/// 10 June 2011 /// 11-22

Summary
Our house, in the middle of the strip
Owning ones own place of residence used to be a family man kind of investment. The 2000s changed everything Overview, page 2

Heavy rain for the United Kingdom

Housing and manufacturing sectors on the downside prices The Bank of England in command
The clouds are gathering over the UK. Real estate prices have fallen again, which is never a good sign on that side of the channel. The manufacturing cycle probably hit a peak in January. It is now showing a marked slowdown. This is likely to continue over the next few months, as the slowing of the global manufacturing cycle and the consequences of the Japanese earthquake and tsunami conspire against British industry (production and new order components of the PMI manufacturing industry were both below 50 in May). In addition, fiscal consolidation is hitting household spending by eating into purchasing power, and is also affecting companies that supply the government. The Bank of England is thus caught between Scylla and Charybdis. In the circumstances, it has opted for caution, hoping that inflation will ease in 2012. For the time being prices continue to race away, with inflation back to the peak levels seen in late 2008, when the bank nevertheless continued to cut rates in order to deal with the more pressing issue of stemming the economic and financial crisis.
BAD OMEN
United Kingdom, housing prices vs. GDP 6% 25%
4% 2% 0% -2% -4% -6% 2004 2006 2008 2010 2012 -25% 0%

Running

The week in the US

Page 3 Page 4

The week in the Eurozone

ECB: In a tightening mood

At its June meeting the ECB signalled its intention to raise key policy rates within one month. Inflationary pressure is building up; the tightening cycle will continue over the coming quarters. However, it will probably unfold at a moderate pace. Focus, page 5

GDP, y/y variation - lhs Real house prices (Halifax), y/y variation rhsSource : Thomson Datastream

Economic indicators
Page 8

THE WEEK ON THE MARKETS

Week 6-6 11 > 9-6-11
CAC 40 S&P 500 Volatility (VIX) Euribor 3m (%) Libor $ 3m (%) OAT 10y (%) Bund 10y (%) US Tr. 10y (%) Euro vs dollar Gold (ounce, $) Oil (Brent, $) 3 891 1 300 18.0 1.44 0.25 3.37 3.04 2.99 1.46 1 538 115.1 3 879 1 289 17.8 1.46 0.25 3.39 3.04 3.00 1.45 1 540 119.1 -0.3 -0.9 -0.2 +2.8 -0.2 +2.0 +0.2 +0.3 -0.4 +0.1 +3.4 % % % bp bp bp bp bp % % %

Market overview
Page 12

Also in

economic-research.bnpparibas.com

Alexandra Estiot

10 June 2011 11-22

Overview Our house, in the middle of the strip

Our house is our castle and our keep goes the song. Well, it used to be. Residential investment, as in owning ones own place of residence, has always been seen as a family man kind of investment. It was not coming with an income, but at least it was a safe heaven: valuations were always up, fast enough to hedge against inflation. Once the mortgage repaid, this was providing an almost costless shelter, which was, for most households, the very first way to prepare for retirement. In the US, the burst of the internet-bubble in 2000 reinforced this view. At that time, the losses suffered on the equity market were cushioned by the fact that households wealth was mainly in residential assets. Sometime during the last decade, things began to go wrong, and residential bubbles inflated in many developed countries. It is still hard to assess exactly when prices began to run faster than they should have. In Spain, Ireland and Australia, for instance, the dynamic GDP growth, the drop in the unemployment rate, the increase in net immigration and the rise in GDP per capita were all pleading for a (sustained) rise in property prices. As Alan Greenspan once said, it is very difficult [to] identify a bubble until after the fact that is, when its bursting confirmed its existence. With the very exception of Japan and Germany, real estate prices in the developed world have been rising fast over the last decade, with a peak in 2006-07. From 1999 to 2007, housing prices in OECD countries recorded an average increase of 83.5% in nominal terms and of 54.7% in real terms. Eight countries recorded increases above 100% in nominal terms: Australia, France, Ireland, New Zealand, Norway, Spain, Sweden and the UK. However, not all countries suffered a bubble as defined by Greenspan. Some, after having recorded impressive increases in prices, did not suffer (yet, maybe) a correction thereafter: from 2007 to 2009, real estate prices were up 8% (nominal terms) in Australia and 4.9% in Sweden, for instance. On the contrary, the US suffered a very bad burst of its housing bubble. So far, the adjustment in housing prices has been particularly dramatic in the US, Ireland and in the UK, milder in Spain, already finished (or pausing) in Iceland and France and non-existent elsewhere. According to Reinhart and Rogoff1, housing bubbles bursting materialises into an average 35.5% drop in real housing prices. Ireland and the US already experienced such a correction (a greater one, actually) and the UK is almost there. In Spain, however, there is still a 10-15% drop to be achieved. The length of the correction also has to be taken into account: 6 years on average according to Reinhart and Rogoff. Under this benchmark, no improvement in real estate should be expected before early 2012 in the US, mid-2013 in the UK and Spain and early 2014 in Ireland. The reason for such a prolonged correction is quite simple: when the housing bubble goes burst, a growing numbers of households default on their mortgage debt, leaving lenders with properties. When they do have the choice, they usually choose not to dump them, keeping them in books hopping to sell them later at a better price. This limits the early correction in prices but also postpones their subsequent recovery since the inventories of unsold homes stay high for a while. Mortgage delinquencies are then numerous for a lengthy period, since the economy usually enters a vicious cycle when a housing bubble bursts: housing prices fall, driving down activity in the construction sector and its suppliers, lifting the unemployment rate up with an according development in defaults that weighs on bank profitability (and solvency) leading to a credit crunch which limits demand for housing, which, in turn, leads to further declines in housing prices. Usually, monetary policy helps soften the crisis, providing cheap liquidity to banks helping lowering mortgage interest rates. This time was surely different, since the US bubble burst led major financial institutions into bankruptcy, which dramatically worsened the credit crunch part of the vicious cycle. It remains very different: while the developed world sank into recession, the developing world did not, fuelling commodity inflation which eventually translated into accelerating consumer inflation in the developed world. So the ECB started (and will continue, see Focus ECB: In a tightening mood) tightening its policy. European mortgage rates are thus going up early in the housingcorrection cycle with potentially dramatic collateral effects. Irish and Spanish households are massively indebted at variable rates (75% and 85% respectively). The rise in interest rates will not just limit demand for housing there: it will also hurt already-indebted households. This, in turn, is likely to result in greater defaults, with side effects on a not-yet healed banking sector, with a potential threat on the sovereign risk. One should not expect the housing sector to support growth any time soon, even if the drag exerted will ease progressively. That is for the countries that already suffered housing bubble burst. Then, there are the ones who still dont. The main country to mention is China. Authorities have been trying for years to slowdown the buoyant property market. Recent anecdotal evidence show that they may have finally succeeded. However, this is not plain good news, since growth used to be (partly) fuelled by the residential market (some estimates that property construction accounted for as much as 13% of Chinese growth last year). A burst of the Chinese housing bubble would drag down activity in many related domestic sectors, as well as mining in Australia, which still has a housing bubble of its own.

