan Stanley Research forecasts 72 7% At most, we expect the ECB to cut rates one more time: 70 Contrary to our previous call for aggressive monetary easing 68 6% by the ECB up to and including a deposit rate cut (see 1985Q1 1988Q4 1992Q3 1996Q2 2000Q1 2003Q4 2007Q3 2011Q2 2015Q1 EuroTower Insights: Another Dose of Draghinomics? May 22, Source: European Commission, Eurostat, Morgan Stanley Research 2013), we now only see scope for one more refi rate reduction after the German election – in line with the ECB’s forward In terms of the different demand components, domestic guidance. Afterwards, we expect the bank to leave interest demand will likely stabilise next year and begin to expand rates unchanged over the whole forecast horizon. We would the year after, following a marked contraction this year. The expect the bank to use forward guidance to keep the money stabilisation in domestic demand is supported by investment and bond markets anchored. However, our conviction spending (largely on the back of maintenance spend). At the regarding the ECB’s willingness to ease has taken a hit due to same time, consumer spending should also move from a inactivity over the summer. The main reason why we continue further fall in expenditure this year to timid growth in the to expect some easing is that otherwise financial conditions remainder of the forecast horizon. Rebuilding of inventories would tighten materially, not just because the balance sheet is should also support overall growth – albeit not permanently – shrinking but also because EONIA would rise back to the refi thus helping to counterbalance a temporary decline in the rate. Our composite financing cost indicators lie consistently growth contribution coming from net foreign trade. above nominal GDP growth, suggesting that private sector financing conditions are still relatively restrictive and are only On our projections, HICP inflation will likely fall further easing slowly. over the forecast horizon as one-off effects stemming from rises in indirect taxes and administrative prices fall out of the Exhibit 5 year-on-year comparisons. With no meaningful job creation Financing Cost Indices Are Above Nominal Growth and subdued wage growth, we believe that unit labour costs will 8.0 EMU: Financing Cost Indicators 8.0 barely rise and could even fall outright – a phenomenon not 7.0 7.0 uncommon in the early stages of a recovery. Hence, core 6.0 6.0 inflation should ease gradually over the forecast horizon, reflecting the limited pricing power of companies and workers. 5.0 5.0 Headline inflation should hold steady around 1.5%Y, helped by 4.0 4.0 a weaker EUR on our FX team’s forecasts and above-average 3.0 3.0 food price inflation. Recent geopolitical events would point to potential upside risks to the oil price assumptions underlying our 2.0 2.0 Non-Financial Corporates forecasts. Any oil price spike would have a deflationary impact in 1.0 Households 1.0 Refi Rate an economy such as the euro area where capacity is so 0.0 0.0 severely underutilised. Initially, this deflationary impact would 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 be masked by the first-round impact on headline inflation. Source: ECB, Morgan Stanley Research 3 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Forward guidance alone won’t prevent a rise in the EONIA extend to QE purchases. The BoE, for instance, gets rate once excess liquidity falls below a threshold of authorisation from the Chancellor each time the MPC decides €150-200 billion, which based on the current pace of banks to embark on a new round of QE. For the German finance paying back VLTRO funds could happen early next year. For us, minister to sign such a document, he would most likely need to a potential sharp rise in the EONIA rate is one of the key reasons obtain the parliament’s approval, we think. why the ECB needs to lower its policy rate again. Without a refi Exhibit 6 rate cut, it is difficult to see why banks, which consistently keep Pace of Austerity Slows Materially, Especially in paying back their VLTRO funds, would be keen to load the Periphery liquidity boat again if offered another VLTRO at the same terms Structural Primary Balance (Chg., % GDP) as the outstanding operations. Once the ECB has decided that it 3 has reached the bottom of the interest rate cycle and won’t be 2 cutting anymore, it could consider offering a VLTRO at a fixed, rather than a tracker, rate. This would be a powerful way to 1 reinforce the ECB’s forward guidance. 0 We see serious obstacles in terms of the ECB’s OMT -1 programme and potential QE action. At this stage, we can see Ireland requesting an ECCL after the end of its current -2 programme that would make it eligible for OMT support. Eurozone Core Periphery -3 However, we don’t see any other viable candidates for OMT. This is because Portugal’s recent political turbulence will likely -4 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 have negatively affected the ECB’s assessment of the extent to Source: Eurostat, European Commission, Morgan Stanley Research forecasts which the country has regained full market access. The Portuguese government itself has started to talk about the Fiscal policy should remain contractionary in most need for a second programme. Before the German countries, with Germany being a notable exception next year. Constitutional Court has ruled on OMT, which will likely happen But the pace of austerity will likely slow materially (see Death of only after a new German government has been formed, Austerity? May 21, 2013). As a result, we expect debt/GDP probably in late 2013, we do not expect any OMT purchases to ratios to keep rising. However, to let austerity slip further or to be made by the ECB. consider outright fiscal stimulus would be unlikely to be In fact, we are concerned that the German Constitutional successful in boosting overall demand because the debt crisis Court ruling on OMT might erect additional hurdles to QE. has raised the public awareness about the unsustainable This is because the key point the Constitutional Court has nature of many fiscal policy trajectories. Only where the fiscal made in all euro-related cases is that the German parliament easing is essential to overcome credit constraints in the private cannot be sidelined by the decision-making process moving to sector can it prove to be effective, we think. However, here, the European level, e.g., to the Ecofin or the European Council. direct bank recapitalisations might prove to be more effective. But, as long as parliament has been adequately involved, the Exhibit 7 Court so far has been satisfied that there was no violation of Still Plenty of Risks to Baseline Forecast the German Grundgesetz. In our view, the set-up of OMT takes 3 Base Bull Bear Case Our estimates this concern into account as the ESM credit line that is a precondition for OMT eligibility (and equally a full programme) 2 will have to be approved by the Bundestag. At that point, when the country applying and the time period the credit line is 1 granted for are known, it is straightforward to calculate the 0 maximum amount of bonds the Eurosystem could buy and what the Bundesbank’s share would be. But there is a potential -1 Bear case problem in insisting that the Bundestag needs to pre-approve - Sharp rise in UST yields, spills into Bunds, widens periph spreads - ECB action constrained by constitutional and political concerns OMT. For one, it could become more difficult to obtain political -2 - Export demand dented, negative spillovers into domestic demand Bull case approval in parliament once it is obvious that it would also give - Decline in UST yields, spills into core mkts, compresses spreads - ECB able to raise rates gradually in 2015, anchors bond markets a green light to ECB bond purchases. What’s more, if the Court -3 - Export demand recovery spills into domestic demand (esp. capex) 2007 2008 2009 2010 2011 2012 2013 2014 2015 insists on OMT being pre-approved by parliament, as a corollary, the need for parliamentary approval might also Source: Eurostat, Morgan Stanley Research forecasts 4 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Exhibit 8 Euroland – Detailed Macroeconomic Forecasts, 2010-15E Growth rates, % 2012 2013E 2014E 1Q 2Q 3Q 4Q 1Q 2Q 3QE 4QE 1QE 2QE 3QE 4QE 2010 2011 2012 2013E 2014E 2015E GDP Eurostat (qoq) -0.1 -0.2 -0.1 -0.6 -0.3 0.3 0.1 0.2 0.2 0.3 0.3 0.3 GDP Eurostat (qoq, annualised) -0.2 -0.7 -0.4 -2.4 -1.1 1.2 0.4 0.9 0.9 1.0 1.2 1.2 GDP (yoy) -0.1 -0.5 -0.7 -0.9 -1.1 -0.7 -0.5 0.3 0.8 0.8 1.0 1.1 1.9 1.5 -0.5 -0.5 0.9 1.2 Private Consumption (qoq, ann.) -0.7 -2.0 -0.6 -2.5 0.1 0.4 0.4 0.0 0.0 0.4 0.4 0.4 1.0 0.2 -1.3 -0.5 0.2 0.5 Government Consumption (qoq, ann.) -0.5 -1.1 -0.5 0.2 -0.6 0.4 -0.4 -0.4 0.6 0.4 0.4 0.4 0.8 -0.1 -0.4 -0.3 0.2 0.5 Gross Fixed Investment (qoq, ann.) -5.1 -7.1 -3.2 -5.8 -7.4 1.5 -2.8 -1.2 -0.1 0.3 0.6 0.9 -0.4 1.5 -4.2 -4.0 -0.3 1.3 Machinery & Equipment (qoq, ann.) -5.9 -7.3 -5.3 -6.6 -10.5 2.0 -3.9 -1.6 -0.4 0.0 0.4 1.0 5.6 4.5 -4.3 -5.3 -0.7 1.5 Construction (qoq, ann.) -5.7 -7.7 -2.2 -5.8 -7.0 0.8 -2.8 -1.6 -0.4 0.0 0.4 0.4 -4.3 -0.4 -4.8 -4.0 -0.6 0.9 Other (qoq, ann) 4.3 -1.7 -0.6 -2.8 4.9 4.1 2.4 3.2 3.0 3.0 3.0 3.0 3.6 2.2 1.1 1.7 3.1 3.0 Contribution to Growth Inventories (qoq, ann.) -0.1 -0.2 -0.6 -0.2 -0.1 -0.2 0.3 0.9 0.7 0.4 0.3 0.1 0.6 0.2 -0.5 -0.1 0.5 0.0 Net Exports (qoq, ann.) 1.4 2.2 1.2 0.3 0.4 0.8 0.4 0.3 0.1 0.2 0.4 0.6 0.7 1.0 1.6 0.7 0.3 0.6 Final Domestic Demand (qoq, ann.) -1.5 -2.7 -1.0 -2.4 -1.4 0.6 -0.4 -0.3 0.1 0.4 0.4 0.5 0.7 0.3 -1.6 -1.1 0.1 0.6 GDP Gap (actual versus potential) -2.2 -1.6 -2.9 -4.1 -4.0 -3.5 Main Euro Area Countries Germany (qoq, ann.) 2.7 -0.3 0.8 -1.8 0.0 2.9 1.0 1.6 2.0 1.8 1.6 1.6 4.2 3.0 0.7 0.4 1.8 1.8 France (qoq, ann.) 0.1 -1.3 0.6 -0.7 -0.6 1.9 -0.5 0.3 0.7 0.9 0.9 0.9 1.6 2.0 0.0 0.0 0.6 1.2 Italy (qoq, ann.) -4.0 -2.5 -1.0 -3.6 -2.6 -0.8 0.2 0.4 0.4 0.4 0.8 0.8 1.7 0.5 -2.4 -1.7 0.4 0.7 Spain (qoq, ann.) -1.7 -2.0 -1.5 -3.1 -1.5 -0.4 0.2 0.6 1.0 1.0 1.1 1.4 -0.2 0.1 -1.6 -1.3 0.8 1.1 Employment, Income, Profits Employment (qoq) -0.4 0.0 -0.1 -0.3 -0.5 -0.2 -0.1 -0.1 0.0 0.0 0.1 0.1 -0.5 0.4 -0.7 -0.9 -0.1 0.2 Unemployment Rate, % of labour force 10.9 11.3 11.5 11.8 11.9 12.0 12.1 12.2 12.3 12.3 12.3 12.3 10.1 10.2 11.4 12.1 12.3 12.4 Compensation per Employee (qoq) 0.6 0.3 0.3 0.3 0.9 0.5 0.3 0.3 0.3 0.3 0.3 0.3 1.8 2.1 1.8 1.9 1.3 1.2 Real Disposable Income (qoq) -0.7 -0.4 -1.0 0.4 0.4 0.9 Savings Ratio (% of disposable income) 13.8 13.4 13.7 14.5 14.6 14.9 Gross Operating Surplus (qoq) 4.2 2.6 -0.4 2.0 2.1 3.2 Productivity, Costs, Inflation Labour Productivity per capita (qoq) 0.3 -0.2 0.0 -0.3 0.2 0.5 0.2 0.3 0.2 0.3 0.3 0.3 2.5 1.1 0.2 0.5 1.0 1.0 Unit Labour Costs (yoy) 1.7 1.4 1.8 1.5 2.0 1.5 1.3 0.8 0.2 0.2 0.2 0.2 -0.7 1.0 1.6 1.4 0.2 0.2 Inflation (HICP), yoy 2.7 2.5 2.5 2.3 1.9 1.4 1.4 1.5 1.6 1.7 1.5 1.4 1.6 2.7 2.5 1.5 1.6 1.4 Core inflation, yoy 1.6 1.6 1.5 1.5 1.5 1.2 1.1 1.1 1.1 1.1 1.0 0.9 1.0 1.4 1.5 1.2 1.1 0.9 Balance Sheets Current Account (% of GDP) 0.0 0.1 1.3 2.4 2.3 2.4 General Government Balance (% of GDP) -6.2 -4.1 -3.7 -3.1 -2.9 -2.7 General Government Gross Debt (% of GDP) 85.6 88.1 91.4 94.5 96.5 96.2 Source: National Statistics, Eurostat, Morgan Stanley Research forecasts QoQ = Quarter on Quarter, YoY = Year on Year Exhibit 9 European Interest Rate Forecasts at a Glance, 2013-15E Current Sep 13E Dec 13E Mar 14E Jun 14E Sep 14E Dec 14E Mar 15E Jun 15E Sep 15E Dec 15E Euro Area ECB Deposit (Floor) Rate 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 ECB Refi Rate (EoP) 0.50 0.50 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 ECB Marginal Lending (Ceiling) Rate 1.00 1.00 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 3M Money market futures 0.22 0.24 0.31 0.41 0.49 0.57 0.66 0.75 0.86 0.99 1.13 United Kingdom BoE repo rate (EoP) 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.75 0.75 1.00 3M Money market futures 0.50 0.53 0.55 0.61 0.69 0.78 0.88 1.00 1.15 1.33 1.55 Sweden Riksbank Repo (EoP) 1.00 1.00 1.00 1.00 1.00 1.00 1.25 1.25 1.50 