Promising Beginning of Year in Hungary, Vulnerable Global Economy

Transcription

1 Promising Beginning of Year in Hungary, Vulnerable Global Economy A macroeconomic analysis by the Hungarian Development Bank Chief economist: Erzsébet Gém Authors: Erzsébet Gém Álmos Mikesy Zsolt Szabó Co-author: Klaudia Stankovits MFB Zrt. Closing date of the analysis: 1st July 13

2 Executive summary Global economic prospects did not improve considerably in the last six months, which indicates that the recovery from the crises will be still long lasting. Since the middle of 12 the international trade has been growing at an annual rate of around, well behind the long term average, and growth indices do not point toward acceleration in the short term. The G group of the world s major economies, and in particular the BRIC countries functioning as the engine of world economy in the last decade, faced further slowdown in growth in the beginning of 13, causing increasing concerns especially over the outlook for China. Among developed countries, the US economy is growing at the highest rate (1. y/y in Q1 13), which however represents a significant slowdown compared with 12. The eurozone has been in recession for the sixth consecutive quarter, and the majority of forecasts for 13 project a year-on-year decline of.: continued deleveraging, high unemployment, slackening lending and uncertain business prospects continue to restrain domestic demand through its two components, notably consumption and investments. According to projections, an increase in net exports driven by the international economic upturn along with a slight growth in consumption supported by low inflation and slowly improving income trends will help the eurozone s economy pick up in the second half or at the end of this year. However, these processes are rather uncertain, so the eurozone s recovery is likely to remain fragile for a long time, especially because there is still no sign of effective government intervention to support growth. The governments policies to reduce general government deficit have brought some progress, although to varying degrees in different countries, but no best practices for stimulating growth are available, and the negotiations on deepening integration have also slowed down. The unconventional central bank policies had beneficial effect on liquidity in money and capital markets and therefore on asset prices, although their ability to boost growth remains questionable. The Fed s monthly USD 85 billion asset purchase programme launched in the beginning of the year strengthened risk appetite in the markets in the first five months of the year: government bond yields declined, US and eurozone interbank and commercial bank rates stagnated or fell, equity markets soared, and there was also strong demand for emerging market assets. On the other hand, the vulnerability of money and capital market processes is indicated by the fact that even an allusion to the possible end to the Fed s programme could trigger a major adjustment in international financial markets in the middle of May. It became clear that quantitative easing is an important financial umbilical cord, and the timing, manner and phasing of cutting it is a highly sensitive issue. Amid abundant global liquidity, there was also high demand for Hungarian financial assets. The enhanced risk appetite which lasted until May pushed down Hungarian government bond yields to a record low, and the BUX index outperformed the regional average in the first six months, despite the surtaxes levied on certain sectors and the equity market adjustments in May. Unfortunately, the Hungarian forint hardly benefited from the favourable investor sentiment, as its attractiveness was reduced by the decline in bond yields in domestic markets, caused by the rate cutting cycle continued by the central bank in 13, and then the rise in yields in developed markets, which started in May. The favourable international climate was ideal for continuing the regular monthly 25-basis-point rate cuts, in the last step of which the Monetary Council of the Hungarian central bank (NBH) lowered the policy rate to 4.2 in June. The rate cutting cycle was originally launched to accelerate slower than potential economic growth, but later it was also supported by the inflation rate, which had sunk to a record low since the beginning of the year. The decreasing base rate drove down the interbank and commercial bank rates in Hungary, but further rate cuts will basically depend on the development of the international financial environment in the coming period. Investors demand for Hungarian assets was increased by, among other things, the sustained improvement in Hungary s external and internal balance. The general government deficit to GDP ratio was 1.9% in 12, and having forecast a deficit to GDP ratio of 2. and 2.9% for this year and next year, respectively, the European Union put an end in June the excessive deficit procedure launched against Hungary in 4. The improvement in external balance, which started years ago, continued in the first quarter of 13: according to the data of financial accounts, foreign debt repayments by Hungarian economic actors stood at 7. of GDP, and therefore (among other factors) net external debt dropped to 39. (a level unseen since early 7). Continued deleveraging coupled with increasing financial savings in the Hungarian private sector resulted in a strong external financing capacity: net household and corporate savings reached 5. and 3. of GDP, respectively, while the financing requirement of general government only amounted to 2. of GDP in the first quarter of 13. On the other hand, a significant increase in net private sector savings may, through reduced domestic demand, hold back 2