This time is different Eight centuries of financial folly, Carmen M. Reinhart and Kenneth S. Rogoff, Princeton University Press, 2009.

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Jean-Marc Lucas

10 June 2011 11-22

The week in the US Monetary policy: neither tightening nor QE3

Neither early tightening of monetary policy nor a further round of quantitative easing (QE3). This was the key theme to emerge from a speech by Ben Bernanke at a conference on monetary issues held in Atlanta this week. The Federal Reserve Chairmans comments support the ideas that no increase in Fed Funds rates is likely in 2011 and that quantitative easing will come to an end with the closure of the QE2 programme at the end of June. Regarding the health of the economy, Mr Bernanke admitted that growth so far this year had been weaker than expected, due to two clearly identified shocks: the increase in energy prices and the disruptions caused by the earthquake and tsunami in Japan. Drawing on the idea that these shocks are temporary1, Mr Bernanke expects stronger growth in the second half. We share this view. With more modest price increases and a recovery in the Japanese economy, US consumer spending and industrial production are likely to perk up in the second half. Mr Bernanke stressed the importance of trends in the labour market. He noted the improvement in the situation since the beginning of the year (relative to last year) but also highlighted poor figures for recent weeks. The labour market, through its effect on private consumption, determines to a substantial degree the solidity of the recovery. If job creation continues at the rate seen since the beginning of the year (157,000 per month) then household income will increase at a reasonable pace and unemployment will fall. If however the rate is closer to the 54,000 new jobs created in May, growth in consumer spending is highly likely to remain modest and unemployment will climb. For this reason, figures on the labour market are currently scrutinised with particular attention. During the week of 4 June, the number of first unemployment benefit claims stood at 427,000, from 426,000 the previous week. The latest figures are midway between the very good numbers seen in February and March (+394,000 on average) and the disappointing levels of late-April and early-May (+449,000 on average over three weeks). This suggests that: (a) the weakness of the labour market was, for a short period, accentuated by negative shocks (events in Japan, floods and tornados in some states); and (b) the current pace of growth, in terms of job creation, is lower than in February and March. Turning to inflation, Mr Bernanke confirmed that the FOMC believes that the bulk of the price rises over recent quarters is temporary. There are several indicators to back this up: (a) the increase mainly reflects changes in the energy component, for which no further big increases are expected over the next few months; (b) tension in the labour market and the market for goods remains low; (c) long-term inflation expectations remain relatively stable. If the oil price
An economic recovery in Japan could even produce a positive counter effect
1

First unemployment benefit claims

750 700 650 600 550 500 450 400 350 300 250 00 01 02 03 04 05 06 07 08 09 10 11

Initial claims (thousands) Initial claims (thousands, 4-week moving average)

Source: Bureau of Labor Statistics

stabilises over the next few months then inflation stands every chance of peaking at around 3.5% in the second half, before falling significantly in 2012. Underlying inflation has remained very modest (1.4%), due notably to the high level of unemployment, and looks unlikely to accelerate suddenly over the next few quarters. These factors underpin the expectations of status quo in monetary policy over the second half. On the one hand, the weak nature of the recovery is unlikely to encourage the FOMC to raise its policy rate in the next few months. The caution displayed for a number of months in this area by the members of the FOMC has no doubt been increased by disappointing numbers in recent weeks. On the other hand, the increase in underlying inflation since the end of last year (from 0.7% to 1.0% on the basis of the consumer spending deflator) and the fact that a double-dip recession is not currently the most likely scenario mean that QE3 is also unlikely to happen. Long-term yields are already extremely low (the 10-year yield was just below 3% this week) and the marginal effect from further purchasing of securities could be modest at best. In his speech, Mr Bernanke also touched on fiscal issues. He confirmed that Federal public finances need to be put back on a sustainable medium-term footing, but did not go as far as to support the option of a sharp short-term consolidation (which could be counter-productive if it hampered the recovery).