1.50 1.75 3M Money market futures 1.21 1.23 1.28 1.43 1.58 1.73 1.89 2.04 2.18 2.31 2.44 Riksbank's Own Repo Forecast (Avg) 0.99 0.94 0.94 0.94 1.00 1.25 1.50 1.75 2.00 2.25 Source: Reuters, Bloomberg, Morgan Stanley Research forecasts 5 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Still Plenty of Risks to Our Baseline Scenario Morgan Stanley & Co. EM markets to varying degrees, and would likely be Elga Bartsch International plc Elga.Bartsch@morganstanley.com accompanied by a rally in risk markets, thus easing financial Daniele Antonucci conditions; and ii) A Chinese soft take-off in growth, with Daniele.Antonucci@morganstanley.com confidence being enhanced by successful sector-specific Key Points stimulus and bold structural reforms that promote Given the uncertainty around major policy decisions both in rebalancing. All this, and the reversal of capital flows back the region and elsewhere, and the fragile state of the euro into EM as a consequence, would be quite supportive of an area economy, single-point forecasts seem even less useful export-led recovery in the euro area. than usual. We therefore encourage our readers to think about a range of outcomes, reflecting a range of different Equally, recent geopolitical events suggest caution on the assumptions along three dimensions: global, European and price of oil. The same applies to FX: While the baseline national assumes a gradual weakening of EUR, any meaningful deviation from that forecast would have an impact on growth Exhibit 10 estimates. Bull and Bear Scenarios – GDP Growth Base Case Bear Case Bull Case 2013e 2014e 2015e 2014e 2015e 2014e 2015e 2. Europe – EU Policy and the ECB Subjective Prob. 60% 20% 20% The global context is by no means the only – or even main – EU-15 -0.1 1.2 1.4 0.2 0.0 1.9 2.0 EMU -0.5 0.9 1.2 -0.1 -0.2 1.6 1.8 risk to the euro area economic outlook, for several reasons: Austria 0.5 1.6 1.6 0.6 0.2 2.2 2.2 Belgium 0.1 1.2 1.7 0.3 0.3 2.1 2.4 Finland -0.2 0.8 1.2 -0.2 -0.2 1.5 1.8 • First, not only will the banking system, which remains short France 0.0 0.6 1.2 -0.4 -0.1 1.6 2.1 of capital, have to continue with its balance sheet repair. We Germany 0.4 1.8 1.8 0.8 0.4 2.4 2.4 Greece -4.0 0.0 0.4 -1.0 -1.0 0.6 1.0 also believe that there are some key challenges ahead: Ireland 0.4 2.1 2.5 0.1 1.1 2.8 3.1 Italy -1.7 0.4 0.7 -0.6 -0.7 1.0 1.3 i. In the short term: We think that the Asset Quality Netherlands -1.2 0.5 0.8 -0.5 -0.6 1.1 1.1 Portugal -2.0 0.2 0.5 -0.7 -0.8 0.9 1.1 Review and the bank stress test in 1H14 are Spain -1.3 0.8 1.1 -0.2 -0.3 1.4 1.7 potentially important events that could eventually Sweden 1.1 2.2 3.0 1.2 1.7 2.9 3.6 refocus market participants on the lack of a full Source: National data, Morgan Stanley Research forecasts circuit-breaker between banks and sovereigns (see 1. Global – All Eyes on US Rates, EM Markets and China European Banks: Don’t Underestimate the AQR, August In our global outlook, the baseline scenario assumes that DM 29, 2013). bond markets stabilise and China slows down in a controlled fashion. By contrast: ii. In the medium term: We think that a fully fledged banking union is the minimal solution to fix the flawed • Our bear case explores the impact of: i) US bond yields institutional set-up of the euro area. While a new surging to 4% in the next few months on fears of earlier Fed resolution regime is in the making, prospects of a Single rate hikes. The rise in bond yields is then transmitted to Resolution Mechanism, a common bank rescue fund other DM and EM markets to varying degrees. It would likely and a deposit guarantee appear remote. be accompanied by a sell-off in risk markets, thus tightening financial conditions; and ii) Chinese growth rolling over to • Second, the political situation remains quite fragile and 5-6%Y quickly. This alone, and the severe disruption to EM vulnerable to setbacks. There’s as much support fatigue in capital flows, would be enough to put the euro area – and core Europe as there’s austerity fatigue in peripheral indeed the global economy – back in recession. Europe. This is not to say that no reforms have happened. To some degree, and in selected areas, they actually have. • Our bull case explores the impact of: i) US data in the But the key point is that even the limited progress we’ve sweet spot of continued expansion and the Fed seen has resulted in overstretched political promises, along successfully accomplishing the separation. It does begin with voters’ disillusion, on belt-tightening and reforming the tapering, but combines it with a strong signal of its intent to economy, pushing through further EU coordination keep rates low for a very long time. The accompanying mechanisms and rescuing the weakest members of the decline in bond yields would be transmitted to other DM and currency union. 6 MORGAN STANLEY RESEARCH September 3, 2013 European Economics • Third, the ECB hasn’t embarked on any extra easing. implement significant institutional reforms (including new Conversely, it has allowed its balance sheet to shrink. In the electoral rules), along with product and labour market reforms, context of Fed tapering, we are concerned that the ECB is not impossible. Yet, a bear case of political procrastination, might find it difficult to counteract any adverse impact on as well as domestic instability and EU reform blockage, might euro area markets. Thus, European core rates might well challenge the consensus view that the worst is behind us. rise more than expected and, potentially, peripheral Spain: The Spanish economy might recover faster than spreads might re-widen to a meaningful extent. This is all expected. In our view, investors have not caught up yet with the more complicated due to the upcoming ruling by the Spain’s ability to grow rather than just stagnate. In our bull German Constitutional Court on OMT. Our bear case case, a structurally strong export engine, which is getting assumes an inactive ECB that is clearly restricted by stronger as competitiveness improves, a more growth-friendly shifting political and legal boundaries as well as slow fiscal policy, the sharp contraction in construction coming to decision-making in what seems to be a divided Governing an end and visible disinflation might well trigger a decent, Council. A marked rise in funding costs would cause a rather than sub-par recovery. But a bear case of a more full-blown credit crunch and, due to rising debt-service costs, intense deleveraging than envisaged could cause fresh could lead to additional fiscal tightening. Our bull case, by concerns about the sustainability of the improvement. Thus, contrast, assumes lower funding costs – also helped by while the consensus might well start to revise up, we see little further political steps towards crisis resolution – and less scope for extra upside to GDP growth from what we project aggressive fiscal tightening (which has already been currently. relaxed). In this case, the ECB should be able to start Portugal and Greece: With signs of adjustment stress having raising rates in late 2014. recently emerged in both countries, their ability to refocus on 3. Country-Level – Any Engines of Growth/Reforms Left? their programmes will be closely watched. In Greece, the Germany: The main risk emanating from Europe’s largest focus is on public sector downsizing and on reviving the economy is the September 22 elections. In our view, a major privatisation process, on which we stay cautious. A bull case shift in the stance on key issues such as debt relief, joint of smooth execution on all fronts appears a stretch, but would issuance and direct bank recaps is unlikely if the incumbents comfort investors and make near-term OSI more likely. A bear are re-elected or if Chancellor Merkel is forced into a Grand case would envisage renewed tensions, both in domestic Coalition. In fact, a narrow majority for the centre right could politics and with the Troika, which might delay or complicate reinforce a relatively tough stance on these issues. Only in the upcoming reviews. In Portugal, devising a plan B of a unlikely event of a Red-Green coalition would the chances of precautionary credit line or a second bailout with the official a European debt-redemption fund rise materially, we think. lenders is likely to dominate the debate. A bull case of a stronger political commitment would make financial support France: In our view, developments in France are key to the become clearer sooner. But domestic politics remains a stability of the euro area, notably the core’s ability to contain hurdle, as does the recent decision of the Constitutional Court the crisis in the periphery. With growth in slow motion, the to strike some spending cuts. In a bear case, austerity fatigue French current account deficit, which is now the largest in the would aggravate and a resolution might only come after euro area, both in absolute terms and as a percentage of GDP, significant damage to confidence, which could – in turn – could be a potential tipping point. In the absence of a make a delayed market comeback more likely. correction of the underlying structural issues, dependence on foreign capital would grow, potentially causing the country to Ireland: The finishing stretch for Ireland’s programme exit in become more vulnerable to shifts in international investor early 2014 could be more uphill than expected. The economy sentiment (see Foreign Capital Dependence: Should slipped back into recession in mid-2012 and government Investors Be Concerned? July 3, 2013). In our bull case, we parties are debating an easing of austerity. Mortgage arrears assume that the authorities tackle structural imbalances are still rising and repossessions only starting. Debt at 125% swiftly, particularly in the public sector, with a fiscal of GDP is already high, chances to offload ~40pp of debt from consolidation strategy focused on the spending side. bank rescues seem remote, and the deficit remains one of the highest this year. Also, the euro crisis could re-escalate, legal Italy: Policy-makers struggle to strengthen Italy’s near-zero or political setbacks could hit the ECB’s OMT programme and potential GDP growth. An uncertain political situation mishaps are possible in the run-up to the SSM. Equally, complicates the picture further. Rising political volatility investors might find that none of these concerns materialise, following the recent court verdict might test government the strong Irish fundamentals reassert themselves and Ireland cohesion. While not very likely, conceiving a bull case where sails out of its rescue programme full steam ahead. the authorities focus less on internal political issues and quickly 7 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Germany – Not Strong Enough as a Single Engine Morgan Stanley & Co. as proposed by all opposition parties do not seem to be Elga Bartsch International plc Elga.Bartsch@morganstanley.com conducive to this goal, we think. Hence, we would deem a complete change in government after the September 22 Key Points election as negative for German equities. To what extent a Despite the recent stellar performance, the German economy government more open-minded towards pooling financial alone is not strong enough to pull the euro area along. resources in the euro area, e.g., via a debt-redemption fund Instead, we believe that the newly elected government faces and a bank rescue fund, would be able to offset this negative several key policy challenges after the September 22 ballot. impact through improving the growth prospects in the rest of the euro area is an open question. The sharp rise in EUR that We would not read too much into the spurt in German would likely result from such step towards pooled financial GDP growth in the spring. Part of it is just a normalisation resources would likely undermine some of the near-term after a very cold winter. As a result, we would expect a growth momentum (for a detailed analysis of the election, see renewed moderation in growth in 3Q. At present, our GDP Merkel to Score a Hat-Trick, August 27, 2013). indicator is tracking just 0.2%Q between July and September. In 1H, growth was significantly boosted by domestic demand, Exhibit 11 notably consumer spending and also government expenditure. Massive Inventory Build Did Not Show in 2Q GDP In addition, investment spending recovered noticeably, which 115 Mfg Output, LH 110 is partly attributed to a catching-up in construction investment Industrial Sales, LH 108 110 Inventories in Mfg, RH after the unusually cold winter. As domestic orders of capital 106 goods were rather weak in 2Q, we would not expect a massive 105 104 contribution from capex itself. Finally, net exports also boosted 102 100 headline GDP growth as export growth outpaced import growth. 