3 economic growth in the short term, and it also reflects the uncertainty of economic actors and business prospects, as well as the postponing of planned developments. Household and corporate incomes are on a downward trend due to the slack in the labour market, uncertainty about economic recovery and weak corporate profitability. This trend reduces and restrains corporate and household consumption and investments, also held back by the contraction of lending, which began in the autumn of 8 and is not likely to change before the middle of next year. The above are reflected by the level of domestic demand, which has been continuously falling, and thus slowing down or impeding the growth of the Hungarian economy, for years. Following a 1. economic decline in 12, Hungary s GDP expanded by. quarter-on-quarter in the first quarter of 13, although it represents a. decline in year-on-year terms. On the final use side, investment shrank by another 5. on a year-on-year basis, while household consumption fell by.. On the other hand, data showing an increase in retail trade and improving consumer confidence indices point towards an upturn in the latter, and the increase in net wages in the beginning of the year, the improvement in the labour market, the considerable reduction in inflation and the significant overhead cut may also help consumption to pick up. Consequently, consumption is expected to slightly expand on a year-on-year basis in 13. As a result of an external upswing, net exports grew yet again early this year, and trade surplus hit record high once more due to the restrained domestic consumption of import goods, which accompanied the accelerating exports. The growth in exports was attributable to an increase in manufacturing exports, although on the production side of GDP as a pleasant surprise construction and agriculture made a positive contribution to GDP growth in the first quarter, while production declined in industry and the manufacturing. However, industrial production revived in the spring months, and both Hungarian and German business expectations suggest that it will positively contribute to this year s GDP growth from the second quarter, and so will the agricultural sector, the output of which was very low last year. Overall, Hungary s GDP is expected to grow by about half percent in 13, accompanied by a record low inflation rate of around 2. and a slightly improving labour market conditions. Ezsébet Gém chief economist 3

4 World economy Slower than expected growth in both developed and emerging regions of the global economy Following continued improvement in early 13, expectations deteriorated increasingly after the spring and foreshadow slower than expected global growth this year (Chart 1). World trade is still growing at a rate that is lower than the long term average (Chart 2) and, according to the growth prospects in both developed and emerging markets, no substantial change can be expected in the remaining part of the year (Charts 3-4). In the developed world, the US was the only country that showed convincing GDP growth in the first quarter: while household consumption fuelled by improving labour market conditions and rising real estate prices has a pulling effect on the US economy, declining government purchases caused by fiscal problems and worsening industrial figures present risks. In the eurozone, the new monetary policy direction taken by the European Central Bank (ECB) eased money market tensions, but its effects on the real economy are yet to be felt. Long term (investment) decisions in the non-financial sector were adversely affected by the crisis in Cyprus, which revived debt crisis fears. The outcome of Japan s new economic policy is also questionable: based on the experiences of the past years, a significant increase in the monetary base will not necessarily lead to accelerating inflation, and the rebounding of economic growth remains uncertain without structural reforms (Chart 5). Emerging economies also face heavy slowdown: the Chinese growth rate is falling as a result of a combination of a worsening external environment and internal tensions. Another BRIC country that seems to be vulnerable is Brazil: as a result of the upsurge in inflation caused by monetary easing, the central bank may decide to take monetary tightening measures this year, which may further hamper the already slow growth (Chart 6). Chart 1: World economy climate Chart 2: Outlook of the world economy (OECD CLI*) and the world export (y/y) Sources: Ifo World Economy Survey (WES), MFB Q Q Q Q Q Q Q Q Q Q Q1 Q3 Q1 1 Q3 1 Q1 2 Q3 2 Q1 3 Q3 3 Q1 4 Q3 4 Q1 5 Q3 5 Q1 6 Q3 6 Q1 7 Q3 7 Q1 8 Q3 8 Q1 9 Q3 9 Q1 1 Q3 1 Q1 11 Q3 11 Q1 12 Q3 12 Q1 13 Economic expectations (by the end of the next 6 months) Current economic situation ** 3-month rolling average Sources: CPB, OECD, MFB OECD CLI (LHS) * OECD Composite Leading Indicator: OECD members World export** (RHS) + Brazil, China, India, Indonesia, Russia, South Africa World export long-term average growth between and 1 (RHS) Chart 3: Business climate* in certain area of the global economy (January 7 = %) Chart 4: Economic expectations in the BRIC countries % % 9 9 % % 7 7 % % Eurozone China USA Germany *Eurozone: ESI Index, China: PMI Index, USA: ISM Index, Germany: IFO Index 95 Sources: OECD, MFB 9 Brazil Russia China India Chart 5: GDP growth in certain area of the global economy (y/y) Chart 6: GDP growth in the BRIC* countries Q *Brazil, Russia, India, China * annual rate Q3 6 Q1 7 Q3 7 Q1 8 Q3 8 Q1 9 Q3 9 Q1 1 Q3 1 Q1 11 Q3 11 Q1 12 Q3 12 Q1 13 Q1 6 Q3 6 Q1 7 Q3 7 Q1 8 Q3 8 Q1 9 Q3 9 Q1 1 Q3 1 Q1 11 Q3 11 Q1 12 Q3 12 Q1 13 Japan Eurozone Germany USA* Brazil Russia India China 4