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Catherine Stephan

10 June 2011 11-22

The week in the Eurozone Slowdown in German manufacturing activity growth

Decrease in German industrial production in April (0.6% m/m)
Industrial production decreased in April for the first time since December 2010 (-0.6% m/m, after +1.2% m/m in March). The rise of production in energy sector (+3.7% m/m, after -0.4% m/m) offset the sharp decrease in construction sector (-5.7% m/m), which benefited from a catching-up effect at the beginning of the year. However, manufacturing output also decreased by 0.6% m/m (+1.1% m/m in March) principally in line with a fall of activity in capital sector (-1.5% m/m, after +1.7% m/m in March). Only intermediate goods production rose (+0.1% m/m, after +0.3% m/m). Manufacturing production, which is still 3.4% below its pre-crisis level, should grow further in the coming months, but at a slower pace in comparison with the beginning of the year. Indeed, the evolution in manufacturing new orders suggests that output growth should slowdown. The rise in manufacturing new orders in April (+2.8% m/m) offset the decrease of the previous month (-2.7% mm). Both domestic (+2.1% m/m) and foreign demand (+3.4% m/m) underpinned manufacturing orders but orders from non-Eurozone countries were strong (+5.3% m/m, after -4.3% m/m). Orders increased in all sectors, except in intermediate goods sector (-0.3% m/m, after +0.7% m/m in March). Orders of capital goods sharply rose (+4.9% m/m, after -5.3% m/m in March) mainly in line with robust foreign demand (+6.6% m/m, after -4.9% m/m). The rise in domestic demand in capital goods was weak in comparison with the sharp decrease in the previous month (+3.4% m/m, after -6.1% m/m), but it suggests a further rise in investment. Manufacturing orders are volatile principally because of important change in transport orders, but the underling trend of new orders slowed (+1.6% m/m mm3). At the same time, the decrease of the expectations IFO index and the PMI activity in May also points to a slowdown in manufacturing orders and production growth over the months ahead. Moreover the decrease in goods exports (- 5.5% m/m in April, after +7.2% m/m in Manufacturing output and orders
40 30 20 10 0 -10 -20 -30 -40 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

production, y/y new orders, y/y,3m-ma new orders, y/y

Graphique 1

Source : Bundesbank

the previous month) suggests a slowdown in external demand growth. Foreign demand should grow at a slower pace in the coming months notably in line with a slowdown in global activity. But it should continue to underpin German economy. Domestic demand should also be sustained by the strength of firms investment and by the ongoing growth in private consumption. Moreover, this slowdown comes after a strong growth of activity at the beginning of the year. The manufacturing PMI, down by 4.2 points in May (to 57.7), still suggests a rise in activity.

Low Italian GDP growth in Q1 2011

The contribution of net exports to the GDP growth (+0.1% q/q, after +0.1% q/q in Q4 2010) was positive in Q1 2011 (+0.2 point) in line with an acceleration of exports expansion (+1.4% q/q, after +0.4%,q/q in Q4 2010) and with a slowdown in imports growth (+0.7% q/q, after +2.8% q/q). Indeed, the domestic demand growth was low. Private consumption and investment rose respectively by 0.2% q/q and by 0.1% q/q, whereas the contribution of inventories was negative (-0.3 point, after +0.9 point in Q4 2010). All in all, the domestic demand contribution to the growth was negative (-0.1 point).

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Clemente De Lucia

10 June 2011 11-22

Focus ECB: In a tightening mood

At its June meeting the ECB signalled its intention to raise key policy rates within one month. Inflationary pressure is building up; the tightening cycle will continue over the coming quarters. However, it will probably unfold at a moderate pace. Conditions in the peripheral countries remain difficult, and their banks are still heavily addicted to ECB liquidity. While there has been a de facto halt to the ECBs Securities and Market Program, the bank has decided to keep in place its non-standard lending measures. The ECB will continue to conduct its refinancing operation at full allotment until the end of Q3 at least. . Inflation and core inflation
3 ,8 3 ,3 2 ,8 2 ,3 1 ,8 1 ,3 0 ,8 0 ,3 - 0 ,2 - 0 ,7 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

C o r e in fla tio n H e a d lin e in fla tio n

E e s te r d is to r tio n

S o u r c e : E c o W in

Chart 1

Source: Eurostat

The tightening cycle will proceed

At its June meeting the ECB Governing Council left its key policy rate unchanged, signalling, however, that an interest rate hike within one month was likely. The code word strong vigilance which in the past had signalled a rate hike within one month was included in the communiqu following the two-day meeting. It looks likely therefore that the refi rate will be raised to 1.5% in July. The tightening cycle looks set to continue. President Trichet stressed that risks to price stability are on the upside. The ECB has raised upward its inflation projections for this year and let them almost unchanged for 2012. Admittedly inflation eased in May (to 2.7% from 2.8%, see chart 1), but this looks unlikely to be any more than a pause in a rising trend. Having been distorted in April by the late timing of Easter, core inflation probably eased in May, but is also likely to start trending higher, albeit at a moderate pace, over the coming months. Firms continue to pass on past price increases in commodities to final prices. Alternative measures of underlying price pressures, such as the trimmed mean, which excludes the most and least volatile components from the HICP each month and in the past has proved to be a good leading indicator of the traditional measures of core inflation, are on the rise. Lastly, ongoing growth in global activity - albeit at somewhat slower pace - will continue to keep oil prices at fairly high levels. Headline inflation will therefore rise over the coming months and could reach and exceed the 3% threshold by year-end, before easing next year. Other indicators confirm the build-up in price pressure. The output gap the difference between current output and the level of production which can be achieved using available production factors without generating inflationary pressure, or potential output is still

Underling measures of price pressures and output gap

3 ,5 T rim m ed m ea n (3 m m a ) E x e n erg y a nd u n pro ce sse d foo d O u tp u t g ap 3

3 ,0

1 2 ,5 0 2 ,0 -1 1 ,5 -2 1 ,0

-3

0 ,5 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

-4

Chart 2

Sources: Eurostat, BNP Paribas

negative, but it is closing, pointing to rising price pressures (see chart 2). It is, however, worth noting that there are two reasons for the narrowing of the gap. First, it is true that the recovery in the eurozone has strengthened, particularly in the first quarter of the year. GDP growth accelerated to 0.8% q/q in Q1 2011 from 0.3% q/q in the previous quarter, sustained by the sharp rebound of investment and by exports, while private consumption, constrained by still tough labour market conditions and the fiscal consolidation measures adopted in several eurozone countries, progressed at a much slower pace. The ECB has also revised upward its growth forecasts for this year. Secondly, however, it also seems likely that potential output has decreased as the disruption from the financial crisis has probably reduced the stock of capital and increased the structural rate of

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Clemente De Lucia

10 June 2011 11-22

unemployment. The European Commission and the ECB are forecasting a potential GDP growth rate for the eurozone of around 1-1.2%, while before the crisis it was close to 2%.