100 While the preliminary GDP report does not show any significant 95 98 inventory rebuilding, monthly industrial data we track would 90 96 suggest a very sharp rise in manufacturing inventories over the 94 summer. 85 92 2010=100 80 90 While Germany is the only large euro area country that shows 2003 2005 2007 2009 2011 2013 some clear signs of recovery at the moment, we remain Source: Deutsche Bundesbank, Morgan Stanley Research concerned about the longer-term challenges that Exhibit 12 Europe’s largest economy faces. These challenges include: Germany – Main Macro Forecasts, 2011-15E i) The increasingly tight labour market causing bottlenecks in 2011A 2012A 2013E 2014E 2015E Real GDP 3.0 0.7 0.4 1.8 1.8 certain sectors and regions; ii) The increasingly expensive Private Consumption 1.7 0.6 1.7 1.3 1.4 push towards renewable energy sources; and iii) The Government Consumption 1.0 1.4 0.2 1.4 1.2 Gross Fixed Investment 6.2 -2.6 -0.6 3.2 3.0 persistent underinvestment in terms of public infrastructure and Machinery and Equipment 7.0 -4.8 -3.4 3.9 4.1 corporate capex. In our view, the latter is the main problem Exports 7.8 3.7 1.7 4.3 4.3 Imports 7.4 1.8 2.4 4.3 4.3 behind the sizeable German current account surplus. Instead Contribution to GDP Growth (%) of investing in productive capacity at home, Germany has Final Domestic Demand 2.2 0.2 0.9 1.6 1.6 Net Exports 0.7 1.1 -0.1 0.3 0.3 invested a large part of its domestic savings in financial assets Inventories 0.1 -0.6 -0.4 -0.1 -0.1 abroad. Unfortunately, the track record for such investments is Unemployment Rate (% of Labour Force) 6.0 5.5 5.5 5.5 5.4 Real Disposable Income -0.5 0.9 1.1 1.1 1.3 very poor. On average, Germany has lost about 0.5% of GDP Personal Saving Rate (% of Disp. Income) 10.2 10.3 9.8 9.6 9.5 per annum on its net foreign assets. Inflation (CPI) 2.1 2.0 1.6 1.9 1.9 GDP Deflator 1.2 1.5 2.4 1.9 1.6 Unit Labour Costs 3.9 3.2 2.1 0.6 1.2 To harness the domestic growth potential in full and divert Current Account (% of GDP) 6.2 7.0 6.7 6.6 6.6 domestic savings towards domestic investment, the next General Government Balance (% of GDP) -0.8 0.2 0.0 0.1 0.3 German government will need to address the labour market Primary Government Balance (% of GDP) 1.8 2.6 2.2 2.2 2.4 General Government Debt (% of GDP) 80.4 81.3 80.3 77.8 75.2 issue, the energy policy question and the degenerating public Net Government Debt (% of GDP) 50.8 50.9 N/A N/A N/A infrastructure. Marked tax increases and minimum wage hikes Source: National Statistics, Deutsche Bundesbank, Morgan Stanley Research forecasts 8 MORGAN STANLEY RESEARCH September 3, 2013 European Economics France – Slow-Motion Economic Recovery Morgan Stanley & Co. ultimately, limit any meaningful recovery going forward. Finally, Olivier Bizimana International plc Olivier.Bizimana@morganstanley.com the contribution from net exports should be neutral, as we expect exports and imports to improve gradually. Key Points We expect a slow-motion economic recovery over the coming Fiscal policy set to remain restrictive. France has been quarters, amid a still-restrictive fiscal policy. granted two more years to reduce its budget deficit to Domestic demand should remain soft, as weak corporate bellow 3% of GDP by 2015: Nevertheless, fiscal adjustment is balance sheets should limit any meaningful recovery. set to continue, with a reduction in the structural deficit expected to be about 1.8pp in 2013 and 1.0pp in 2014, The general government deficit is projected to decline slightly according to the 2013-2017 Stability Programme. Under our to 3.5% of GDP in 2014 and the debt/GDP ratio to keep rising. growth forecasts, the general government deficit should fall to The economy continues to stabilise, but headwinds 3.9% of GDP in 2013 and 3.5% in 2014. The debt/GDP ratio remain: The economy is projected to grow at a sub-par pace should continue to rise to 95.3% in 2014 (from 90.2% in 2012). next year, after two consecutive years of stagnation. Growth is Exhibit 13 set to pick up pace slightly in 2015, though staying below its historical trend. If anything, we expect a slow-motion recovery. France – Main Macro Forecasts, 2011-15E 2011A 2012A 2013E 2014E 2015E Despite the extension of the deficit deadlines, fiscal policy Real GDP 2.0 0.0 0.0 0.6 1.2 Private Consumption 0.5 -0.4 0.2 0.5 0.9 should remain restrictive and continue to have a significant Government Consumption 0.4 1.4 1.5 1.0 1.1 drag on growth. The risks to the outlook remain higher than Gross Fixed Investment 3.0 -1.2 -2.5 0.4 1.8 normal. In particular, uncertainty about the fiscal outlook is Contribution to GDP Growth (%) Final Domestic Demand 1.0 -0.1 0.0 0.6 1.1 likely to persist. What’s more, the weakness of balance sheets Net Exports 0.0 1.0 0.0 0.0 0.1 Inventories 1.1 -0.8 0.0 0.0 0.0 could also make it more difficult for firms to access external Unemployment Rate (% of Labour Force) 9.2 9.8 10.5 10.8 10.7 financing, which could weigh further on growth. Real Disposable Income 0.6 -1.0 0.6 0.3 0.6 Savings Rate (% of Disp. Income) 16.1 15.6 16.0 15.8 15.7 Exit recession to enter stagnation: Real GDP growth Inflation (CPI) 2.1 2.0 1.0 1.6 1.4 Unit Labour Costs 0.6 1.8 1.4 1.3 1.2 rebounded in 2Q, after two consecutive quarters of contraction Current Account (% of GDP) -1.9 -2.3 -2.1 -2.2 -2.3 (technical recession). Several of the underlying components of General Government Balance (% of GDP) -5.3 -4.8 -3.9 -3.5 -3.2 real GDP registered solid growth. In particular, consumer Primary Government Balance (% of GDP) -2.7 -2.3 -1.3 -0.9 -0.5 General Government Debt (% of GDP) 85.8 90.2 93.6 95.3 95.8 spending bounced back, while public consumption remained Net Government Debt (% of GDP) 62.5 70.7 N/A N/A N/A strong. Likewise, export growth expanded at a rapid clip and Source: INSEE, Morgan Stanley Research forecasts changes in inventories made a positive contribution to growth. Exhibit 14 By contrast, both corporate and residential investment Slow-Motion Expansion continued to decline. In the near term, though, the momentum swing in 2Q is not expected to carry into 3Q, as some of the %,Q France: GDP growth contributions 1.6 Domestic demand (excl. inventories) Inventory changes elements supporting growth in 2Q were one-off factors and are Net exports GDP not likely to persist. Heading into 3Q, key data flows point to 1.2 relatively weak momentum. We expect a small contraction in Forecasts real GDP in 3Q, followed by sluggish growth in 4Q and 0.8 throughout 2014. 0.4 Domestic demand is soft, and consumption spending is 0.0 expected to remain rather tepid: A continuation of the bleak labour market conditions, with rising unemployment, will likely -0.4 keep consumer spending growing at a moderate pace. Moreover, consumers should maintain a high saving rate, -0.8 Q1-11 Q3-11 Q1-12 Q3-12 Q1-13 Q3-13 Q1-14 Q3-14 Q1-15 Q3-15 partly reflecting uncertainty about the medium-term outlook for Source: INSEE, Morgan Stanley Research forecasts fiscal policy. Business investment should stabilise somewhat. More fundamentally, the weak corporate balance sheets and low level of profit margins should hamper capital spending and, 9 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Italy – Another ‘Political Year’ Morgan Stanley & Co. Yet, Italy has struggled to deliver on key structural Daniele Antonucci International plc Daniele.Antonucci@morganstanley.com reforms to strengthen its economic fabric and bring back some decent growth – at least so far. While there’s Key Points consensus on the need of some key institutional changes, The economy should stabilise soon, but we see nothing more including a new electoral law capable of generating stronger than near-stagnation in 2014, and modest growth thereafter. majorities, they haven’t materialised yet, and deep economic Fiscal policy is giving some respite to the economy. But key changes still seem unlikely for now. institutional and structural reforms are not happening for now. Apart from potentially more difficult market and broad macro The political situation remains very fragile, in terms of both conditions on the external side, the picture is further near-term government stability and medium-term prospects of complicated by an uncertain political situation, with several a less volatile environment. It’s Italy’s biggest risk. tests still ahead of us. At a minimum, we’d expect rising political The Italian economy might well have stabilised in 3Q, after volatility following the recent court verdict, which might possibly a two-year recession – the longest since records began. test government cohesion and stability, both on the centre-right Industrial production looks set for a better quarter, and hard and on the centre-left of the political spectrum. With very low data more broadly have become less bad, even though they visibility yet on the rules of the game and its main actors, it haven’t really turned visibly at this stage. Most business looks like Italy is set to go through another ‘political year’. surveys are showing a lifting of pessimism, certainly on the Exhibit 15 manufacturing side (where the corresponding PMI is now Italy – Main Macro Forecasts, 2011-15E above the threshold of 50 separating expansions from 2011A 2012A 2013E 2014E 2015E recessions) but also, lately, on the services side (where the Real GDP Private Consumption 0.5 0.1 -2.4 -4.3 -1.7 -2.2 0.4 -0.2 0.7 0.1 corresponding PMI has picked up notably, but it’s still pointing Government Consumption -1.2 -2.9 -1.4 -0.8 0.7 Gross Fixed Investment -1.4 -8.0 -5.0 1.9 2.2 to contracting activity). Construction -1.7 -7.2 -5.9 0.8 1.1 Contribution to GDP Growth (%) Final Domestic Demand -0.5 -4.7 -2.5 0.0 0.6 These dynamics might be helped by a more growth-friendly Net Exports 1.5 2.8 0.8 0.4 0.2 fiscal policy. The Italian government has started to pay a Inventories -0.5 -0.6 0.0 -0.1 -0.1 Employment 0.8 -0.2 -1.4 0.3 0.5 substantial portion of its unpaid bills. Even assuming that just a Unemployment Rate (% of Labour Force) 8.4 10.7 11.6 12.4 13.0 small part will boost business investment, and that the bulk of Inflation (CPI) 2.8 3.0 1.4 1.5 1.6 the cash injection is used to pay wage and salary arrears and Current Account Balance (% of GDP) -3.1 -0.6 0.9 1.4 1.6 General Government Balance (% of GDP) -3.8 -3.0 -3.3 -2.4 -2.2 to build a cushion for precautionary purposes, this could lift Primary Government Balance (% of GDP) 1.2 2.5 2.2 3.4 3.8 General Government Debt (% of GDP) 120.8 127.0 131.6 131.6 130.8 GDP growth by half a percentage point over the next 12 Net Government Debt (% of GDP) 97.5 112.9 N/A N/A N/A months (see Paying the Bills, April 24, 2013). Source: ISTAT, Bank of Italy, Morgan Stanley Research forecasts Exhibit 16 The stimulus under way, together with an easing in the pace of austerity (e.g., VAT tax hikes postponement and eventual Near-Zero Potential Growth – Problem Yet to Solve elimination, overhaul of IMU property tax) might give the 12 Real GDP (% Y/Y) 1961-70 = 5.7% 1971-80 = 3.7% corporate sector some respite, with a plan to pay an extra 1981-90 = 2.4% 1991-00 = 1.5% €20-25 billion of government arrears on top of €40 billion 8 2001-10 = 0.4% already approved. As we suspected, apart from rising confidence (partly due to European policy-makers’ actions), 4 extra time to reduce the budget deficit, less fiscal retrenchment and a targeted stimulus programme are 