5 Inflation in the world economy Low economic activity and falling commodity prices lead to reduced inflationary pressure Global crude oil prices showed a decline of 5. in year on year terms in the first half of this year (average daily quote: 17.5 USD/barrel). The price of the black gold has been held back by the shrinking Chinese demand in the first place, while its lower limit is set by OPEC through the regulation of supply, a permanent reduction in oil production in some non-opec countries (e.g. Syria, Yemen and Sudan), and geopolitical risks (mainly the embargo on Iran). In the light of expectations of the strengthening US dollar, the price of crude oil and other dollar-denominated assets may go up in the second half of the year (Chart 1). The vast majority of commodity market products also became cheaper in the first half of this year: significant price declines of over emerged in the markets of silver, gold and corn, and the prices of several metals and food ingredients were also more than lower than in the end of last year (Chart 2). Slackening economic activity along with falling commodity prices eased inflationary pressures all over the world. The US consumer price index dropped to a record low unseen since 9 (April 13: 1. yoy). In China, prices rise at a permanent rate of and are also driven up by the effect of loans provided by the shadow banking system, which poses a risk owing to the limited influence of monetary policy in this respect (Charts 3-4). Residing at 1. in May 13, the eurozone s consumer price index implies that there is space for further monetary easing. The deceleration in price growth was primarily driven by a decline in fuel prices and a weak internal demand. The German inflation rate jumped from 1. in April to 1. in May as a result of rising food prices (Charts 5-6). Chart 1: Commodity price indices and world crude oil price Chart 2: Changes in commodity prices by the S&P GSCI spot price ( = %) CRB commodity price index (LHS) Brent Crude Oil (RHS) CRB foodstuff price index (LHS) $/barrel Livestock Energy S&P GSCI Commodity index Brent Crude Oil Zinc Soya Lead Platinum Sugar Industrial metals Copper Aluminium Wheat Nickel Corn Gold Silver % 7 % 9 % Chart 3: Consumer price index and core inflation rate in the USA (y/y) Chart 4: Consumer prices in China (y/y) 12, 1, Sources: NBSC, MFB 2 7, 5, ,, -2, Core inflation CPI CPI - non-food (LHS) CPI (LHS) CPI - food (RHS) Chart 5: Consumer prices in the eurozone (y/y) * Harmonised index of consumer prices month inflation rate* (RHS) Food prices (LHS) Energy prices (LHS) Chart 6: Consumer prices in Germany (y/y) Sources: Eurostat, MFB * Harmonised index of consumer prices month inflation rate* (RHS) Food prices (LHS) Energy prices (LHS) 5

6 United States The US economy is outperforming its global competitors The US economy is expected to grow at a rate of around this year, but according to the forecast its growth rate may accelerate to by 14. The figure for the first quarter was 1. year over year, and. on a quarter-on-quarter basis. This faster-than-expected growth was primarily the result of an upsurge in household consumption and a higher than usual inventory accumulation (Charts 1 and 2). The US economy is likely to slow down in the second quarter, because the entry into force of fiscal cuts had negative effects on household purchases, and the impact of inventory accumulation is likely to be lower. Consumption trends may be heavily influenced by the imminent fiscal austerity measures: household expenditures may be adversely affected by the tax hikes and government spending cuts. On the other hand, no significant decline can be observed in retail trade yet, which may be the joint result of a sustained improvement in employment, a reduction in the rate of household savings, and an increase in consumer lending, accompanied by the favourable impact of a low rate of inflation (Charts 3-4). Deterioration in expectations is indicated by the fact that the processing industry s ISM index hit a four-year low in May 13: both the indicator of production and the indicator of new orders dropped below 5 points, which are signs of decline. The United States balance of trade showed significant improvement in the first quarter: both exports and imports shrank (with imports falling more than exports), which is another indication of sluggish economic activity (Charts 5-6). Considering that these latter trends contradict the improving trends in the labour market and may call for caution in monetary policy, no significant reduction in quantitative easing is likely over the short term in the US * seasonally adjusted data Chart 1: GDP growth* in the USA Quarter/quarter (LHS) Year/year (RHS) Sources: Eurostat, MFB Q1 5 Q2 5 Q3 5 Q4 5 Q1 6 Q2 6 Q3 6 Q4 6 Q1 7 Q2 7 Q3 7 Q4 7 Q1 8 Q2 8 Q3 8 Q4 8 Q1 9 Q2 9 Q3 9 Q4 9 Q1 1 Q2 1 Q3 1 Q4 1 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Q percentage point 7,5 5, 2,5, -2,5-5, -7,5-1, Chart 2: Contribution of the main components to GDP growth in the USA Q1 8 Q2 8 Q3 8 Q4 8 Q1 9 Q2 9 Q3 9 Q4 9 Q1 1 Q2 1 Q3 1 Q4 1 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Q1 13 Gross fixed capital formation Household consumption Government spending** Sources: BEA, MFB * federal; ** state and local Net export Government spending* Chart 2: Retail sales, personal savings, consumer credit in the USA 1, 7, 5, 2,, -2, -5, -7, Sorces: St. Loius Fed, Reuters, MFB Retail sales (y/y, RHS) Personal saving* (as % of disposable income, LHS) Consumer credit* (y/y, LHS) *3-month rolling average Chart 5: ISM Manufacturing index* in the USA thousand people Chart 4: Employment and unemployment in the USA 1 9% Changes in private sector's employment (m/m, LHS) Unemployment rate (RHS) Sorces: St. Louis Fed, MFB Chart 6: US trade balance during the first quarter (-13) Sources: St. Louis Fed, MFB * seasonally adjusted data 5 3 $ billion ISM index (Production) ISM index (New orders) ISM index (Composite) -1 - Sources: St. Loius Fed, MFB