Relationship between disposable income and Euribor

12,0 Spain 10,0 8,0 6,0 Eurozone 4,0 2,0 0,0 0 -2,0 -4,0 1 2 3 4 5 6 y = -0,9811x + 6,6332 y = -1,9853x + 12,481

..but at moderate pace

However, the picture for the eurozone as a whole masks deep differences between countries. Core countries, especially Germany, are doing pretty well. Activity in Germany has even come back to its pre-crisis level. However, conditions in peripheral countries are extremely different, with activity either showing very low growth or even contracting. Internal divergences within the zone are a problem for setting a common monetary policy and will remain so. The ECB will continue to set interest rates for the eurozone as a whole as it has done in the past. The Bank would place itself in a very difficult position if it were to be perceived to be setting the interest rate with a view to economic conditions in a particular country or group of countries rather than for the region as a whole. This said, internal divergences will probably affect at least two aspects of ECB monetary policy: the pace of monetary tightening and the exiting of non-conventional lending measures. As regards the first point, it is likely that the ECB will continue to raise rates every three months, while in the previous tightening cycle, the Bank raised rates within 2 months (at least for a part of the cycle). An interest rate hike is likely to be more damaging for peripheral countries than for core countries. Spain and Portugal, for instance are among the countries with the most negative exposure to the ECB's monetary tightening cycle, since almost all their mortgages have variable rates and are indexed to Euribor. As shown in chart 3, disposable household income in Spain is much more sensitive to changes in Euribor interest rates than the eurozone average.

Chart 3

Sources: Eurostat, BNP Paribas

Yields on 2 year Government bond and the refi

6 G erm any R efi F rance Italy S pain

Although tensions in sovereign debt markets persist, the Securities and Market Program (SMP) has probably ended
The interest rate monetary transmission channel is not working properly at present. Under normal conditions monetary interest rates are transmitted along the yield curve, affecting the financing costs of firms and households. Higher policy rates would lead to higher government and corporate bond yields, to higher mortgage rates and higher interest rates. Prior to the financial crisis there was fairly strong correlation between all countries 2-year rates (where credit risks do not play a crucial role), and the policy rate. As shown in chart 4, the correlation between yields on 2-year German and French government bonds and the refi rate remains strong. However, this is no longer true for those countries more affected by the sovereign debt crisis (see chart 5). Funding costs for these economies are therefore much higher, as markets are extremely nervous regarding their fiscal positions. Conditions are also tougher for Italy and Spain (see again chart 4).

0 00 01 02 03 04 05 06 07 08 09 10 11

Chart 4

Sources: ECB, Reuters EcoWin Pro

Yields on 2 year Government bond and the refi

25 R e fi G re e c e P o rtu g a l

20

15

10

0 04 05 06 07 08 09 10 11

Chart 5

Sources: ECB, Reuters EcoWin Pro

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Clemente De Lucia

10 June 2011 11-22

In May 2010, when tensions in the sovereign debt markets intensified and the ECB launched its Securities and Market Program (SMP), interest rates on sovereign debt issues were below current levels. This would suggest that the SMP should be further increased. However, the ECB has de facto stopped the program at around EUR 75bn. The last time that the Bank intervened in the market was at the end of March 2011. In this way the ECB is increasing pressure on governments to find a solution to the debt crisis by sending a clear message that they cannot count on the ECB to solve fiscal issues, something that could damage its credibility and independence. To some extent this is bearing fruit. EU leaders are coming closer to an agreement regarding additional funding for Greece, which will help to cover its funding needs until mid-2014. Given that there are divisions in the ECB Governing Council where the SMP is concerned it is extremely unlikely that it will be expanded further.

Banking lending rates (to NFCs up to 1 year) and refi rate

9 8 7 6 5 4 3 2 1 0 2003Jan Spain Greece Refi EZ Portugal

2005Jan

2007Jan

2009Jan

2011Jan

Chart 6

Source : ECB

Further withdrawal of non-standard measures has been postponed

lending

EZ-US 2 years yield spread and exchange rate

1,60 1,55 1,50 1,45 1,40 1,35 1,30 1,25 1,20 1,15 06 07 08 09 10
Lehm an collapse (Novem ber 2010) Ireland Plan (Novem ber 2010)

2,5 EUR/USD 2 Year EUR-USD bond yield spread

G reek Plan (M ay 2010) Portugal Plan (April 2011)

