Suffolk County Council
The Cost of Austerity
European Economic Outlook
Azad Zangana
Schroders’ European Economist
James Montefiore
Client Director
25 July 2012
For professional investors only. This material is not suitable for retail clients
Key issues
European Economic Outlook
• Growth vs. Austerity, can there be a winner?
• Where next for the Eurozone?
• When will the UK recession end?
1
Backlash against austerity gains legitimacy
Hollande victory lends credibility to growth debate
Source: Telegraphy online
2
Austerity is clearly affecting growth
Divergence in recovery paths within Europe
GDP level (100=2008 peak)
104
104
Austria
Germany
102
100
100
France
98
98
Spain
Portugal
Italy
96
94
96
94
92
92
90
90
88
Ireland
86
82
88
86
84
84
Greece
0
1
2
3
4
5
6
7
Source: Eurostat, Thomson Datastream. Updated: 12 July 2012
3
102
8
9
10
Quarters
11
12
13
14
15
16
17
18
82
Eurozone recession likely to be underway
Leading indicators vs. Eurozone GDP growth
GDP Growth (Y/Y)
6%
4%
2%
0%
-2%
-4%
-6%
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Eurozone GDP
BNB survey
PMI composite
Source: Thomson Datastream, Markit, BNB, Schroders. Updated 12 July 2012
4
2010
2011
2012
More growth comes at a cost, and debt levels are already high
Peripheral government bond spreads and debt to GDP levels
10-year Govt. bond yield spreads over Bunds, %
50
Government debt as % of GDP
180
45
160
Greece
debt swap
completed
40
35
140
120
30
100
25
80
20
60
15
40
10
20
5
0
Jan 09
0
Sep 09
Italy
5
May 10
Greece
Jan 11
Ireland
Sep 11
Spain
May 12
Portugal
Ger
Ire
2008
Gre
2009
Spa
2010
Source: Thomson Datastream (right); European Commission Spring 2012 Forecast (right). Updated: 22 May
2012. Please see the forecast risk warning on the important information slide.
Fra
Ita
2011
2012
Neth
2013
Por
Greece endgame in sight
6
Sovereign debt crisis reaches dangerous stage
Greece could exit Eurozone in 2013
 Greece finally has a new government
that wants to stay in the Eurozone.
 However, it also plans to test the
Troika’s resolve by trying to postpone
and reverse some fiscal and
structural reforms.
 Given the stress now present in Spain
and Italy, we believe the Troika is
likely to relax the conditions on
Greece, in order to focus on the
others.
 However, Greece remains deeply
uncompetitive, and we think
Greece will be forced to abandon
the Euro in 2013.
Source for image: Schroders
7
What to expect from a Greek exit?
Greece could exit Eurozone this year
 Exit would happen during a




8
weekend/out of business hours.
Capital controls would instantly be
applied including border checks.
All deposits would be switched into
the new Drachma, and the Bank of
Greece would start to replace.
physical currency as soon as possible
The Drachma is expected to
depreciate by 30-70%, causing high
inflation in the first few years, along
with a very deep recession.
However, local tourism and some
export industries will begin to boom,
which should lead to the start of the
recovery.
Source for image: Reuters
Banks must hold on to the confidence of investors
Premium for cost of borrowing for banks vs. non-banks
Spread between European financial & non-financial corporate credit yields, bps
2500
2000
1500
1000
500
0
-500
2007
2008
2009
2010
AA
Source: Thomson Datastream, Schroders. Updated 10 July 2012
9
A
BBB
2011
2012
However, ECB itself will be a big loser from a Greek exit
TARGET 2.0 central banks’ claims at ECB
€bn
800
600
400
200
0
-200
-400
-600
-800
-1000
2004
2005
Germany
2006
France
2007
Core (Fr, Ger, Fin, Neth, Aust)
Source: Thomson Datastream, Schroders. Updated 18 July 2012
10
2008
2009
Italy
2010
2011
Peripheral (Por, Ire, It, Sp, Gr)
2012
Greece
Greek and Spanish deposits flying out of the door
Household and non-bank corporate deposits in banks
Change in banking deposits, y/y
20%
15%
10%
5%
0%
-5%
-10%
-15%
-20%
-25%
2007
2008
2009
2010
Greece
Spain
Source: Thomson Datastream, Bank of Spain, Bank of Greece. Updated 10 July 2012
11
2011
2012
Who will suffer if the Eurozone goes into recession?
Eurozone exports by partners
Czech Rep.
Norway
Poland
Hungary
UK
Switzerland
Russia
Brazil
India
China
US
Japan
Australia
Canada
0%
10%
20%
30%
40%
% of total exports
50%
% of GDP
60%
Source: IMF Direction of Trade (DOT) database. Average between 2006-11. Updated 22 May 2012
12
70%
80%
90%
Example: UK exports to peripheral Europe underperforming
Export values levels by partner (Jan’10=100)
120
135
110
130
125
100
120
90
115
110
80
105
70
100
60
95
50
Jan 10
Spain
Jul 10
Italy
Jan 11
Ireland
Jul 11
Greece
Source: ONS, Schroders. Updated 12 July 2012.