7 China Shrinking global demand and domestic tensions explain China s economic slowdown Refuting expectations, the growth of China s economy slowed down in Q1 of this year: compared with a growth rate of 7.9% in Q4 12, the GDP only grew by 7. (y/y) between January and March owing to a lower increase in investments (Charts 1-2). (The growth rate for this year is likely to be around 7. in contrast to the projected.) This deceleration is increasingly reflected by market prices, as shown by the relatively poor performance of the Shanghai Stock Exchange Composite Index (Chart 3) amid the global stock market rally. The return of the double-digit growth pattern of the past years is not likely over the short term for three main reasons: continued low external demand, the reforms launched by the new political leadership, and tensions in the financial system. Following the continuous and rather fast deceleration of the growth in Chinese exports since early 13, exports from China to both the eurozone and the US shrank (y/y) in the second quarter of this year. A reduction in exports to the US has been unprecedented since the deepest crisis in 9, and the development of the PMI also implies that growth driven by industrial exports will not return (Charts 4-5). The declining performance of exports and investments may be explained, among other things, by the fact that the new leadership intends to reduce dependence on global demand and to mitigate domestic (social and regional) inequalities by promoting the strengthening of consumption and the service sector. On the other hand, economic growth is highly dependent on whether or not the Chinese central bank will tighten the rules of non-bank lending (i.e. the shadow banking system), and if so at what pace, because it poses a significant risk to financial stability despite its substantial contribution to growth until now through, among other things, the boost to the property sector (Chart 6). Chart 1: GDP growth and business climate in China Chart 2: The main components' contribution to GDP growth (y/y) Source: National Bureau of Statistics, China (NBSC), MFB *Business Climate Index percentage points Q1 Q3 Q1 1 Q3 1 Q1 2 Q3 2 Q1 3 Q3 3 Q1 4 Q3 4 Q1 5 Q3 5 Q1 6 Q3 6 Q1 7 Q3 7 Q1 8 Q3 8 Q1 9 Q3 9 Q1 1 Q3 1 Q1 11 Q3 11 Q1 12 Q3 12 Q1 13 Business climate* (LHS) GDP growth (y/y, RHS) -5 Q1 9 Q2 9 Q3 9 Q4 9 Q1 1 Q2 1 Q3 1 Q4 1 Gross fixed capital formation Final consumption Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Q1 13 Net export of goods and services Chart 3: The Chinese Shanghai Composite and the US S&P equity indices ( = %) Chart 4: China's export (y/y, 3-month rolling average) 1 S&P Shanghai Composite % % % % Chart 5: Purchasing Manager Index (PMI) in China Chart 6: House prices in China , 1, 1,, Month/month (LHS) Year/year (RHS) 45 45, PMI - Manufacturing PMI - New export orders Sources: NBSC, MFB ,,, -, -, Sources: NBSC, MFB World Eurozone USA