The ECB will continue to support the peripheral economies through its non-standard lending measures. At its June meeting the Bank decided to continue to conduct all its refinancing operations with full allotment at least until the end of Q3. The ECB is currently allotting more than 60% of its liquidity to Greece, Portugal, Spain and Ireland, whereas these economies amount to only 16% of the Eurozone GDP. Portuguese, Greek, Irish and to a lesser extent Spanish, banks are still highly addicted to ECB liquidity, which suggests that they have problems in finding liquidity in the money market. Funding difficulties for the banking sectors are transmitted to the rest of the economy to some degree. Chart 6 shows the bank lending interest rates to non-financial corporations (NFCs up to 1 year and up to EUR 1 million) for some peripheral countries and for the eurozone as a whole. The common picture is that bank lending rates did not decline as much as the fall of the refi rate would have suggested (this was one reason why the ECB adopted non-standard lending measures during the crisis). Bank lending rates for the eurozone started to increase only moderately after the ECB announced in March 2011 that it intended to raise rates. However, this was not the case in peripheral countries where banking rates began to increase earlier and at a faster pace (again see chart 6), meaning that funding costs for these economies rose faster than the policy rate would have suggested. All in all, the ECB will continue its tightening cycle. Inflation is on the rise and the Bank will use its standard policy instruments, that is key rates, to maintain inflation in line with its objective of price stability in the medium term. In addition, the Council fears that leaving interest rates at low levels for too long could create distortions, favouring further imbalances. Nevertheless, the ECB decided to keep its nonstandard lending measures in place, as some segments of the money market are not working perfectly. The ECB is also the guarantor of the smooth functioning of the payment systems as stated in the Treaty (art. 105), and, as Mr Trichet has said more than once, whatever the interest rate, the money market has to function.

2,0 1,5 1,0 0,5 0,0 -0,5 -1,0 -1,5 -2,0

11

Chart 7

Source: Reuters EcoWin Pro

An unbalanced recovery and persistent tensions in financial markets will induce the ECB to proceed in its tightening cycle at a modest pace. Apart from anything else, the strong euro has the effect of tightening monetary and financial conditions, reducing the need for higher rates. Different monetary policy orientations on the two sides of the Atlantic are widening the yield spread between the US and the eurozone, strengthening the euro (see chart 7). The euro is likely to remain at elevated levels for a while (the OECD estimate of fair value is around 1.25, based on PPP for GDP), before easing next year when the Fed is expected to start its own tightening cycle.

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OECD countries

10 June 2011 11-22

Review of economic indicators United States

To watch from 13 to 17 June 2011
Retail sales (by value) rose 0.5% m-o-m in April. They probably fell in May -- the first fall since June 2010 -- due to a marked drop in vehicle sales (down 10.5% m-o-m in unit terms) as the motor industry was significantly disrupted by the consequences of the Japanese earthquake and tsunami (supply problems). This sector apart, sales probably remained more or less unchanged from one month to the next (a slight increase in petrol sales and a slight fall in sales of other goods). In the final analysis, retail sales may have dipped by around 1% on their April level (figure due out 14 June) In April, consumer prices rose sharply (0.4% m-o-m), driven most notably by the energy component. A moderation of this component in May will change the picture and suggests a much more modest increase in consumer prices (0.1% m-o-m expected, figure due on 15 June). Underlying prices probably grew at a similar rate to that in April (0.2% m-o-m), with some sectors managing to pass on higher input prices. Inflation is likely to come out at 3.3%, from 3.2%, its highest point since 2008. It would thus significantly outpace the increase in hourly wages (1.8% at present). Aprils industrial production showed no change, as it was hit by a sharp contraction in automotive production following the earthquake and tsunami in Japan. Outside the autos sector, activity rose. These trends are expected to change in May. Surveys of manufacturing (including autos) in May (and particularly the PMI index) all suggested a significant slowdown in activity due to disruptions to the supply chain. Thus, a slight dip in production looks likely (-0.2% m-o-m expected, figure due on 15 June).

From 3 to 10 June 2011

Labour market report (non-farm sector)
March April May 194 232 54 20 24 -5 179 213 80 8.8 9.0 9.1 2.1 2.1 2.1 33.6 33.6 33.6 Source : Department of Labor - Bureau of Labor Statistics Employment (m/m, 000) Manufacturing sector Private services Unemployment rate (%) Hourly wages (y/y, %) Hours worked per week EcoFlash 11-163

ISM surveys
ISM - manufacturing PMI Production New orders Employment Prices ISM - non manufacturing NMI Activity New orders Employment Overall (M&N) (*) Composite index (*) Activity/production (*) Employment (*) March 61.2 69.0 63.3 63.0 85.0 57.3 59.7 64.1 53.7 April 60.4 63.8 61.7 62.7 85.5 52.8 53.7 52.7 51.9 May 53.5 54.0 51.0 58.2 76.5 54.6 53.6 56.8 54.0

EcoFlash 11-162

57.7 53.7 54.5 60.2 54.9 53.6 54.8 53.2 54.5 Source: ISM - (*) manufacturing and non-manufacturing : weighted sums according to sector weights within GDP

Trade balance
USD bn, sa Goods and services Goods Services February -46.0 -59.7 13.7 Source: Department of Commerce March -46.8 -61.1 14.3 April -43.7 -58.1 14.4

EcoFlash

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OECD countries

10 June 2011 11-22

Japan
To watch from 13 to 17 June 2011 We expect core machinery orders to have strengthened in April by 4.5%, underpinned by the reconstruction effort (publication 12 June). It would be the second consecutive increase. Last month, the market had already been surprised by the increase in machinery orders by 2.9% in March, dispelling fears that investment demand would have been undermined by the uncertainty following the Great East Japan Earthquake.
Economy Watchers Survey
March Current Conditions Overall Household Business Employment Outlook Overall Household Business Employment Source: Cabinet Office 26.6 25.3 30.6 37.3 26.6 25.9 26.2 31.9 April 38.4 27.1 29.3 33.8 38.4 38.7 37.3 39.0 May 44.9 36.3 34.7 36.6 44.9 44.8 43.3 49.3 EcoFlash 11-164

From 3 to 10 June 2011

Gross Domestic Product (final estimate)
Changes in %, cvs q/q q/q ar y/y Private consumption Residential investment Non residential investment Public consumption Exportations Importations Source: Cabinet Office Q3 2010 0.9 3.6 4.8 0.8 1.9 1.0 -2.5 1.6 2.9 Q4 2010 -0.7 -2.9 2.4 -1.0 3.2 0.0 -6.0 -0.8 -0.3 Q1 2011 -0.9 -3.5 -0.7 -0.6 0.7 -1.3 -1.4 0.7 2.0 EcoFlash