0 bringing some upside surprises in the data and have made economic risks more balanced (see Death of -4 Austerity? May 21, 2013). -8 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011 Source: ISTAT, OECD, Morgan Stanley Research 10 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Spain – Bottoming Out and Rebalancing Morgan Stanley & Co. The current account is now in surplus: This is encouraging, Daniele Antonucci International plc Daniele.Antonucci@morganstanley.com and should continue. Yet, Spain’s highly negative international investment position represents a key vulnerability, as it leaves Key Points it subject to shifts in market sentiment and financial market We expect a return to (fractional) growth later this year and shocks. By summing up the net financial asset positions of all expect the economy to expand, but just modestly, in 2014-15. the domestic sectors (households, firms and the public sector), Yet, high unemployment for longer, a sharper housing market the international investment position is closely related to adjustment and unfavourable financial conditions are key risks. economy-wide deleveraging as much of it is foreign debt. Fiscal and external imbalances are narrowing (e.g., current The correction in the housing market might only be account surplus, narrower budget deficit). However, external slightly more than halfway through: So, prices will likely fall debt remains high, and government debt keeps rising. further, and for quite a while. But (residential) construction There are signs that GDP might have stabilised – or even investment, as a share of GDP, is now lower than the eurozone expanded – in 3Q: We expect a resumption of positive average. Therefore, one major hindrance that was pulling the sequential growth before year-end, and an above-consensus Spanish economy down, i.e., sharp falls in construction 0.8%Y growth in 2014. investment, will no longer be there. After a credit-fuelled housing and consumer boom (now turned Exhibit 17 bust), the drivers of growth are shifting away from Spain – Main Macro Forecasts, 2011-15E 2011A 2012A 2013E 2014E 2015E domestic demand and into exports – which are structurally Real GDP 0.1 -1.6 -1.3 0.8 1.1 strong and getting stronger (and a bigger share of the GDP pie), Private Consumption -1.2 -2.8 -2.6 0.1 0.4 Government Consumption -0.5 -4.8 -1.3 -0.1 0.4 courtesy of improving competitiveness on the back of wage Gross Fixed Investment -6.5 -8.0 -7.4 -3.0 -0.5 Construction -10.9 -9.7 -10.5 -5.2 -2.0 moderation and labour market reforms. This is Contributions to GDP Growth (%) underappreciated in the market, and it’s likely to be the (only) Final Domestic Demand -2.2 -4.2 -3.2 -0.5 0.2 growth engine in Spain over the forecast horizon. Net Exports 2.1 2.4 1.8 1.3 0.9 Inventories 0.1 0.2 0.1 -0.1 0.0 Unemployment Rate (% of Labour Force) 21.7 25.1 26.5 25.6 24.5 A process of disinflation is now happening, in part courtesy Inflation (CPI) 3.2 2.4 1.7 0.8 1.4 of structural reforms, which make goods and services markets Current Account Balance (% of GDP) -3.7 -1.1 1.7 2.8 3.4 more flexible. And, with last year’s tax hikes now dropping out General Government Balance (% of GDP) -9.4 -10.6 -6.9 -6.0 -5.3 Primary Government Balance (% of GDP) -7.0 -7.7 -3.5 -2.3 -1.4 of the year-on-year comparison, the rate of increase of General Government Debt (% of GDP) 69.3 84.2 91.4 96.2 99.1 consumer prices should decelerate visibly. This is positive for Source: INE, Bank of Spain, Morgan Stanley Research forecasts household disposable income – even though the key driver of Exhibit 18 aggregate private consumption is likely to be the labour market, International Investment Position (% of GDP) which remains quite weak. Direct investment Portfolio investment Financial derivatives Other investment Yet, economy-wide deleveraging means that a sustained pace Reserves Net claims w/ Eurosystem of growth is probably too much to hope for. We’re worried that 20 Other net assets of BdE Total the unemployment rate will not come down quickly – as 0 positive job creation has only happened when GDP was growing twice as fast as the rate we project. -20 -40 Balance sheet repair has to progress further, and its pace -60 and intensity are key risks. Corporates seem further advanced than households on this front. As long as this continues, GDP -80 growth is likely to stay weak – even after exiting recession. The -100 budget deficit, slowly, is narrowing more or less according to 2000 2002 2004 2006 2008 2010 2012 official projections, and important reforms are happening in this Source: Bank of Spain, Morgan Stanley Research area too. Yet, government debt is high and on an upward trajectory, which points to limited room for manoeuvre. 11 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Netherlands – As Safe as Houses? Morgan Stanley & Co. gas due to the relatively cold weather conditions. Government Elga Bartsch International plc Elga.Bartsch@morganstanley.com spending also fell as a result of spending cuts. While investment rebounded, gross fixed capital formation still stands Key Points 9.5% lower than a year ago. In the construction sector, The Netherlands continues to struggle with the aftermath of the investment is still declining, but less rapidly than before. Yet, financial crisis and falling housing prices. On our downwardly with house prices likely to fall further and with some evidence revised forecast, the Dutch economy is the weakest in the core. of overbuilding in the past, we would expect construction If it wasn’t for a sizeable current account surplus, a strong investment to keep shrinking. Exports of goods manufactured competitive position and low and stable funding costs, the in the Netherlands fell significantly in 2Q while re-exports economy could be mistaken for inching towards the periphery. growth slowed compared to 1Q. It was only because imports stagnated while exports expanded mildly that net foreign trade The Dutch economy remains the weakest within the core made a positive contribution to GDP growth. Last but not least, and, at the time of writing, was still mired in an extended a considerable boost also came from inventories. recession (see Netherlands Economics: Dutch Economy Still in the Doldrums, April 30, 2013). We had to revise down our Companies are continuing to lay off staff, with payrolls estimate for 2013 again, cutting it to -1.25%Y, from -0.8%Y shrinking by 41K in 2Q, falling by 1.9%Y: Hiring intentions before. For 2014, we are sticking to our forecast 0.5%Y. suggest that this trend will continue. Unemployment has Whether a return to growth can be realistically achieved next already risen to 8.7% of the working-age population (on the year will also depend on the 2014 budget, which the stricter national definition) and to 6.8% on the harmonised ILO government will present to parliament on September 17, the definition. Household confidence is near record lows, with traditional Prinsjesdag when parliament reopens. The main risk purchasing intentions hitting very low levels and anxiety about to the outlook stems from the housing market and its job losses extremely elevated. In addition, household repercussions for the banking system (see Dutch Mortgages: purchasing power has been dented by the government’s Underwater but Not Washed Out, July 25, 2013). austerity policy, which has reduced government transfers, frozen pay for civil servants and hiked VAT by 2pp last October. Unless additional austerity measures are taken, the A sharp upward adjustment in rents pushed CPI inflation to budget deficit is likely to widen materially next year: The 3.1%Y in July. Only in October when the VAT hike is falling out CPB, whose forecasts government policies are based on, of the year-on-year comparison is inflation likely to fall expects the deficit to widen to 3.9% of GDP in 2014, from an materially. But even then it remains above the increase in estimated 3% this year. Despite an extension to the SGP contractual wages of 1.2%Y. Only next year will inflation likely deadline by one year, local media report that the government is fall meaningfully below 2%Y, in our view. contemplating austerity measures of up €8 billion, almost twice Exhibit 19 the amount that was discussed in the spring (a package that was eventually withdrawn after reaching an agreement with the Netherlands – Main Macro Forecasts, 2011-15E 2011A 2012A 2013E 2014E 2015E trade unions and the employer federation) to rein in the deficit. Real GDP 1.0 -1.3 -1.2 0.5 0.8 Private Consumption -1.1 -1.6 -1.9 -0.5 0.4 On balance, we would expect the government to ease its Government Consumption 0.2 -0.7 -0.7 0.0 0.4 austerity drive somewhat in line with the rest of the euro area Fixed Gross Investment 6.1 -4.0 -8.5 1.4 2.5 Exports 4.1 3.2 1.5 3.8 4.5 (see Death of Austerity? May 21, 2013). The lack of a majority Imports 4.2 3.3 -1.1 3.6 4.9 in the upper house of parliament for the VVD-Labour coalition Contributions to Growth Domestic Final Demand 0.6 -1.6 -2.5 0.0 0.7 might also limit the ability of the government to implement a Net Exports 0.3 0.2 2.0 0.6 0.2 pro-cyclical austerity package in the current downturn. Inventories 0.1 0.2 -0.7 -0.4 -0.1 Employment 0.0 -0.3 -0.5 0.0 0.2 Unemployment Rate (%, ILO Definition) 4.4 5.3 6.7 7.2 7.4 In 2Q, GDP fell by a non-annualised 0.2%Q on the back of Real Household Disposable Income -0.8 -0.5 -1.5 0.7 1.2 a marked contraction in consumption of 0.8%Q: Consumer Inflation (CPI) 2.3 2.5 2.8 1.5 1.5 GDP Deflator 1.1 1.3 1.6 1.5 1.6 spending has been falling for more than two years now as Compensation Per Employee 1.5 2.3 1.8 2.2 2.5 Dutch households cut back spending on consumer durables Current Account Balance (% of GDP) 10.2 10.1 8.9 9.9 9.7 General Government Balance (% of GDP) -4.3 -4.0 -3.4 -3.5 -3.4 like cars, clothes and furniture, as well as spending less on Primary Government Balance (% of GDP) -2.3 -2.2 -1.8 -1.8 -1.7 General Government Debt (% of GDP) 65.5 71.2 74.8 77.0 78.7 food, drinks and tobacco. The decline would have been even Net Government Debt (% of GDP) 38.7 42.0 N/A N/A N/A more pronounced had consumers not spent more on natural Source: National Statistics, Morgan Stanley Research forecasts 12 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Belgium – Brighter External Outlook to Spur Recovery Morgan Stanley & Co. Business investment should rebound, amid better demand Olivier Bizimana International plc Olivier.Bizimana@morganstanley.com prospects and favourable financing conditions. Key Points Fiscal consolidation remains dependent on the economic We expect real GDP in Belgium to recover gradually in 2014, cycle: We expect the general government deficit to continue to thanks to brighter economic prospects in the core countries. decline to 2.7% of GDP in 2013 and 2.4% in 2014 (versus 3.9% We also expect domestic demand to pick up pace. in 2012). According to the 2013-2016 Stability Programme (SP), the government expects to reduce the deficit to 2.5% of Fiscal adjustment should continue, though remaining GDP in 2013 and 2.0% in 2014. In particular, the fiscal dependent on the developments on business cycle. structural effort will remain significant – 1.1pp in 2013 and After almost zero growth this year, we expect Belgium’s 0.6pp in 2014. However, the outlook for fiscal policy should economy to recover gradually in the course of 2014, with remains dependent on the cyclical developments. If growth real GDP expanding by 1.2%Y. The economy should return turns out to be weaker than expected, further fiscal effort might gradually to its trend growth in 2015, thanks to robust exports. be required. Meanwhile, we expect debt/GDP to peak at The improvement in economic activity expected in the main 100.5% this year. trading partners, particularly in Germany, should benefit Exhibit 20 Belgium, which is a small, open economy with a relatively strong non-financial private sector. Still, the weakness of the Belgium – Main Macro Forecasts, 2011-15E 2011A 2012A 2013E 2014E 2015E French and Dutch economies, which are also major Real GDP 1.9 -0.3 0.1 1.2 1.7 