8 Eurozone High unemployment, plummeting investments and protracted recession in the eurozone The eurozone has been in recession for one and a half years, including the first quarter of this year. Between January and March 13, the rate of decline was 1. year over year, and. compared to the last three months of 12. Overall, the GDP of the monetary union may shrink by nearly 1. this year. While the change in monetary policy announced by the European Central Bank in the middle of last year eased market tensions considerably, it has not led to any improvement in the real economy until now. Growth is still hampered by domestic demand, household consumption and corporate investments (Charts 1-2). The growth of domestic demand is restrained by fiscal tightening and a record high unemployment rate (Chart 3), while corporate investments are influenced simultaneously by a number of braking forces, which keep the gross fixed capital formation in the eurozone more than below their level in 5 (Chart 4). Long term corporate planning is impeded by debt crisis fears, which strengthened as a result of internal political problems in the beginning of the year (Italy, France) and then by the Cypriot and the Slovenian crises, despite the easing of market tensions by monetary policy measures. Under these circumstances, corporate prospects remain far below the long term average, near their level in 8 and 9 (Chart 5). Although the costs of sovereign debt financing decreased, improving money market sentiment has not resulted in better corporate lending conditions until now: according to the lending survey conducted by the ECB in April 13, the percentage of the credit institutions intending to tighten corporate lending conditions in the next three months is still higher than those that do not, although their majority is lower, except in the market of short term credit products (Chart 6). Chart 1: GDP growth* in the eurozone Chart 2: Contribution of the gross fixed capital formation and household consumption to GDP growth Greece* Spain Portugal Cyprus Slovakia Ireland Eurozone Italy France Slovenia Estonia* Belgium Finland Netherlands Malta Luxembourg Germany Austria * seasonally adjusted data Quarter/quarter (LHS) Year/year (RHS) Sources: Eurostat, MFB Q1 5 Q2 5 Q3 5 Q4 5 Q1 6 Q2 6 Q3 6 Q4 6 Q1 7 Q2 7 Q3 7 Q4 7 Q1 8 Q2 8 Q3 8 Q4 8 Q1 9 Q2 9 Q3 9 Q4 9 Q1 1 Q2 1 Q3 1 Q4 1 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Q1 13 Chart 3: Unemployment rate in the eurozone (April 13) *March 13 Sources: Eurostat, MFB Chart 5: Economic sentiment in the eurozone percentage point % 9 % 7 % Q1 7 Q2 7 Q3 7 Q4 7 Q1 8 Q2 8 Q3 8 Q4 8 Q1 9 Q2 9 Q3 9 Q4 9 Q1 1 Q2 1 Q3 1 Q4 1 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Q1 13 Gross fixed capital formation Sources: Eurostat, MFB Household consumption expenditure Chart 4: Investment in some eurozone member countries (5=%, seasonally adjusted data) Sources: Eurostat, MFB Q1 5 Q3 5 Q1 6 Q3 6 Q1 7 Q3 7 Q1 8 Q3 8 Q1 9 Q3 9 Q1 1 Q3 1 Q1 11 Q3 11 Q1 12 Q3 12 Q1 13 Eurozone Germany Spain France Italy Chart 6: Changes in bank's credit standards* over the next three months in the eurozone 1 1 % 9 % 7 % Sources: ECB, MFB Long-term average (1985-1) Average between 8 and 9 ESI sentiment indicator Source: European Commission, MFB Q1 7 Q2 7 Q3 7 Q4 7 Q1 8 Q2 8 Q3 8 Q4 8 Q1 9 Q2 9 Q3 9 Q4 9 Q1 1 Q2 1 Q3 1 Q4 1 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Q1 13 Q2 13 Loans to large enterprises SME loans *net percentage: difference between the percentage for "tightening" and the percentage for "easing" Long-term loans Short-term loans 8

9 Germany German growth is slowed down by the decline in global demand and the crisis in the eurozone also Even the German economy was unable to detach itself from the impact of the Eurozone s recession and the decline in global trade in the first quarter: as a result, the German GDP has for the first time since the last three months of 8 shrunk on a year-onyear basis (-,), even though it showed. growth compared with the period from October to December 12 (Chart 1). Germany is not likely to function as the economic engine of the continent this year, considering that its GDP may only grow by around. in 13. This is primarily the result of a significant fall in investments, and net exports minimal contribution to the GDP was only made possible by a decline in imports. On the other hand, household consumption increased (Chart 2) thanks to the favourable situation in the labour market. A new flare of the European debt crisis (Cypriot crisis, Italian political deadlock) and the unusually cold weather in March (delaying construction projects) also contributed to the decline in investments. Confidence indicators suggest that corporate developments may increase in the second quarter, but no significant growth can be expected in the remaining part of the year owing to the poor growth prospects (Charts 3-4). As a result of the shrinking of global (primarily Chinese and US) demand, German exports have fell for the first time since 9 (on a year-on-year basis). Considering that the slowdown of Chinese growth seems to be long-lasting and the eurozone faces protracted recovery, a fast upturn in exports remains unlikely in the second half of the year (Chart 5). Owing to the low level of investments, the rate of productivity improvement may remain behind the rate of wage growth (Q1 13: +3.), which may lead to a rise in labour costs and erode the competitiveness of German exports (Chart 6). Chart 1: GDP growth* in Germany Chart 2: Contribution to GDP (q/q) * seasonally adjusted data Quarter/quarter (LHS) Year/year (RHS) Sources: Eurostat, MFB Q1 5 Q2 5 Q3 5 Q4 5 Q1 6 Q2 6 Q3 6 Q4 6 Q1 7 Q2 7 Q3 7 Q4 7 Q1 8 Q2 8 Q3 8 Q4 8 Q1 9 Q2 9 Q3 9 Q4 9 Q1 1 Q2 1 Q3 1 Q4 1 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Q percentage points Q1 8 Q2 8 Q3 8 Q4 8 Q1 9 Q2 9 Q3 9 Q4 9 Q1 1 Q2 1 Q3 1 Q4 1 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Q1 13 Household consumption expenditure Investment Net export Chart 3: Economic sentiment indicators in Germany Sources: ZEW, CESifo, MFB ZEW index (LHS) IFO index (RHS) Chart 5: 5: The The world export and and the German export Chart 4: Invesments and business climate (IFO index) in Germany Q1 7 Q2 7 Q3 7 Q4 7 Q1 8 Q2 8 Q3 8 Q4 8 Q1 9 Q2 9 Q3 9 Q4 9 Q1 1 Q2 1 Q3 1 Q4 1 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Q1 13 Residential buildings (y/y, LHS) Non-residential buildings (y/y, LHS) Machines and equipments (y/y, LHS) IFO index* (RHS) Sources: CESifo, Statistisches Bundesamt, MFB * quarterly average Chart 6: Compensation of employees and the unemployment rate in Germany * 3-month rolling average World export* (y/y) German export* (y/y) Sources: CPB, Statistisches Bundesamt (Wiesbaden), MFB % Q1 5 Q3 5 Q1 6 Q3 6 Q1 7 Q3 7 Q1 8 Q3 8 Q1 9 Q3 9 Unemployment rate (LHS) Compensation of employees* (RHS) Real compensation of employees* (RHS) Q1 1 Q3 1 Q1 11 Q3 11 Q1 12 Q3 12 Q * gross Sources: Eurostat, Statistisches Bundesamt, MFB 9