Tertiary index
Changes in % Tertiary sector Source: METI m/m y/y February 0.8 2.0 March -5.9 -3.1 April 2.6 -2.4

EcoFlash 11-168

Leading and Coincident indicators

Leading indicator Coincident indicator Lagging indicator Source: Cabinet Office February 104.0 106.8 90.4 March 100.1 103.5 88.9 April 96.4 103.8 90.7

EcoFlash 11-164

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OECD countries

10 June 2011 11-22

Eurozone
To watch from 13 to 17 June 2011 In March, the eurozone industrial production was almost stable, falling by a mere 0.1% m/m after rising by 0.6% m/m in February. In April, it probably stabilised or rose marginally (to be released on 15 June). Survey data (industrial confidence indicator and PMIs) signalled that activity in the sector has already peaked and it should moderate going forward. Its underlying trend, measured by the 3-month rate of change, which smoothes the monthly volatility, was 1% in the three month ending in March, down from 1.7% in the three months to February. According to Eurostat flash estimate, inflation eased to 2.7% in May from 2.8% in April. The final reading (to be released on 17 June) is expected to confirm the preliminary estimate. The breakdown will probably show that core inflation, having been distorted in April by the late timing of Easter, probably moderated in May. Energy prices probably eased too, reflecting lower oil prices over the months. Going forward, headline inflation should resume however, trending higher, reaching and exceeding the 3% threshold by year-end, before easing next year.
Having risen sharply in March, French inflation continued upwards in April, coming out at 2.1% (from 2% in March). It may have paused for breath in May (figure due on 15 June), with a slowdown in the rise in energy prices (up 13.7% y/y in April) offsetting a fresh increase in food prices (0.6% y/y). However, inflation is likely to remain on a slight uptrend over the summer, with energy prices remaining high, food price inflation gathering pace and something of an increase in underlying inflation.

From 3 to 10 June 2011

Eurozone Gross Domestic Product
Changes in % q/q, sa Real GDP y/y Private Consumption Public Consumption Fixed Investment Exports Imports Contributions (points) Final domestic demand Inventories Net exports (contribution) Germany France Italy Spain Q3 10 0.4 2.0 0.2 0.2 -0.2 1.7 1.2 0.1 0.1 0.2 Q4 10 0.3 1.9 0.3 -0.1 0.0 1.7 1.3 0.2 -0.1 0.2 Q1 11* 0.8 2.5 0.3 0.8 2.1 1.8 1.9 0.8 0.1 0.0 EcoFlash

0.8 0.4 1.5 0.4 0.3 1.0 0.3 0.1 0.1 0.0 0.2 0.3 Source: Eurostat, Deutsche Bundesamt , INSEE, ISTAT, INE EcoFlash March 1.2 11.4 1.1 12.5
April

Germany Industrial production

Changes in %, sa Total, Manufacturing, Source : Bundesbank m/m y/y m/m y/y February 1.7 15.0 1.8 15.8 -0.6 9.6 -0.6 10.7

11-165

Germany- Manufacturing orders

Changes in % Total, February March m/m 1.9 -2.7 y/y 19.6 10.2 Domestic orders, m/m 2.1 -2.6 y/y 15.4 7.0 Foreing orders, m/m 1.7 -2.9 y/y 23.4 13.0 Source : Bundesbank -- monthly changes are seas. adj. April 2.8 10.5 2.1 6.7 3.4 13.9

EcoFlash

Germany Trade balance

Bn EUR, sa Trade balance Exports Imports February 11.3 84.7 73.5 Source : Statistisches Bundesamt March 15.1 90.9 75.8 April 12.0 85.9 73.9

EcoFlash

10

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OECD countries

10 June 2011 11-22

France Trade balance

EUR bn, SA Trade balance February -6.4 Exports 34.7 Imports 41.1 Source: Customs -- data FOB-FOB March -5.9 35.1 41.0 April -7.1 34.4 41.5

EcoFlash

United Kingdom
To watch from 13 to 17 June 2011 Inflation accelerated from 4.0% in March to 4.5% in April, its highest level since October 2008. The timing of Easter in 2011 had a significant impact on certain travel costs included in the CPI due to the collection periods for air transport, sea transport and international rail travel including the Easter holidays. This factor disappeared in May. Nonetheless, rising energy and food prices should have compensated this downward impact. Inflation is likely to have stabilised at 4.5% in May (data released on Tuesday 14 June). Despite the improvement of hiring intentions in manufacturing surveys, while the manufacturing cycle has already peaked, new budgetary measures are likely to affect the job market in the public sector but also in services. In this context, the Claimant Count number should have increased in May (data released on Wednesday 15 June), following its marked rise the previous month (+12.4K), while the jobless rate should be stable at 4.6% in May. In April, retail sales increased markedly (+1.1% m/m, the biggest increase since April 2002), following a small increase in March in (+0.3% m/m). The warm weather and the royal wedding contributed to this good performance, in particular in the clothing and food sectors. In May (data released on Thursday 16 June), these favourable conditions are unlikely to occur again and retail sales should be down by around 0.5% m/m.