Private Consumption 0.2 -0.3 0.4 0.9 1.3 trading partners, remains the major wildcard for the Government Consumption 1.1 0.4 0.6 1.3 1.6 near-term outlook. A greater-than-expected cyclical Fixed Gross Investment 4.2 -0.6 -2.4 1.2 1.9 slowdown could jeopardise fiscal consolidation this year. Contributions to Growth Domestic Final Demand 1.2 -0.2 -0.2 1.0 1.4 What’s more, the federal elections that will be held in mid-2014 Net Exports -0.1 0.2 0.4 0.2 0.1 Inventories 0.7 -0.2 -0.1 0.0 0.2 could generate uncertainty, especially given the popularity of Unemployment Rate (%, ILO Definition) 7.2 7.6 8.6 8.6 8.2 the Flemish nationalist party. Real Household Disposable Income -1.6 0.7 0.6 0.9 1.3 Savings Rate (% of Disp. Income) 14.2 15.2 15.4 15.4 15.5 Inflation (CPI) 3.5 2.8 1.3 1.7 1.7 Economic activity in Belgium has been particularly weak GDP Deflator 2.0 2.0 1.8 1.6 1.7 over 1H13: Part of this stemmed from weak export Current Account Balance (% of GDP) -1.2 -1.7 -0.5 -0.2 0.2 performance due to deteriorating economic activity in the rest General Government Balance (% of GDP) -3.7 -3.9 -2.7 -2.4 -1.1 Primary Government Balance (% of GDP) -0.4 -0.5 0.7 0.8 2.1 of the euro area, especially in the core countries. Moreover, General Government Debt (% of GDP) 97.8 99.6 100.5 100.3 98.2 Net Government Debt (% of GDP) 81.1 82.0 N/A N/A N/A domestic demand remained feeble, as high uncertainty further Source: BNB, Morgan Stanley Research forecasts eroded business and consumer confidence. The key monthly data indicate a noticeable improvement in business Exhibit 21 conditions in 3Q. In particular, the leading economic Stronger German Growth to Spur Recovery indicators rebounded in 3Q, although remaining below their Real GDP 6 long-term average, suggesting still-subdued economic activity. (Percentage change) MS forecasts In the near term, we forecast real GDP to expand at a modest 4 pace of 0.2%Q in 3Q, after a small 0.1%Q gain in 2Q. 2 We expect economic growth to accelerate in the quarters 0 ahead: In particular, exports should benefit from the recovery in Germany and in global trade, as well as a stabilisation in -2 France and, to a lesser extent, in the Netherlands. Domestic demand should pick up pace as some of the uncertainties -4 Belgium Germany and headwinds should lessen. A continuation of positive real -6 income growth should boost household consumption. We 2001 2003 2005 2007 2009 2011 2013 2015 expect the labour market to improve in 2014, with further gains Source: BNB, Destatis, Morgan Stanley Research forecasts in private sector jobs and a gradual decline in unemployment. 13 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Greece – Going for Three? Morgan Stanley & Co. budget surplus this year, as we predict – and to the extent Daniele Antonucci International plc Daniele.Antonucci@morganstanley.com that the reforms have progressed further – an announcement on OSI in 1H14. But, whatever the final form of this extra relief Key Points (which, at a minimum, will involve further reduction of the Growth has not come back yet, but the data have improved, interest rates on the official loans, and additional ‘debt and the many shocks that hit the economy are dissipating. equitisation’), from a European perspective the negotiations Competitiveness has improved, but progress has been slower are likely to be difficult, and partly driven by the political on public sector downsizing, tax compliance and privatisations. calendar. Tough talks have happened before, and workarounds have been found, but a lot of ‘political capital’ has To close a funding gap, a third bailout encompassing lower already been spent – domestically and in Europe. interest rates and ‘debt equitisation’ is likely to be announced in 2014, after Greece reaches a primary budget surplus. The risks have to do with the significant challenges of the As in other eurozone countries, economic data have surprised adjustment programme itself. There’s a large debt overhang, on the upside in Greece too. A recovery hasn’t started yet, a traumatised economy, a more difficult external environment but activity data are becoming less bad, as many shocks (Fed tapering, slowing EMs, no strong impetus towards that hit the economy are getting re-absorbed, e.g., euro exit European integration, etc.) and a smaller majority now worries, heavy fiscal retrenchment and reforms creating supporting the government – with the downsizing of the public near-term uncertainty due to job and pension uncertainty, as sector yet to gather pace, and the privatisation plan so far we’ve suspected for a while (see From Shake-Up to lagging behind expectations. The Troika reviews and, more Shape-Up? January 21, 2013). Yet, a severe credit crunch is broadly, the government’s ability to stay the course – on what still unfolding, and Greece’s 2Q GDP still was more than 4.5% remains an ambitious agenda across the board – will continue lower than a year ago – in what is the sixth year of recession. to be widely watched by investors over time. Exhibit 22 Our GDP indicator points to an improvement in Greece’s economic situation heading into year-end, taken at face Cyclical Stabilisation – Not Far Off value and with a pinch of salt, which might even have stabilised 3% Industrial Production & Retail Sales (2012-13) or be close to it. This is mainly due to the effect of growing Industrial production (% 3m/3m) industrial production, together with the rise in several Retail sales (% 3m/3m) confidence measures, while consumer indicators – from retail 0% sales to car registrations – are still stagnant or falling. NA On the structural front, Greece’s price competitiveness has improved substantially: Even though this process has further -3% to go – given that Greece was uncompetitive even when it joined the EMU – it’s worth noting that the Greek economy has recovered virtually all the lost ground since the inception of the monetary union, courtesy of sizeable wage cuts and more -6% Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 substantial labour market reforms than in the rest of southern Source: Eurostat, Morgan Stanley Research Europe. In other areas, including tax compliance, results have been more mixed (but not totally discouraging). Exhibit 23 Greece – Main Macro Forecasts, 2011-15E Based on current projections, there will be a €4.4 billion 2011A 2012A 2013E 2014E 2015E Real GDP -6.1 -6.6 -4.0 0.0 0.4 funding gap in 2014, rising to €6.5 billion in 2015. The Final Domestic Demand (% contr.) -7.8 -9.0 -7.7 -2.3 0.1 Unemployment Rate (% of Labour Force) 17.7 24.2 26.1 26.6 26.8 European lenders will have to close it, or this might have Inflation (CPI) 3.3 1.5 -0.6 -0.4 0.1 implications for IMF financing under its ‘12-month rule’. Current Account Balance (% of GDP) -9.9 -3.4 -1.1 0.9 1.5 Therefore, we think there will have to be a further official sector General Government Balance (% of GDP) -9.5 -10.0 -4.0 -3.6 -2.7 Primary Government Balance (% of GDP) -2.4 -1.3 0.1 1.2 2.6 involvement (OSI) and, probably, a third bailout with fresh General Government Debt (% of GDP) 170.3 156.9 168.8 171.6 172.8 Net Government Debt (% of GDP) 142.6 102.8 N/A N/A N/A money. We’d expect a debate to start after the German Source: National Statistics, Morgan Stanley Research forecasts elections, and provided that Greece achieves a primary 14 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Portugal – Going for Two? Morgan Stanley & Co. Market access remains a critical issue: The Portuguese Daniele Antonucci International plc Daniele.Antonucci@morganstanley.com debt agency plans to resume bond issuance only if conditions are conducive. Portugal is fully funded for this year, and the Key Points government is now prefunding for 2014. But the latest official The 2Q GDP gain is unlikely to be sustainable. We expect a loan disbursement is in June 2014, after which there will be no payback, and only see a broad stabilisation at this stage. EU/IMF funding under the current programme. Should a Rebalancing is progressing, and competitiveness is improving market comeback be delayed, then Portugal would need extra as well, along with other structural reforms. support by the official lenders in the form of a precautionary credit line or a full second bailout – and probably get it, rather The political crisis might have increased risks of a delayed than debt restructuring. market comeback. Should this happen, we’d expect a second bailout with no PSI, but the process is unlikely to be smooth. A further issue, in a hypothetical scenario of delayed market We remain cautions on the macro environment: We see comeback, is the negotiations needed in several countries for tentative signs of economic stabilisation, but we think that a extra official funding to materialise – if needed. The political return to sustainable growth is far off. Portugal’s GDP calendar might play an important role as well, just like the expanded by 1.1%Q in 2Q – after having contracted outright for verdict of the German Constitutional Court on OMT (probably 10 quarters in a row. This was the strongest performance in the in 4Q13). We think that market participants will remain vigilant eurozone, with a pace of growth nearly twice that of Germany. and look at the domestic and European situations quite closely. There’s the risk that the gains might well reflect the one-off At this stage, a potentially negative impact from rising core effect on growth from stock-building after the heavy negative rates, and slowing EMs, are further risks to watch out for. contribution in 1Q, refinery expansion and a short-lived boost Exhibit 24 to consumption given by the Constitutional Court’s cancellation in April of legislated cuts in bonus payments. Portugal – Main Macro Forecasts, 2011-15E 2011A 2012A 2013E 2014E 2015E Real GDP -1.6 -3.2 -2.0 0.2 0.5 Private Consumption -3.8 -5.6 -3.9 -1.1 0.4 As such, it’s far too early to say that a sustainable recovery Government Consumption -4.3 -4.4 -2.6 -2.7 -1.0 is under way, and a temporary fallback, i.e., a triple-dip, due to Gross Fixed Investment -10.6 -14.5 -8.0 0.7 3.3 Contribution to GDP Growth (%) inventories might well take place. Yet, encouragingly, it looks Final Domestic Demand -5.6 -7.2 -4.3 -1.1 0.6 like the pick-up is fairly broad-based, suggesting that some Net Exports 4.7 3.8 1.7 1.3 0.1 Inventories -0.7 0.2 0.7 0.1 -0.1 underlying improvement is taking place too. What’s more, Unemployment Rate (% of Labour Force) 14.2 17.1 19.2 20.6 19.0 structural measures continue to be implemented, with the Inflation (CPI) 3.7 2.8 0.6 1.3 1.3 Current Account Balance (% of GDP) -7.0 -1.5 0.2 1.4 2.1 economy recovering competitiveness and also becoming more General Government Balance (% of GDP) -4.4 -6.4 -5.7 -4.3 -2.8 open, along with a significant improvement of the current Primary Government Balance (% of GDP) -0.4 -2.0 -1.3 0.2 1.6 General Government Debt (% of GDP) 108.3 123.6 131.8 134.4 135.1 account, which is finally in surplus. Net Government Debt (% of GDP) 78.5 88.5 N/A N/A N/A Source: Statistics Portugal, Bank of Portugal, Morgan Stanley Research forecasts A crucial factor is the ‘buy in’ of the politicians and the Exhibit 25 population at large: A U-turn in policy doesn’t seem to be Shifting Towards Export-Led Model forthcoming, and the recent agreement within the ruling 110 Exports (2012,% of GDP) coalition – following the political crisis – is an attempt to work out a compromise to continue to execute on the adjustment 90 programme. Yet, investors will be watching whether the 70 deterioration in sentiment that has already happened or 50 difficulties with the Troika reviews delay market access (see 30 Portugal and the Austerity Fatigue, July 3, 2013). 