10 Monetary policy Markets are not yet prepared for the end of the use of unconventional tools Major central banks continue to face limitations in the application of conventional monetary policy: the prime rate is -.2 in the US and Switzerland,. in Japan and.5 in the UK, while the European Central Bank cut the policy rate to.5 in May (Chart 1). In its efforts to help the Japanese economy recover from its several-decade-long ailment, Japan s central bank decided to launch an aggressive asset purchase programme in May, but markets responded to it positively. In the US, the Fed has been buying USD 85 billion worth of financial assets each month in the secondary market since the start of the year in order to bring down long term interest rates. At the same time, its communication policy seems to place increasing emphasis on the slow-down of quantitative easing, partly in response to the better-then-expected macroeconomic indicators, and partly to prevent the formation of a bubble, as well as in preparation for a future exit strategy. These developments lowered risk appetite in markets across the world in the same way as the ending of the first and second asset purchase programmes did. The favourable investment climate which evolved in the first months of the year made the ECB to reduce its portfolio of securities purchased for monetary policy purposes earlier by approximately EUR billion. In other words, for the time being it relies mainly on verbal communication and interest rate cuts in helping drive down the Member States sovereign bond yields. Despite these efforts, besides the Bank of Japan, the European Central Bank had the largest bank balance sheet total relative to the GDP in June 13 (Charts 2-5). Facing a deceleration in recovery the central banks of the Central and Eastern European region responded to the deterioration of the macroeconomic environment partly by cutting interest rates and partly by maintaining unchanged policy rates (Chart 6). Chart 1: Central bank base rates in the US, the eurozone, the UK, Switzerland and Japan Chart 2: The Chicago PMI and monthly change of Fed funds rate (January June 13) Sources: ECB, Fed, SNB, BoE, BoJ, MFB 7 Change of Fed funds rate (RHS, m/m) Chicago PMI (LHS) 1,5 1, ECB Fed SNB BoJ BoE ,5, -,5-1, -1,5 percentage point $ billion Chart 3: The Fed balance sheet total and the global risk appetite ( ) the end of QE1 the end of QE Fed balance sheet total (LHS) increasing global risk appetite Sources: Fed, CBOE, MFB VIX index (RHS) - point, inverted scale point Chart 4: Change in stock of securities held by ECB for monetary policy purposes and the global risk appetite (VIX index) Sources: ECB, CBOE, MFB inceasing global risk appetite billion *VIX stands for the volatility index of the S&P and is often referred to as a global fear index VIX index (LHS) Changing in stock of securities (on a weekly basis, RHS) % 5 Chart 5: Balance sheet total of major central banks (September 7 = %) GDP proportional rate: % 35. Sources: Fed, ECB, BoE, BoJ, IMF, MFB Fed ECB Bank of England Bank of Japan % Chart 6: Central bank base rates in China, Russia, Hungary, Poland, Czech Republic and Romania Sources: the central banks' web sites, MFB China Romania Czech Republic Poland Hungary Russia 1