France - Industrial production

Changes in %, SA-WDA February Overall industry * m/m 0.4 y/y 5.8 Manufacturing sector m/m 0.7 y/y 7.5 Source: INSEE -- * excluding construction March -1.1 3.2 -1.1 4.4 April -0.3 2.6 0.2 4.1

EcoFlash 11-167

Italy Gross Domestic Product

Changes in % q/q, sa Real GDP y/y Private Consumption Public Consumption Fixed Investment Exports Imports Contributions (points) Final domestic demand Inventories Net exports (contribution) Source: ISTAT Q3 10 0.3 1.4 0.4 -0.3 0.6 2.8 4.5 0.8 0.5 -0.5 Q4 10 0.1 1.5 0.3 -0.6 -0.8 0.4 2.8 0.8 0.9 -0.7 Q1 11* 0.1 1.0 0.2 0.5 0.1 1.4 0.7 -0.1 -0.3 0.2

EcoFlash

From 3 to 10 June 2011

Industrial output
%, m/m, s.a. Industrial output Mining, quarrying Manufacturing Electricity, gas, water Source : ONS February -1.4 -8.1 -0.1 -1.8 March 0.2 0.1 0.1 0.6 April -1.7 -0.4 -1.5 -5.0 Ecoflash 11-169

11

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OECD Team

10 June 2011 11-22

Markets overview
The essentials over the week
Week 6-6 11 > 9-6-11
CAC 40 S&P 500 Volatility (VIX) Euribor 3m (%) Libor $ 3m (%) OAT 10y (%) Bund 10y (%) US Tr. 10y (%) Euro vs dollar Gold (ounce, $) Oil (Brent, $) 3 891 1 300 18.0 1.44 0.25 3.37 3.04 2.99 1.46 1 538 115.1 3 879 1 289 17.8 1.46 0.25 3.39 3.04 3.00 1.45 1 540 119.1 -0.3 -0.9 -0.2 +2.8 -0.2 +2.0 +0.2 +0.3 -0.4 +0.1 +3.4 % % % bp bp bp bp bp % % %

CAC 40
4 200 4 000 3 800 3 600 3 400 3 200 3 000 2 800 2 600 2 400 2009 2010 09 June 2011 3 879

10 year bond yield, %

4.00 3.75 3.50 3.25 3.00 2.75 2.50 2.25 2.00 2009 2010 3.00 3.04

Euro Dollar
1.55 1.50 1.45 1.40 1.35 1.30 1.25 1.20 1.15 2009 2010 1.45

09 June 2011

09 June 2011

Bunds

US Treasuries

Money & Bond Markets

Interest Rates
BCE Eonia Euribor 3 month Euribor 12 Month $ Federal Reserve Libor 3 month Libor 12 month Bank of England Libor 3 month Libor 12 month Au 9-6-11 1.25 1.30 1.46 2.16 0.25 0.25 0.72 0.50 0.82 1.58

highest 11
1.25 1.43 1.46 2.17 0.25 0.31 0.80 0.50 0.83 1.61 le le le le le le le le le le 13/04 21/04 09/06 05/05 03/01 14/02 09/02 03/01 24/05 08/04

lowest 11
1.00 0.35 1.00 1.50 0.25 0.25 0.72 0.50 0.76 1.51 le le le le le le le le le le 03/01 07/02 10/01 03/01 03/01 09/06 08/06 03/01 03/01 03/01

2011
+0.4% +0.5% +0.8% +0.1% +0.3% +0.4% +0.7%

2011() Yield (%)

+0.4% +0.5% +0.8% -7.4% -7.2% Euro MTS 5-7y Bund 2 year Bund 10 year OAT 10 year Entreprises BBB $ Treasuries 2y Treasuries 10y Entreprises BBB 3.83 1.60 3.04 3.39 4.97 0.43 3.00 4.23 0.84 3.28

highest 11
4.08 1.91 3.49 3.79 5.18 0.85 3.72 4.76 le le le le le le le le 01/04 04/05 11/04 11/04 01/02 08/02 08/02 08/02

lowest 11
3.51 0.80 2.87 3.29 4.81 0.40 2.96 4.15 le le le le le le le le 05/01 03/01 10/01 04/01 26/05 08/06 01/06 01/06

2011 2011()
+0.1% -0.5% +1.0% +1.4% +2.6% +0.9% +4.4% +5.2% +0.1% -0.5% +1.0% +1.4% +2.6% -6.7% -3.4% -2.7%

-3.0% Treasuries 2y -2.6% Treasuries 10y Capitaliss Au 9-6-11

1.55 le 09/02 3.97 le 09/02

0.84 le 09/06 +0.9% -2.4% 3.25 le 02/06 +3.5% +0.1% Perf. avec coupon rinvesti Greece (1328 pdb) Ireland (753 pdb) Portugal (718 pdb) Spain (239 pdb) Italy (166 pdb) Belgium (113 pdb) Austria (41 pdb) France (35 pdb) Finland (28 pdb) Netherlands(26 pdb) Germany

Yield curve (%)

4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 1W 1M 3 6 12 2A 5 7 10 30

Base Rates (%)

2.75 2.50 2.25 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25 0.00 2009 2010

2 year bond yield

2.00 1.75 1.50 1.25
1.25 0.25 09 June 2011

10y bond yield & spreads

16.33% 10.57% 10.23% 5.43% 4.70% 4.18% 3.45% 3.39% 3.33% 3.31% 3.04%

1.60

1.00 0.75 0.50 0.25 2009 2010 0.43 09 June 2011

9-6-11

9-6-10

BCE

Fed

Bunds

US Treasuries

Forex & commodities

EUR exchange rate versus
US Dollar Pound Sterling Suiss Franc Yen Australian Dollar Chinese Yuan Brazilian Real Russian Rouble Indian Rupee Au 9-6-11 1.45 0.89 1.22 116.22 1.37 9.39 2.30 40.30 64.90

highest 11
1.49 0.90 1.32 122.74 1.43 9.67 2.38 40.87 66.18 le le le le le le le le le 02/05 03/05 11/02 08/04 17/03 02/05 04/05 03/01 04/05

lowest 11
1.29 0.83 1.21 107.04 1.30 8.56 2.18 39.17 58.43 le le le le le le le le le 11/01 +8.1% 11/01 +3.4% 01/06 -2.4% 10/01 +6.8% 07/01 +4.4% 11/01 +6.3% 07/01 +3.4% 08/03 -1.6% 11/01 +8.2% Variations