10 A (much delayed) Troika mission is about to start: The -10 Portugal government has to approve €4.7 billion of austerity in GR FR PT IT ES PT FI DE AT BE NL IE the 2014 budget (2.8% of GDP), and resume the privatisation (avg 1995- plan. The opposition in parliament opposes all this but, by and 2007) large, they don’t have the numbers to trigger a political crisis. Source: Eurostat, Morgan Stanley Research 15 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Ireland – A Steep Uphill Finish Morgan Stanley & Co. the credit line to focus on the banking sector and no additional Elga Bartsch International plc Elga.Bartsch@morganstanley.com fiscal austerity measures (see Reuters, August 9, 2013). Key Points The focus for Ireland will be transitioning out of the bailout …where Ireland still faces a number of hurdles: For starters, programme at year-end, and securing sustained access to the mortgage arrears continue to increase (especially long-term bond markets in 2014. Disappointing growth, political disunity arrears), which is a source of risk to banks’ asset quality. about austerity and upcoming bank checks are risks to watch. Recently several reforms have been implemented to deal with arrears, ranging from the Code of Conduct on Mortgage We expect growth to pick up next year, on the back of Arrears, the Personal Insolvency Act and the ‘Land and stronger net exports and domestic demand: The start to Conveyancing Law Reform Act’. Strict targets for resolving 2013 was disappointing as GDP contracted by 0.6%Q in 1Q. mortgage arrears have also been set for banks. The impact of We expect net exports to boost growth again in 2014, with these reforms will likely only be felt later this year though. export demand benefitting from stronger dynamics in Ireland’s Furthermore, tracker mortgages constitute a drag on banks’ key trading partners the UK and US. We expect domestic profitability, an issue that could be addressed, at least in part, demand to return to growth, with investment spending and by backing them with an ESM guarantee (see Independent, private consumption both picking up. After a sharp decline in August 24, 2013). private consumption (of ~10% between 1Q08 to 1Q13), we expect a gradual stabilisation followed by some tepid growth. As elsewhere, the new Bank Recovery and Resolution Even though there are signs that house prices are bottoming Directive (BRRD), the Asset Quality Review (AQR) and the out, we will be watching mortgage arrears closely for any EBA bank stress test (BST) could unveil additional capital potential risks to this baseline. needs. Another potential hurdle is the patent cliff that is affecting Irish exports as a number of blockbuster drugs come Mild fiscal slippage likely in 2013 due to a growth shortfall: off patent (pharma accounts for 27% of Irish goods exports). We expect the deficit to exceed the target level of 7.5% of GDP Once a drug comes off patent, the pharmaceutical companies marginally, reaching 7.8%. Assuming that the planned are less likely to continue production in Ireland. The potential austerity measures worth €3.1 billion under the bailout impact on value-added is expected to be limited though as programme are implemented in October, when the budget is these blockbuster drugs are usually associated with high being presented, we see scope for the deficit to outperform the royalty payments to the overseas parent company. Being programme target of 5.1% of GDP in 2014, reaching 4.9%. The recorded as services imports, these royalty fees reduce Irish ruling two-party coalition government is still divided on the GDP. issue, with the larger party, Fine Gael, not in favour of easing We acknowledge the contribution of Gaura Sengupta. the budget, while the junior coalition partner, Labour, is in favour of easing austerity efforts. While in principle the Exhibit 26 promissory note deal reached earlier this year would allow for Ireland – Main Macro Forecasts, 2011-15E 2011A 2012A 2013E 2014E 2015E some easing in austerity, we think it would make sense for Real GDP 2.2 0.1 0.4 2.1 2.5 Ireland to build some budget buffers, especially given that the Private Consumption -1.5 -0.3 -0.7 0.8 0.7 Government Consumption -2.8 -3.8 -0.8 -1.1 -1.2 country will likely have the highest deficit in the euro area this Investment Spending -9.6 -0.7 -8.1 2.2 3.4 Exports 5.3 1.6 0.0 4.7 4.6 year. Budget implementation faces a number of risks, including Imports -0.4 0.0 0.4 3.4 4.0 Contribution to Growth a potential higher one-off cost from liquidating bad bank IBRC, Domestic Demand -2.4 -0.8 -1.3 0.4 0.5 public sector pay agreements and overruns on healthcare. Inventories -1.1 -0.6 2.1 -0.4 0.4 Net Foreign Trade 5.6 1.6 -0.4 2.1 1.6 Other Economic Indicators Employment -1.8 -0.6 0.9 0.0 0.3 Focus is on transitioning out of the bailout programme… Unemployment Rate (%) 14.7 14.7 13.6 13.5 13.4 Current Account (% of GDP) 1.2 4.5 6.0 6.0 6.5 Detailed negotiations for an effective backstop to smooth Inflation (YOY) Ireland’s return to the bond markets will likely begin post the Consumer Prices 1.2 1.9 1.0 2.1 1.6 GDP Deflator 0.7 0.7 -1.1 1.0 1.0 German elections on September 22. The most likely option is a Wages Per Employee -0.1 0.8 -1.3 0.3 0.1 Unit Labour Costs (Total Economy) -3.4 0.0 -1.5 -1.8 -1.9 precautionary credit line that would qualify Ireland for the Budget ECB’s OMT programme. According to press reports, the Irish Primary Govt. Deficit (% of GDP) -10.0 -4.6 -2.8 0.0 2.7 General Govt. Deficit (% of GDP) -13.3 -8.1 -7.8 -4.9 -2.2 government would like the (light) conditionality associated with General Govt. Debt (% of GDP) 106.4 120.2 127.2 125.4 119.3 Source: Eurostat, CSO Ireland, Morgan Stanley Research forecasts 16 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Austria – At the Heart of the Core Morgan Stanley & Co. Only in 2014 and 2015 do we see the small, open Austrian Elga Bartsch International plc Elga.Bartsch@morganstanley.com economy to expand a brisker pace again. As the global Key Points economy recovers, we expect Austrian companies to bump up On our forecast, economic activity will expand at a much faster investment and eventually hiring. Hence, disposable income is rate in 2014/2015, driven by domestic demand and exports. likely to increase. With a stable savings rate and falling inflation, consumer spending should strengthen. To sum up, along with But the general election will be key for economic policies next Germany, Austria should be the strongest-growing country in year. Our base case is that the new government will stick to the core of the euro area this year and next, only to be outdone fiscal plans submitted to European Commission. next year and the year after by export-driven Ireland. A general election on September 29 will be key for Austrian inflation to stay above the euro area average: economic policies in Austria next year, notably budget policies. HICP inflation peaked at 2.4%Y in May, way above the euro While the 2008 election brought major losses for the governing area average of 1.6%Y, driven by a variety of factors. Going Grand Coalition and sizeable gains for the populist right, the forward, inflation should moderate slightly and should average coalition between the Social Democrats, SPO, and the Austrian 2.0%Y over the remainder of the forecast horizon. People’s Party, OVP, was continued for another five years. Polls would suggest that both parties need to brace themselves for Exhibit 27 further, albeit small losses. Thanks to the 4% hurdle for Early Signs of a Sharp Austrian Growth Acceleration parliamentary representation in Austria, they might just win 65 enough votes to continue to govern in the current formation. If Manufacturing PMI they fail to win a sufficient number of seats in the Nationalrat, the 60 two parties would likely extend an invitation to the Greens to join them on the government benches. A participation of the Free 55 Democrats, FPO, is unlikely, we believe, because of their 50 anti-European policy stance and ongoing internal problems. 45 Our baseline forecast assumes that the next Austrian Austria government will broadly stick to the plans submitted to 40 EMU (ex. Germany) European partners in the spring and sees the budget deficit Germany around the 2% mark for the remainder of the forecast horizon, 35 a level that should allow Austria to stabilise its debt/GDP level, 1998 2000 2002 2004 2006 2008 2010 2012 if not slight reduce it by the end of 2015. One source of Source: Markit, Morgan Stanley Research uncertainty about the (cash) deficit and the government debt Exhibit 28 dynamics stems from ongoing problems in the banking sector, notably the need for additional state aid to the Hypo-Alpe Adria Austria – Macro Forecasts, 2011-15E 2011A 2012A 2013E 2014E 2015E group, where the supervisory board has signalled the need for Real GDP 2.7 0.8 0.5 1.6 1.6 additional government injections of up to €2.5 billion (~0.9% of Private Consumption 0.7 0.4 0.0 0.8 1.2 Gross Fixed Investment 7.3 1.3 -1.2 0.8 2.0 GDP) (see “Horrorverlust bei der Hypo”, Die Presse, August 28, Exports 7.1 4.8 1.8 4.5 4.1 Imports 7.2 0.8 0.8 3.7 4.7 2013). So far, the government has pumped nearly €3 billion Contribution to GDP Growth into the troubled institution. Final Domestic Demand 1.8 0.4 0.4 0.9 1.2 Inventories -0.1 0.1 -0.5 0.0 0.4 Net Exports p y 0.4 0.6 0.6 0.7 0.0 Having stagnated in early 2013, the Austrian economy Unemployment Rate (% of LF) 4.1 4.4 4.8 5.0 4.9 returned to positive growth in 2Q13 when overall activity Consumer Prices 3.6 2.6 2.1 2.0 2.0 Current Account, EUR bn 4.1 5.4 7.2 9.6 9.6 expanded by a meagre 0.2%Q, driven by consumer spending Current Account (%of GDP) 1.4 1.8 2.3 3.0 2.9 and net foreign trade. Investment, by contrast, continued to General Government Balance (% of GDP) -2.4 -2.5 -2.3 -1.9 -1.9 General Government Debt (% of GDP) 72.5 73.4 74.8 74.2 73.6 contract. For the full year, we forecast the Austrian economy to Source: Statistics Austria, BoA, Morgan Stanley Research forecasts expand by only 0.5%Y. As a result, job creation, which has held up surprisingly well so far, will likely slow and unemployment which at ~5% is the lowest in the euro area, might inch higher. 17 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Finland – Crisis Takes its Toll Up North Morgan Stanley & Co. we expect the overall budget deficit to stay a touch below 2.5% Elga Bartsch International plc Elga.Bartsch@morganstanley.com of GDP between 2013 and 2015. Key Points We expect government debt to rise, ultimately breaking In line with our Finnish fatigue call, we expect a weak recovery above the 60% of GDP ceiling in 2015: Finland is one of the in 2014 on the back of domestic demand returning to growth. few euro area countries that currently still meets both the deficit The government deficit should remain almost unchanged, and debt criteria of the SGP. But the rise in debt from 33.9% of causing debt/GDP to reach and breach 60% in 2015. GDP before the crisis to 60%+ in 2015 is worrying. In contrast, net government debt/GDP has almost gone back to pre-crisis For Finland, we have pencilled in a weak recovery in 2014: levels. One of the reasons behind the recent diverging trends in This call is consistent with our theme of Finnish growth fatigue net debt and gross debt is the guarantees granted to the EFSF. (see European Economics: Crisis Contained, Not Resolved, Eurostat includes guarantees granted to the EFSF in January 7, 2013). The recovery will largely be driven by government debt, which is reflected in the gross debt metric. domestic demand returning to growth. This year, GDP should Meanwhile, for net debt it is cancelled out as similar entries are still contract on average, even though the Finnish economy made on the assets and liabilities side. The amount included as managed to shake off its recession in 2Q. After weak domestic guarantees in government debt rose to €2.7 billion in 2012 from demand dampens overall GDP, with investment and €0.3 billion in 2011. In addition, weaker-than-expected growth consumption contracting this year, we expect economic has forced the government to run rising deficits, having printed conditions to improve next year. Investment should revive as a surplus until 2008. overall demand conditions improve and as the corporate tax is reduced from 24.5% to 20%. Private consumption is likely to We acknowledge the contribution of Gaura Sengupta. benefit from better employment prospects. But the gains in Exhibit 29 private consumption will likely be muted, as a rise in income taxes due to tax brackets not being adjusted for inflation and an Debt to Exceed 60% Due to Persistent Deficits increase of indirect taxes will limit consumers’ purchasing power. 