11 Liquidity of the international financial system Medium term risks arising from liquidity conditions in international financial markets remained low, while tensions grew in the Chinese financial system Despite the level of central bank rates and the intensity of monetary stimulus, the supply of broad money expanded at a relatively low rate of in the US, 2- in the eurozone and Japan, and only (y/y) in China in the spring months. However, the medium term liquidity outlook is favoured by the fact that the gap between the additional demand for funding due to the high level of sovereign debt and the growth in global savings may narrow in 13 and 14 (yet the funding requirements of states with high debt may continue to attract funds from other regions in international money and capital markets until rebalancing occurs) (Charts 1-2). In 13 banks can continue to borrow funds at favourable costs in interbank markets: the 3-month Euribor and USD LIBOR rates have been hovering around. and.3, respectively, since the end of 12. With global investment activity up until May and the ECB committed to easing, European banks also faced improving conditions in swap markets, and the LIBOR-OIS spread used as an indicator of internal banking system tensions dropped to a level unseen for two years in both the euro area and the US. Strengthening uncertainty surrounding the imbalances in the Chinese banking system led to an upsurge in interbank rates in June (Charts 3-5). Although the Asian banking system is also affected by the tensions in China, the risk position of the eurozone s banks has been perceived worse than that of their UK, US and Asian counterparts since early 1, despite the easing of liquidity tensions. On the other hand, the risk premium of the eurozone s banks may fall substantially after the common European bank supervisor becomes operational in the spring of 14 (Chart 6) Chart 1: Changes in broad money in the USA, Japan, the eurozone and China Eurozone USA Japan China Chart 3: Money market interest rates ( ) $ billion Chart 2: Budgetary demand for external financing* in the G7 economies and the increase in global money supply Sources: IMF, MFB * demand over the debt refinancing requirements Chart 4: VIX index and the 3-month euro/dollar swap spread ( ) Difference ( = demand - supply) Government demand: G7 general government deficit Money supply: changes in global saving trends $ billion point 7 decreasing global risk appetite more expensive USD finance basis point, inverted scale 1-month EURIBOR 3-month EURIBOR 6-month EURIBOR 3-month USD LIBOR 3-month SHIBOR VIX index (LHS) 3-month euro/dollar swap rate (RHS) Chart 5: LIBOR-OIS spread in the eurozone and the USA ( ) Chart 6: 5-year CDS spread on banks in the eurozone, Great Britain, USA and Asia basis point Sources: Reuters, MFB EURIBOR-OIS spread (3 month, LHS) USD LIBOR-OIS spread (3 month, LHS) VIX index (RHS) decreasing global risk appetite , 87,5 75, 62,5 5, 37,5 25, 12,5, point basis point Great Britain USA Eurozone Asia basis point 11

12 Changes in foreign bank funding Foreign funding grows in developing countries, while funds are withdrawn from Europe Following a modest setback in late 11, banks reporting data to the Bank of International Settlements (BIS) dynamically expanded their portfolio of foreign claims vis-à-vis developing countries in 12. Developing Asian countries and offshore centres experienced the most dynamic inflows of foreign funds. In the fourth quarter of 12, banks foreign claims vis-à-vis these regions were up by 1. and 8., respectively, compared with the same period of the previous year. In Central and Eastern Europe, the inflow of foreign funds increased by 7. in the same period, but foreign claims vis-à-vis this region tend to fluctuate from one quarter to another, rather than showing a linear upward trend (Chart 1). In contrast to the flow of funds to emerging economies, cutting exposures and low risk taking remained more typical in most developed European countries. Comparing the data for the end of 12 with the values recorded one year earlier, it is apparent that a significant increase in foreign funds only took place in Germany and Belgium, while the most funds are still withdrawn from the PIIGS countries (Portugal, Italy, Ireland, Greece and Spain). In addition to these trends, some European countries, including Switzerland, France, Germany, the Netherlands and Belgium, intentionally reduced their foreign exposure the withdrawal of considerable funds in the period concerned. Only Spanish banks increased their foreign claims to a higher extent in the last calendar year, which included for the most part the provision of funds to Portugal (Chart 2). The data for 12 show a contraction in foreign claims vis-à-vis the PIIGS countries, and the increase in foreign funds in Italy was already 3. on a year-on-year basis in the end of 12, which may be a sign of strengthening investor confidence in the country as a result of the implemented reforms. Conversely, foreign banks dramatically reduced their exposure to Greece. By December 12, 51. of foreign funds had been withdrawn compared with the previous year, which may have been due to the strengthening negative market expectations regarding Cyprus and the close links of the Greek economy to its Cypriot counterpart. All these illustrate the differentiated treatment of the eurozone s peripheral countries by investors, a strengthening trend which can be observed since the middle of 11 (Chart 3). The largest foreign claims on the PIIGS countries are held by Germany, France, the United Kingdom, the Netherlands, Switzerland and the US. The majority of funds were withdrawn from Greece in relation to cutting French banks exposure to the country between late 11 and late 12. While French banks also reduced their foreign claims on Portugal and Spain, although to a lesser extent, their foreign claims on Ireland and Italy have slightly increased. German banks withdrew funds from all PIIGS countries, which involved the most significant reduction of foreign claims on Spain and the least reduction of foreign claims on Italy. The flow of funds from the US to Italy was mainly attributable to the fact that Italy ended 12 with a positive balance (Chart 4). $ billion Chart 1: Claims of foreign banks in developing countries and Japan % Q1 7 Q2 7 Q3 7 Q4 7 Q1 8 Q2 8 Q3 8 Q4 8 Q1 9 Q2 9 Q3 9 Q4 9 Q1 1 Q2 1 Q3 1 Q4 1 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Offshore centres Developing Latin Am. & Caribbean Japan Sources: BIS, MFB Central Eastern Europe Developing Asia Africa & Middle East Chart 3: Foreign banks' claims vis-à-vis PIIGS countries $ billion Chart 2: Foreign claims vis-à-vis European countries and development of foreign claims between December 11 and December $ billion Sources: BIS, MFB Spain Ireland Greece Portugal France Finland United Kingdom Austria Belgium Switzerland Italy Netherlands Germany Switzerland France Netherlands Germany Belgium Ireland Austria Portugal Italy Finland Greece United Kingdom Spain Other countries' claims on the country Country's claims on other countries Chart 4: Portfolios of foreign claims held by Germany, France, United Kingdom, Switzerland, Netherlands and United States vis-à-vis PIIGS countries between Q4 11 and Q % Sources: BIS, MFB Q1 7 Q2 7 Q3 7 Q4 7 Q1 8 Q2 8 Q3 8 Q4 8 Q1 9 Q2 9 Q3 9 Q4 9 Q1 1 Q2 1 Q3 1 Q4 1 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 $ billion Sources: BIS, MFB Greece Spain Ireland Portugal Italy Spain Greece Ireland Italy Portugal Switzerland Germany France United Kingdom Netherlands United States Balance 12