Spot price in dollars Oil, Brent Gold (ounce) Metals, LMEX Copper (ton) CRB Foods wheat (ton) Corn (ton) Au 9-6-11 119.1 1 540.0 4 086.2 9 040.0 502.7 281.0 306.3

highest 11 126.6 le 28/04 1 552.1 le 06/06 4 478.4 le 14/02 10 179.5 le 14/02 513.6 le 05/04 329.1 le 09/02 306.3 le 09/06

lowest 11 93.8 le 04/01 1 325.9 le 25/01 3 925.6 le 23/05 8 679.8 le 11/05 443.7 le 04/01 238.0 le 15/03 225.0 le 07/01

2011() +18.6% +0.5% -10.3% -13.4% +5.6% -9.4% +21.8%

Variations

12

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OECD Team

10 June 2011 11-22

Markets overview -suiteOil, Brent ( $ )

130 120 110 100 90 80 70 60 50 40 30 2009 2010 09 June 2011 119

CRB Foods ( $ )
540 510 480 450 420 390 360 330 300 270 2009 2010 09 June 2011 503

Metals (LMEX, $)
4 800 4 400 4 000 3 600 3 200 2 800 2 400 2 000 1 600 2009 2010 09 June 2011 4 086

Gold ( $ )
1 600 1 500 1 400 1 300 1 200 1 100 1 000 900 800 2009 2010 09 June 2011 1 540

Equity indices
highest 11 World
MSCI World 1 308 1 289 275 3 879 7 160 10 122 5 856 578 813 1 142 2 703 18 385 63 469 1 941 1 392 le 02/05 1 364 le 29/04 297 4 157 7 528 11 113 6 091 le le le le le 18/02 18/02 02/05 17/02 08/02 1 260 le 16/03 1 257 le 16/03 267 3 697 6 514 9 438 5 598 le le le le le 16/03 16/03 16/03 10/01 16/03 2.2% 2.5% 0.1% 1.9% 3.6% 2.7% -0.7% -7.6% -9.6% -5.5% -5.2% 0.1% 1.9% 3.6% 2.7% -4.0% -12.9% -15.3%

Performance by sector (DJStoxx Europe)

lowest 11 2011 2011()
Year 2011 to 9-6,
+6.2% +4.5% +4.5% +4.1% +1.1% +0.1% -0.1% -0.5% -0.8% -1.2% -1.4% -2.4% -3.0% -3.0% -3.5% -3.9% -5.0% -8.1% -12.2% Real Estate Health Insurance Chemical Car Food industry Industry Technology Construction Consumption Goods Utilities Oil & Gas Retail Financial services Media Telecoms Banks Travel & leisure Commodities

North America
S&P500

Europe
DJ Euro Stoxx France, CAC 40 Germany, DAX 30 Spain, IBEX 35 UK, Footsie 100

Asia
MSCI, loc. Japan, Topix 663 le 18/02 975 le 21/02 1 206 3 057 20 561 71 633 2 124 le le le le le 02/05 18/04 03/01 12/01 08/04 560 le 15/03 767 le 15/03 1 087 2 677 17 463 62 345 1 765 le le le le le 24/02 25/01 10/02 23/05 23/05

Emergents
MSCI Emergent ($) China, Shanghai comp. India, BSE 30 Brazil, Bovespa Russia, RTS Au 9-6-11 -0.8% -8.3% -3.7% -9.4% -10.4% -17.1% -8.4% -11.4% 9.6% 11.4% Variations

S&P 500
1 400 1 300 1 200 1 100 1 000 900 800 700 600 2009 2010 09 June 2011 1 289

Volatiliy (VIX, S&P 500)

60.00 54.00 48.00 42.00 36.00 30.00 24.00 18.00 12.00 2009 2010 17.77 09 June 2011

MSCI World ( $ )
1 400 1 300 1 200 1 100 1 000 900 800 700 600 2009 2010 09 June 2011 1 308

MSCI Emergent ( $ )
1 300 1 200 1 100 1 000 900 800 700 600 500 400 2009 2010 09 June 2011 1 142

13

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10 June 2011 11-22

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Economic Research Department

Philippe d'ARVISENET Chief Economist Jean-Luc PROUTAT Head of OECD Countries Caroline NEWHOUSE Country economics Alexandra ESTIOT Structural issues, European Financial Integration UNITED STATES, CANADA Jean-Marc LUCAS JAPAN, AUSTRALIA, NEW ZEALAND, BENELUX, PENSIONS, LONG TERM FORECASTS Raymond VAN DER PUTTEN EURO ZONE, ITALY, EURO ZONE LABOUR MARKET Clemente De LUCIA FRANCE, EURO ZONE PUBLIC FINANCES Frdrique CERISIER GERMANY, AUSTRIA, SWITZERLAND, EU ENLARGEMENT Catherine STEPHAN SPAIN, PORTUGAL, GREECE, IRELAND Thibault MERCIER UNITED KINGDOM, NORDIC COUNTRIES Caroline NEWHOUSE BANKING ECONOMICS Laurent QUIGNON Head Cline CHOULET Laurent NAHMIAS COUNTRY RISK Guy LONGUEVILLE Head Franois FAURE Deputy Head Capital flows to emerging markets,Turkey ASIA Delphine CAVALIER Christine PELTIER LATIN AMERICA Sylvain BELLEFONTAINE Valrie PERRACINO-GUERIN AFRICA Stphane ALBY Jean-Loc GUIEZE EASTERN EUROPE Central Europe, Baltic countries, Balkan countries Alexandre VINCENT RUSSIA, FORMER SOVIET REPUBLICS Anna DORBEC MIDDLE EAST SCORING Pascal DEVAUX 33 1.43.16.95.58 philippe.darvisenet@bnpparibas.com

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