13
Jan 12
Portugal
90
Jan 10
China
Jul 10
Australia
Jan 11
Norway
Jul 11
Jan 12
Germany
Austria
Expect another bad Q2
Diamond Jubilee holiday will cause loss of output
Month on month growth
Mining & quarrying inc
oil & gas extraction
Manufacturing
Electricity, gas, steam
and air con
Total Production
Services
0%
-1%
-1.1%
-1.4%
-2%
-1.6%
-1.8%
-3%
-3.0%
-4%
-5%
-4.9%
-5.3%
-6%
-5.9%
-7%
June '02 (Golden Jubilee)
Source: ONS, Market, Schroders. Updated 06/03/2012.
14
-1.6%
-2.0%
April '11 (Royal Wedding)
Austerity UK will keep growth subdued for most of this decade
Public sector net borrowing & change in cyclically adjusted budget deficit
PSBR, % of GDP
14
% of GDP
12
2.5
3.0
11.1
9.3
10
2.0
8.3
Fiscal tightening
delayed
8
5.8
6
1.5
5.9
4.3
4
1.0
2.8
2
0
1.1
09/10
10/11
11/12
12/13 13/14 14/15
Structural
Cyclical
Source: OBR, HMT, Schroders. Updated 23/03/2012.
15
15/16
16/17
0.5
0.0
10/11
11/12
12/13
13/14
14/15
15/16
Budget '12
Autumn Statement '11
Budget '11
16/17
PBR '10
Risks to inflation outlook are on the upside at the 2-year horizon
Schroders inflation forecast
Y/Y
7%
VAT rises to 17.5%
6%
First BoE rate hike
5%
4%
3%
2%
VAT rises to 20%
1%
0%
-1%
-2%
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Jan-13
Jul-13
Forecast
RPI
RPIX
CPI
CPI target bands
Source: ONS, Schroders. Updated 18 July 2012.
16
Jan-14
Jul-14
Fundamental step-change in pricing pressures from goods
UK goods vs. services inflation
Y/Y
6%
5%
4%
3%
2%
Average since '00 = +3.7%
1%
0%
Average since '06 = +2.5%
-1%
-2%
'00-'05 average = -0.6%
-3%
00
01
02
03
04
05
Above 3% annual CPI inflation
Source: ONS, Schroders. Updated 18/07/2012.
17
06
07
Goods
08
09
Services
10
11
12
Interest rates flat as a pancake
Schroders interest rate forecast
Oct 11
Nov 11
Dec 11
Jan 12
Feb 12
Mar 12
Apr 12
May 12
Jun 12
Jul 12
Aug 12
Sep 12
Oct 12
Nov 12
Dec 12
Jan 13
Feb 13
Mar 13
Apr 13
May 13
Jun 13
Jul 13
Aug 13
Sep 13
Oct 13
Nov 13
Dec 13
BoE
ECB
Fed
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
0.50
1.50
1.25
1.00
1.00
1.00
1.00
1.00
1.00
1.00
0.75
0.75
0.75
0.75
0.75
0.75
0.75
0.75
0.75
0.75
0.75
0.75
0.75
0.75
0.75
0.75
0.75
0.75
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
0 - 0.25
%
1.75
1.50
1.25
1.00
0.75
0.50
0.25
0.00
Jul
Sep Nov
Jan Mar May
2012
Source: Schroders, June 2012 forecast
Please see the forecast risk warning on the important information slide
18
Jul
BoE
Sep Nov
ECB
Jan Mar May
2013
Fed
Jul
Sep Nov
Important information
For professional advisers only. This material is not suitable for retail clients.
Schroders has expressed its own views and these may change. The data contained in this document has been sourced by
Schroders and should be independently verified before further publication or use. Past performance is not a guide to future
performance and may not be repeated. The value of investments and the income from them may go down as well as up and
investors may not get back the amount originally invested.
The forecasts included in this presentation should not be relied upon, are not guaranteed and are provided only as at the
date of issue. Our forecasts are based on our own assumptions which may change. We accept no responsibility for any
errors of fact or opinion and assume no obligation to provide you with any changes to our assumptions or forecasts.
Forecasts and assumptions may be affected by external economic or other factors.
Source: Citywire ‘More ratings than anyone else’, as at 30 November 2011.