65% Government debt Budget balance ~rhs 8% New collective wage agreements for 2014 and 2015 will be set 6% 60% this autumn and are expected to be similar to the current 4% agreement that foresees wage increases of 1.8%Y. We expect 55% 2% export demand to pick up in 2014, as growth conditions improve in the euro area and Russia. Restructuring in the electronics and 50% 0% forestry industries will limit the improvements, though, as a large 45% -2% part of the loss in Finnish competitiveness can be traced to the -4% telecom sector, which is dominated by Nokia. 40% -6% 35% We expect the budget deficit to remain unchanged over the -8% forecast horizon. Based on the government’s budget proposal 30% -10% for 2014, the corporate tax rate will be reduced from 24.5% 1995 1999 2003 2007 2011 2015 from 20%, reducing the corporate tax intake by €900 million Source: Eurostat, Morgan Stanley Research (~0.5% of GDP). A number of revenue-increasing measures will likely offset this effect. These measures include tighter Exhibit 30 capital income taxation and reduced support for businesses by Finland – Main Macro Forecasts, 2011-15E 2011A 2012A 2013E 2014E 2015E abolishing or limiting tax incentives. A rise in indirect taxes Real GDP 2.7 -0.8 -0.2 0.8 1.2 (such as exercise duties on tobacco, alcohol, sweets and Final Domestic Demand 2.8 0.0 -0.6 0.4 1.5 Unemployment Rate (% of Labour Force) 7.8 7.8 8.0 7.9 7.5 non-alcoholic beverages as well as electricity) will likely Inflation (HICP) 3.4 2.8 1.7 1.9 1.8 increase revenue by 0.2% of GDP. In addition, the government Current Account (% of GDP) -1.5 -1.8 -1.5 -1.2 -1.2 General Government Balance (% of GDP) -1.1 -2.2 -2.3 -2.4 -2.3 had earlier decided to raise duty on vehicle fuels from next year. Primary Government Balance (% of GDP) 0.3 -0.8 -0.9 -1.0 -0.5 We expect the rise in indirect taxes to contribute 0.6pp to the General Government Debt (% of GDP) 49.0 53.0 56.8 59.5 61.7 Net Government Debt (% of GDP) -54.1 -54.6 N/A N/A N/A overall inflation rate in 2014. In total, we expect these ECB Policy Rate (%, EOP) 1.00 0.75 0.25 0.25 0.25 measures to increase revenues by 0.5% of GDP. As a result, Source: Bank of Finland, Morgan Stanley Research forecasts 18 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Sweden – On the Road to Recovery Morgan Stanley & Co. Inflation to remain low and far below the 2%Y target: On Tomasz Pietrzak International plc Tomasz.Pietrzak@morganstanley.com our forecasts, GDP growth remains below its trend until 2015. Elga Bartsch As a result, the degree of spare capacity is likely to remain Elga.Bartsch@morganstanley.com large, suggesting that underlying inflationary pressures should stay contained. CPIF inflation, which strips out changes in the Key Points repo rate, will most likely reach the inflation target beyond our We expect economic activity to gain momentum into year-end forecast horizon. That said, headline CPI inflation will probably and GDP growth to reach 2.2%Y in 2014, returning to trend. reach the 2%Y target in 2015 as the Riksbank hikes the repo On balance, we think that the Riksbank will leave the repo rate rate. unchanged, as inflation pressures develop gradually. We expect the Riksbank to leave the repo rate unchanged Activity is likely to gain momentum into year-end: We for an extended period, as economic activity improves only revise our 2013 GDP growth forecast down by 0.2pp. This gradually and the Executive Board continues to take high mainly reflects weaker-than-expected economic activity in 2Q household debt and elevated house prices into account. We and thus does not constitute a change in the outlook. All in all, expect the first hike in the repo rate in 4Q14, in line with the we expect GDP to grow by 1.1%Y this year. Going forward, we Riksbank’s forecast but below the current market pricing. foresee economic activity to gain momentum into year-end and grow by 2.2%Y in 2014, a rate close to the historical trend. The Downside risks: A less favourable external environment could output gap will likely only start closing in 2015, when growth weigh more than expected on economic activity as foreign moves above trend, at 3.0%Y. demand weakens and uncertainty increases. A sharper-than- expected correction in house prices could negatively impact Domestic demand the main driver of growth: Domestic household consumption and the financial sector. demand should drive the economic recovery to a greater extent than has been the case in the past. Household consumption is Exhibit 31 likely to accelerate further to an average 2.7%Y next year, Sweden – Macro Forecasts, 2011-15E amid improving consumer confidence, a lower savings rate, 2011A 2012A 2013E 2014E 2015E Real GDP 3.8 0.7 1.1 2.2 3.0 subdued inflation and low interest rates. Ahead of the 2014 Final Domestic Demand 2.7 1.9 0.7 2.2 2.8 general elections, the government will likely announce another Unemployment Rate (% of Labour Force) 7.5 7.9 8.3 8.2 7.6 Inflation (CPI) 3.0 0.9 0.1 1.1 2.2 fiscal stimulus in September, which we would expect to be only Inflation (CPIF) 1.4 1.0 0.9 1.2 1.8 slightly higher than the fiscal stimulus in 2013. That said, we Current Account (% of GDP) 7.0 6.9 6.3 6.5 6.6 General Government Balance (% of GDP) 0.3 -0.4 -2.1 -1.5 -0.5 expect a much sharper recovery in investment spending. Primary Government Balance (% of GDP) 1.2 0.2 -0.9 0.2 1.1 Investment spending, currently at ~18% of GDP, is below what General Government Debt (% of GDP) 38.4 38.2 42.3 42.0 40.6 Net Government Debt (% of GDP) -20.5 -23.3 N/A N/A N/A we see as a long-term equilibrium of 20%. This suggests that Riksbank Repo Rate (%, EOP) 1.75 1.00 1.00 1.25 1.75 there is pent-up demand for investment, supported by low Source: Statistics Sweden, Riksbank, Morgan Stanley Research forecasts interest rates, improving demand and falling uncertainty. Exhibit 32 Net exports should weigh on economic activity, but the GDP Forecast and Composition impact is likely to be small. On our forecasts, net exports will 10 Inventories Net Exports Domestic Demand GDP % yoy likely weigh on headline GDP growth to the tune of 0.2pp. This 8 Our F'cast is mainly due to relatively low external demand growth, notably 6 for capital goods, and a somewhat stronger SEK. Going 4 forward, export growth is likely to accelerate somewhat, albeit 2 at a slower pace as global demand will likely recover gradually. 0 As strong growth in domestic demand is likely to support -2 imports, we expect only a small positive contribution from net -4 exports to GDP growth next year. -6 -8 1Q-95 3Q-97 1Q-00 3Q-02 1Q-05 3Q-07 1Q-10 3Q-12 1Q-15 Source: Statistics Sweden, Morgan Stanley Research forecasts 19 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Denmark – Sun Starts Shining Again Morgan Stanley & Co. All in all, we expect net exports to weigh on GDP growth this Tomasz Pietrzak International plc Tomasz.Pietrzak@morganstanley.com year, but expect a positive contribution next year and in 2015. Key Points Risks to the economic outlook still tilted to the downside: Denmark should leave the recession behind in 2H13. The Weaker-than-expected foreign demand remains the biggest positive growth momentum will likely continue next year, driven risk for economic activity this year, as exports account for by domestic and foreign demand. around 50% of GDP. What’s more, domestic demand might On balance, we think that the Danish National Bank (DNB) is turn out to be weaker than expected if policies intended to likely to cut the lending rate by another 10bp in 4Q13, as the boost corporate investment show only muted results. ECB cuts the refi rate. The Danish National Bank (DNB) is likely to postpone After years of weak economic activity, we expect the Danish additional rate cuts until 4Q, but it will likely keep the depo economy to start to recover slowly. While we are revising rate unchanged and in negative territory: As we continue to our 2013 GDP growth outlook down, amid weaker-than- think that the ECB maintains its easing bias and is likely to cut expected growth in 1H, we continue to expect that economic the refi rate by additional 25bp in 4Q13, we expect the DNB to activity will start to recover in the remainder of this year and lower the lending rate as low as 0.1%. Our forecasts are foresee this trend to continue next year. In 2014, we expect sensitive to developments in the euro area though Should the GDP growth at 1.2%Y, followed by 1.6%Y in 2015. Although upward pressures on the exchange rate intensify, the DNB still weak, we believe that growth will be broad-based, driven might decide to lower the depo rate once again. by both domestic and foreign demand. Exhibit 33 Private consumption is likely to continue to grow, although Denmark – Macro Forecasts, 2011-15E at a slower pace than during past recoveries. Yet, our positive 2011A 2012A 2013E 2014E 2015E Real GDP 1.1 -0.4 0.0 1.2 1.6 outlook for household consumption assumes that households Final Domestic Demand -0.2 0.4 0.5 0.9 1.1 will start spending a greater share of their income after the Unemployment Rate (% of Labour Force) 7.6 7.5 7.7 7.7 7.6 Inflation (CPI) 2.8 2.4 1.0 1.5 1.7 savings rate grew close to all-time highs. What’s more, we Current Account (% of GDP) 5.5 5.1 5.0 5.1 5.2 expect a further increase in consumer confidence, amid General Government Balance (% of GDP) -1.9 -4.0 -2.0 -0.8 0.3 General Government Debt (% of GDP) 46.5 45.8 45.2 43.0 40.3 declining uncertainty related to developments abroad. The Net Government Debt (% of GDP) 3.1 7.0 N/A N/A N/A housing market is also already stabilising, as house prices Danmarks Nationalbank Lending Rate (%, EOP) 0.70 0.20 0.10 0.10 0.10 have been largely unchanged for a few months now, and Danmarks Nationalbank Deposit Rate (%, EOP) 0.30 -0.20 -0.10 -0.10 -0.10 Source: Statistics Denmark, DNB, Morgan Stanley Research forecasts hence consumption should no longer be affected by negative wealth effects. Exhibit 34 DNB’s Rates and CITA Swaps Investment growth is likely to pick up, thanks to pent-up 1.8 demand that built up over the recent years. As the economic 1.6 outlook improves, uncertainty declines and interest rates 1.4 CITA remain low, we expect investment growth to improve. What’s 1.2 DNB Deposit Rate DND Lending Rate more, the government introduced large tax breaks on business 1 DNB Current Acc Rate investment which are likely to support growth in investment in 0.8 2H13. Going forward, business investment will probably also 0.6 be lifted by various infrastructure and public housing 0.4 investment projects, which are a part of government’s growth 0.2 plan. 0 -0.2 Net exports to start supporting GDP growth next year as -0.4 economic activity abroad starts to improve, especially in 2010 2011 2012 2013 Sweden and Germany. However, we believe that stronger Source: Datastream, DNB, Morgan Stanley Research growth in exports will be offset by solid import growth as domestic demand improves, especially investment spending. 