Issued in July 2012 by Schroder Investments Limited, 31 Gresham Street, London EC2V 7QA. Registered No: 2015527
England. Authorised and regulated by the Financial Services Authority. UK02291
19
Appendix
20
Shape of things to come
Baseline GDP forecast
France Germany
2013 2012 2011
Q on Q
Y on Y
2008
2009
2010
2011
2012
2013
2014
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
0.9%
0.0%
0.3%
0.1%
0.0%
-0.1%
0.2%
0.2%
0.2%
-0.5%
-0.2%
0.2%
France
-0.2%
-3.0%
1.6%
1.7%
0.3%
0.0%
0.4%
1.3%
0.3%
0.6%
-0.2%
0.5%
0.2%
0.3%
0.3%
0.3%
-0.5%
-0.3%
0.2%
Germany
0.8%
-5.1%
3.6%
3.1%
1.1%
0.2%
1.3%
Italy
0.1%
0.3%
-0.2%
-0.7%
-0.8%
-0.7%
-0.2%
-0.1%
-0.2%
-0.9%
-0.5%
-0.2%
Italy
-1.2%
-5.5%
1.8%
0.5%
-2.0%
-1.5%
-0.2%
Spain Eurozone
0.4%
0.2%
0.0%
-0.3%
-0.3%
-0.6%
-0.4%
-0.1%
0.0%
-0.7%
-0.4%
-0.2%
Spain
0.9%
-3.7%
-0.1%
0.7%
-1.2%
-1.2%
-0.8%
0.7%
0.2%
0.1%
-0.4%
0.0%
-0.2%
0.0%
0.1%
0.1%
-0.7%
-0.7%
-0.1%
Eurozone
0.3%
-4.3%
1.9%
1.5%
-0.2%
-0.7%
0.0%
GDP growth, Q/Q
3%
2%
1%
0%
-1%
-2%
-3%
-4%
-5%
06 ii iii iv 07 ii iii iv 08 ii iii iv 09 ii iii iv 10 ii iii iv 11 ii iii iv 12 ii iii iv 13 ii iii iv
Germany
Spain
4%
3%
2%
1%
0%
-1%
-2%
-3%
-4%
-5%
2007
2008
2009
Emerging EA
21
Italy
GDP growth, Y/Y
2006
Source: Schroders June 2012 forecast.
France
2010
2011
Wider EA
2012
EA4
2013
2014
Shape of things to come
Baseline UK GDP forecast
Year on Year % contributions to GDP
6
4
1.8
0.8
0.7
2
0
-0.1
Households
Government
Inventories
GDP
-2
Schroders
forecast
Investment
Net Trade
Statistical Discrepancies
-4
-4.0
1998
1999
2000
2001
2002
Source: ONS, Schroder. Updated 12/07/2012.
22
2003
2004
2005
2006
2007
2008
2009
-6
2010
2011
2012
2013
Commodity prices set to help lower inflation in 2012
Annual commodity price inflation and implied rates by forwards
Monthly Y/Y change in price
175%
150%
125%
100%
75%
50%
25%
0%
-25%
-50%
-75%
2007
2008
2009
Forward contracts
2010
Cotton
Source: Thomson Datastream, Bloomberg, Schroders. Updated 22 May 2012
23
2011
Wheat
Oil
2012
Leading indicators suggest weaker near term growth
GDP growth vs. Schroders Activity Index
q/q
2.0%
1.5%
1.0%
0.5%
0.0%
-0.5%
-1.0%
-1.5%
-2.0%
-2.5%
2004
2005
2006
2007
2008
GDP growth
Source: ONS, Markit, Schroders. Updated 12 July 2012.
24
2009
2010
Schroders Activity Index
2011
2012
Biographies
Azad Zangana – European Economist
Responsible for formulating the house view on the UK and Eurozone economies. He is based in the Schroders’
Economics Group in London. Investment career commenced when he joined Schroders in 2009.
Prior to joining Schroders he was an Economist at HM Treasury working on UK Macroeconomic Analysis and
Eastern Europe.
Azad is a regular contributor to the press including television and radio appearances.
He holds an MSc in Economics, University of Southampton and BSc in Economics, Royal Holloway, University
of London. He also holds the Investment Management Certificate (IMC).
James Montefiore – UK Institutional Client Director
Joined Schroders in 2000 as UK Institutional Client Director, based in London
Responsible for client servicing to UK pension funds and their consultants
Previously worked at Threadneedle and Scottish Widows in a similar role.
Prior to that he worked as a private client investment manager/analyst for private bankers, Adam & Company in
Edinburgh from 1989.
Began his career in financial services with private client stockbroker Williams de Broe from 1987
Prior to the financial industry he served for 8 years as an officer in the Royal Marines from 1979.
An Associate of the UK Society of Investment Professionals (UKSIP), previously known as AIIMR.
Member of the CFA Institute. A Fellow of the Chartered Institute of Securities & Investment
25
Important information
For professional advisers only. This material is not suitable for retail clients.
Schroders has expressed its own views and these may change. The data contained in this document has been sourced by
Schroders and should be independently verified before further publication or use. Past performance is not a guide to future
performance and may not be repeated. The value of investments and the income from them may go down as well as up and
investors may not get back the amount originally invested.
The forecasts included in this presentation should not be relied upon, are not guaranteed and are provided only as at the
date of issue. Our forecasts are based on our own assumptions which may change. We accept no responsibility for any
errors of fact or opinion and assume no obligation to provide you with any changes to our assumptions or forecasts.
Forecasts and assumptions may be affected by external economic or other factors.
Source: Citywire ‘More ratings than anyone else’, as at 30 November 2011.
Issued in July 2012 by Schroder Investments Limited, 31 Gresham Street, London EC2V 7QA. Registered No: 2015527
England. Authorised and regulated by the Financial Services Authority. UK02291
26