20 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Norway – Weaker but Still Solid Growth Ahead Morgan Stanley & Co. Given the high level of resource utilisation, inflation Tomasz Pietrzak International plc Tomasz.Pietrzak@morganstanley.com pressures should continue to pick up. On our forecasts, headline inflation will accelerate, but remain below the inflation Key points target of 2.5%Y in 2015. As a result, we expect Norges Bank Mainland GDP growth should decelerate this year to 1.8%Y, to only gradually raise the sight rate, first by 25bp in 4Q14, followed by somewhat stronger growth next year. Domestic followed by two more rate hikes in 2015 to bring the main policy demand remains the main growth driver. rate to 2.25%. Our forecast is largely in line with the current We think that Norges Bank will hike the sight rate in 4Q14, Norges Bank projections, but below the current market pricing. followed by two more rate hikes in 2015. September elections: If the current opinion polls are to be Growth in Norwegian economy decelerates: Mainland GDP believed, the opposition led by the Conservatives is likely to growth was weaker than expected in 1H, partly due to the win the parliamentary elections on September 9, ousting the weather-related drop in electricity output, but also thanks to Labour-led incumbent. The centre-right is likely to form a more lacklustre household consumption, weaker exports and a minority government consisting of the Conservatives, Christian drag from inventory investment. As a result, we are revising Democrats and Liberals. We do not expect any meaningful down our growth forecast for this year and now expect changes to the fiscal policy stance, but it is likely that the new mainland GDP growth at 1.8%Y, somewhat below consensus coalition will cut the wealth tax, while maintaining welfare and expectations. Going forward, we expect only slightly stronger education spending. In terms of structural reforms, we would growth in mainland GDP as investment growth in the petroleum expect some tightening in sick leave compensation and the sector and tighter credit conditions weigh on growth in introduction of more flexible working hours. economic activity. But as the production outlook in the petroleum sector is expected to improve, total GDP growth is Exhibit 35 likely to accelerate more sharply. Monetary Policy Expectations 7.0 Domestic demand will be the main driver of growth over 6.0 Sight Rate & MS F'cast the forecast horizon: First, we expect household Norges Bank F'cast consumption to grow at healthy rate of 2.7%Y this year. This is 5.0 because, despite weaker-than-expected growth in 1H13, real 4.0 MS F'cast disposable income has continued to grow at the strong pace. Going forward, however, growth in household consumption is 3.0 likely to be somewhat weaker as a result of higher inflation, 2.0 tighter credit conditions and a mild correction in house prices. 1.0 While non-oil business investment should be somewhat stronger next year, the investment survey conducted by 0.0 2005 2006 2006 2007 2008 2008 2009 2010 2010 2011 2012 2012 2013 2014 2014 2015 Statistics Norway suggests that petroleum investment is likely to grow at a slower pace than before and hence total investment Source: Norges Bank, Morgan Stanley Research forecasts spending is likely to decelerate next year. Exhibit 36 Norway – Macro Forecasts, 2011-15E We expect export growth to accelerate in 2014, after a fall in 2011 2012A 2013E 2014E 2015E Real GDP (Total) 1.2 3.0 0.6 1.8 2.4 2013. This year, weak economic activity abroad, especially in Real GDP (Mainland) 2.6 3.3 1.8 2.0 2.2 the euro area, is weighing on Norwegian non-petroleum Private Consumption 2.5 3.1 2.7 2.6 2.4 Public Consumption 1.9 1.7 2.5 2.3 2.0 exports. As global growth outlook improves gradually, especially Gross Fixed Investment 7.5 8.1 6.4 4.3 3.1 in Sweden and in Germany, we expect non-petroleum exports to Domestic Demand 2.9 3.3 3.1 2.6 2.2 Exports of Goods and Services -1.8 1.8 -2.0 2.1 2.9 accelerate next year. That said, solid domestic demand should Imports of Goods and Services 3.9 2.3 0.2 2.9 3.8 support import growth and hence net exports are unlikely to Unemployment rate (% Labour Force) 3.3 3.2 3.7 3.7 3.5 contribute significantly to GDP growth. Inflation (CPI) 1.3 0.7 2.0 2.1 2.2 CPI-ATE 1.0 1.2 1.6 2.0 2.0 Norges Bank Policy Rate (%, EOP) 1.75 1.50 1.50 1.75 2.25 Source: Statistics Norway, Norges Bank, Morgan Stanley Research forecasts 21 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Exhibit 37 European Main Macro Forecasts, 2011-15E % YoY GDP CPI 2011 2012 2013E 2014E 2015E 2011 2012 2013E 2014E 2015E Euro Area 1.5 -0.5 -0.5 0.9 1.2 2.7 2.5 1.5 1.6 1.4 Austria 2.7 0.8 0.5 1.6 1.6 3.6 2.6 2.1 2.0 2.0 Belgium 1.9 -0.3 0.1 1.2 1.7 3.5 2.8 1.3 1.7 1.7 Finland 2.7 -0.8 -0.2 0.8 1.2 3.4 2.8 1.7 1.9 1.8 France 2.0 0.0 0.0 0.6 1.2 2.1 2.0 1.0 1.6 1.4 Germany 3.0 0.7 0.4 1.8 1.8 2.1 2.0 1.6 1.9 1.9 Greece -6.1 -6.6 -4.0 0.0 0.4 3.3 1.5 -0.6 -0.4 0.1 Ireland 2.2 0.1 0.4 2.1 2.5 1.2 1.9 1.0 2.1 1.6 Italy 0.5 -2.4 -1.7 0.4 0.7 2.8 3.0 1.4 1.5 1.6 Netherlands 1.0 -1.3 -1.2 0.5 0.8 2.3 2.5 2.8 1.5 1.5 Portugal -1.6 -3.2 -2.0 0.2 0.5 3.7 2.8 0.6 1.3 1.3 Spain 0.1 -1.6 -1.3 0.8 1.1 3.2 2.4 1.7 0.8 1.4 Denmark 1.1 -0.4 0.0 1.2 1.6 2.8 2.4 1.0 1.5 1.7 Sweden 3.8 0.7 1.1 2.2 3.0 3.0 0.9 0.1 1.0 2.1 Norway 1.2 3.0 0.6 1.8 2.4 1.3 0.7 2.0 2.1 2.2 UK 1.1 0.2 1.4 2.4 2.1 4.5 2.8 2.7 2.7 2.3 % of GDP General Government Balance Gross General Government Debt 2011 2012 2013E 2014E 2015E 2011 2012 2013E 2014E 2015E Euro Area -4.1 -3.7 -3.1 -2.9 -2.7 88.1 91.4 94.5 96.5 96.2 Austria -2.4 -2.5 -2.3 -1.9 -1.9 72.5 73.4 74.8 74.2 73.6 Belgium -3.7 -3.9 -2.7 -2.4 -1.1 97.8 99.6 100.5 100.3 98.2 Finland -1.1 -2.2 -2.3 -2.4 -2.3 49.0 53.0 56.8 59.5 61.7 France -5.3 -4.8 -3.9 -3.5 -3.2 85.8 90.2 93.6 95.3 95.8 Germany -0.8 0.2 0.0 0.1 0.3 80.6 81.3 80.3 81.6 81.6 Greece -9.5 -10.0 -4.0 -3.6 -2.7 170.3 156.9 168.8 171.6 172.8 Ireland -13.3 -8.1 -7.8 -4.9 -2.2 106.4 120.2 127.2 125.4 119.3 Italy -3.8 -3.0 -3.3 -2.4 -2.2 120.8 127.0 131.6 131.6 130.8 Netherlands -4.3 -4.0 -3.4 -3.5 -3.4 65.5 71.2 74.8 77.0 78.7 Portugal -4.4 -6.4 -5.7 -4.3 -2.8 108.3 123.6 131.8 134.4 135.1 Spain -9.4 -10.6 -6.9 -6.0 -5.3 69.3 84.2 91.4 96.2 99.1 Denmark -1.9 -4.0 -2.0 -0.8 0.3 46.5 45.8 45.2 43.0 40.3 Sweden 0.3 -0.4 -2.1 -1.5 -0.5 38.4 38.2 42.3 42.0 40.6 Norway 13.4 13.8 13.3 12.6 11.7 34.1 34.6 33.3 33.2 32.0 UK -7.8 -5.5 -6.1 -5.2 -4.4 82.3 90.1 93.5 96.2 97.8 Current Account (% of GDP) Unemployment rate (% of LF) 2011 2012 2013E 2014E 2015E 2011 2012 2013E 2014E 2015E Euro Area 0.1 1.3 2.4 2.3 2.4 10.2 11.4 12.1 12.3 12.4 Austria 1.4 1.8 2.3 3.0 2.9 4.1 4.4 4.8 5.0 4.9 Belgium -1.2 -1.7 -0.5 -0.2 0.2 7.2 7.6 8.6 8.6 8.2 Finland -1.5 -1.8 -1.5 -1.2 -1.2 7.8 7.8 8.0 7.9 7.5 France -1.9 -2.3 -2.1 -2.2 -2.3 9.2 9.8 10.5 10.8 10.7 Germany 6.2 7.0 6.7 6.6 6.6 6.0 5.5 5.5 5.5 5.4 Greece -9.9 -3.4 -1.1 0.9 1.5 17.7 24.2 26.1 26.6 26.8 Ireland 1.2 4.5 6.0 6.0 6.5 14.7 14.7 13.6 13.5 13.4 Italy -3.1 -0.6 0.9 1.4 1.6 8.4 10.7 11.6 12.4 13.0 Netherlands 10.2 10.1 8.9 9.9 9.7 4.4 5.3 6.7 7.2 7.4 Portugal -7.0 -1.5 0.2 1.4 2.1 14.2 17.1 19.2 20.6 19.0 Spain -3.7 -1.1 1.7 2.8 3.4 21.7 25.1 26.5 25.6 24.5 Denmark 5.5 5.1 5.0 5.1 5.2 7.6 7.5 7.7 7.7 7.6 Sweden 7.0 6.9 6.3 6.5 6.6 7.5 7.9 8.3 8.2 7.6 Norway 12.1 13.5 10.3 7.6 7.3 3.3 3.2 3.7 3.7 3.5 UK -1.5 -3.8 -2.7 -2.5 -1.9 8.1 7.9 7.7 7.5 7.3 Source: National data, Eurostat, Morgan Stanley Research forecasts 22 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Exhibit 38 Risk Events for 2H13 Date Country Event London Time Date Country Event London Time 02-Sep INT G20 Finance Ministers' Deputies Meeting (4 days) uncertain 25-Oct EMU Money supply M3, sa 09:00 04-Sep EMU GDP, 1st estimate 10:00 25-Oct EU European Council Meeting (2nd day) uncertain 05-Sep EMU ECB Council Meeting & Press Conference 12:45 25-Oct GER Ifo Business climate, sa 09:00 05-Sep INT G20 Leaders' Summit (2 days) uncertain 25-Oct UK GDP (preliminary) 09:30 05-Sep SWE Riksbank Monetary Policy Decision 08:30 28-Oct ITA ISTAT Business confidence 09:00 05-Sep UK MPC Meeting 12:00 29-Oct US FOMC meeting 19:00 09-Sep ITA Senate committee on Court verdict and on vote uncertain 30-Oct BEL Real GDP, flash estimate 14:00 10-Sep EMU European Parliament to finalise Single Supervisory Mechanism uncertain 30-Oct EMU ECB Bank Lending Survey 09:00 10-Sep ITA GDP, sa (details) 10:00 30-Oct SPA Real GDP, flash estimate 08:00 12-Sep SWE Consumer prices 08:30 30-Oct US FOMC meeting (2nd day) 19:00 13-Sep EMU Informal Eurogroup Meeting 14:00 31-Oct EMU HICP flash, nsa 10:00 14-Sep EMU Informal Ecofin Council Meeting 08:00 15-Sep GER Regional Election in Bavaria uncertain 07-Nov EMU ECB Council Meeting & Press Conference 12:45 15-Sep POR Troika Review uncertain 07-Nov UK MPC Meeting 12:00 15-Sep CYP Troika Review uncertain 11-Nov EMU Ecofin Budget Meeting uncertain 17-Sep GER ZEW Economic Sentiment 10:00 12-Nov SWE Consumer prices 08:30 17-Sep NET Government to present the 2014 budget uncertain 13-Nov UK BOE Inflation report & press conference 10:30 17-Sep US FOMC meeting 19:00 14-Nov EMU GDP, sa (flash estimate) 10:00 18-Sep UK MPC minutes 09:30 14-Nov GER Real GDP, sa (Flash estimate) 07:00 18-Sep US FOMC meeting (2nd day) 19:00 14-Nov ITA GDP, sa (preliminary) 09:00 19-Sep NOR Norges Bank Monetary Policy Decision 13:00 14-Nov NET GDP release, sa (1st estimate) 08:30 19-Sep SWI Monetary Policy Meeting 13:00 14-Nov EMU Eurogroup Meeting 14:00 20-Sep ITA Deadline to present government economic and fiscal forecast 15-Nov EMU Ecofin Council Meeting 08:00 22-Sep GER General Election uncertain 19-Nov GER ZEW Economic Sentiment 10:00 22-Sep GER Regional Election in Hesse uncertain 20-Nov EMU PMI manufacturing (flash) 09:00 23-Sep EMU PMI manufacturing (flash) 09:00 20-Nov EMU PMI services (flash) 09:00 23-Sep EMU PMI services (flash) 09:00 20-Nov UK Autumn Statement uncertain 24-Sep GER Ifo Business climate, sa 09:00 20-Nov UK MPC minutes 09:30 25-Sep FRA INSEE Mfg survey (synth. Index) 07:45 22-Nov GER Real GDP, sa (details) 07:00 26-Sep EMU Money supply M3, sa 09:00 22-Nov GER Ifo Business climate, sa 09:00 27-Sep FRA Real GDP, final estimate 06:30 28-Nov EMU Money supply M3, sa 09:00 27-Sep ITA ISTAT Business confidence 09:00 28-Nov ITA ISTAT Business confidence 09:00 29-Sep GRE Troika Review uncertain 28-Nov SWE Riksbank Financial Stability Report 08:30 29-Sep AUT General Elections uncertain 29-Nov EMU HICP flash, nsa 10:00 29-Sep GER Vote on the enhanced EFSF uncertain 29-Nov SWE Real GDP, 1st estimate 08:30 30-Sep EMU HICP flash, nsa 10:00 30-Nov GRE Troika Review uncertain End-Sep ITA Planned VAT rate hike to be postponed 04-Dec EMU GDP, 1st estimate 10:00 Oct* ITA Vote in the Senate on implications of Court verdict uncertain 05-Dec EMU ECB Council Meeting & Press Conference 12:45 01-Oct EU Deadline for countries to take corrective action under EDP uncertain 05-Dec NOR Norges Bank Monetary Policy Decision 13:00 02-Oct EMU ECB Council Meeting & Press Conference (Paris) 12:45 05-Dec UK MPC Meeting 12:00 04-Oct IRE Referendums on abolition of Seanad & setting up of a Appeal Court 07:00 09-Dec EMU Eurogroup Meeting 14:00 10-Oct INT G20 Finance Ministers & Central Bank Governors Meeting (2 days) uncertain 10-Dec EMU Ecofin Council Meeting 08:00 10-Oct SWE Consumer prices 08:30 10-Dec ITA GDP, sa (details) 10:00 10-Oct UK MPC Meeting 12:00 12-Dec SWE Consumer prices 08:30 11-Oct INT IMF/Worldbank Annual Meeting uncertain 12-Dec SWI Monetary Policy Meeting 13:00 14-Oct EMU Eurogroup Meeting 14:00 15-Dec POR Troika Review uncertain 15-Oct ITA 2014 budget (draft) uncertain 15-Dec CYP Troika Review uncertain 15-Oct EMU Ecofin Council Meeting 08:00 17-Dec GER ZEW Economic Sentiment 10:00 15-Oct GER ZEW Economic Sentiment 10:00 17-Dec SWE Riksbank Monetary Policy Decision 08:30 15-Oct GER Announcement of size renewable energy levy for 2014 uncertain 17-Dec US FOMC meeting 19:00 15-Oct IRE Budget for 2014 will be presented uncertain 18-Dec GER Ifo Business climate, sa 09:00 15-Oct IRE Troika Review (final) uncertain 18-Dec UK MPC minutes 09:30 20-Oct EMU PMI manufacturing (flash) 09:00 18-Dec US FOMC meeting (2nd day) 19:00 20-Oct EMU PMI services (flash) 09:00 19-Dec EU European Council Meeting (1st day) uncertain 23-Oct UK MPC minutes 09:30 20-Dec EMU European Council Meeting (2nd day) uncertain 24-Oct EU European Council Meeting (1st day) uncertain 20-Dec EMU PMI manufacturing (flash) 09:00 24-Oct NOR Norges Bank Monetary Policy Decision 13:00 20-Dec EMU PMI services (flash) 09:00 24-Oct SWE Riksbank Monetary Policy Decision 08:30 30-Dec ITA ISTAT Business confidence 09:00 25-Oct EU European Council Meeting (2nd day) uncertain End-Dec ITA Deadline to approve 2014 budget uncertain Source: ECB, Bloomberg, Morgan Stanley Research *Indicates approximate date/time 23 MORGAN STANLEY RESEARCH September 3, 2013 European Economics Disclosure Section Morgan Stanley & Co. 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