13 Bank lending Upturn in consumer lending in the US, slackening lending activity in the eurozone In the United States, the dynamics of corporate lending slowed down to some degree in the first half of 13 and mortgage lending remained near stagnation, while consumer loans grew at an increasing rate, as purchasing power strengthened (Chart 1). The prime rate has not risen beyond the -.2 range since December 8 and, according to the plans of the Fed, it will remain unchanged until inflation exceeds 2. or the unemployment rate falls below 6., which firmly keeps corporate lending rates between 3 and by anchoring expectations (Chart 2). In the eurozone, the modest lending momentum gained in the spring of 1 clearly reached exhaustion by the end of 12, which will act as an impediment to economic growth in the quarters to come. Both consumer and corporate lending have been contracting (y/y) since June 11 and March 12, respectively, while the growth in home loans was only 1. in April 13. Corporate lending shows significant differences from one Member State to another: lending is shrinking primarily in the PIIGS countries, but it has also been declining in the eurozone s largest economies (Germany, France) since early 13 (Charts 3-4). In the eurozone, average interest rates on home and corporate loans varied between in April and have been gradually falling since December 11 (Chart 5). On the other hand, the price of loans may be increasingly influenced by the worsening business perspectives, which may lead to the exclusion of some businesses from the lending market in the coming period. In China, growth in retail and corporate lending came to a temporary halt at the turn of the year from 12 to 13, but the monthly growth rate was yet again around 2. and.9%, respectively, in recent months (Chart 6). Chart 1: The change in outstanding amount of consumer loans, real estate loans, and non-financial corporate loans in the USA (y/y) Sources: Fed, MFB Non-financial corporate loans Real estate loans Consumer loans Q Chart 2: Interest rates on corporate loans in the USA * interest rate on corporate loans Fed funds rate Q Q Q Q Q Q Q Sources: Fed, MFB Q Q2 Q2 1 Q2 2 Q2 3 Q2 4 Q2 5 Q2 6 Q2 7 Q2 8 Q2 9 Q2 1 Q2 11 Q2 12 Spread* (RHS) Loans in value more than $ 1 million Loans in value $ thousand - $1 million Loans in value less than $ thousand 3 basis point Chart 3: The change in outstanding amount of consumer loans, real estate loans, and corporate loans in the eurozone (y/y) Sources: ECB, MFB Real estate loans Corporate loans Consumer loans Chart 4: Annual rate of change in total amount of corporate loans (April 13) Sweden Netherlands Finland Germany France Belgium Austria Denmark Italy Luxembourg Ireland Portugal Greece United Kingdom Spain Sources: ECB, MFB Chart 5: Interest rates on deposits and loans in the eurozone Chart 6: Corporate loans and household loans in China Sources: ECB, MFB , 5, 4, 3, 2, 1,, percentage point Chinese yuan billion Interest rate difference (household loan and deposit) Corporate loans (loans terminated more than 5 years, outstanding amount) Real estate loans (loans terminated more than 5 years, outstanding amount) Household deposits (terminated max. 1 year, new loan) Household loans (total amount, LHS) Corporate loans (total amount, LHS) Household loans (y/y, RHS) Corporate loans (y/y, RHS) 13

14 International government bond markets Investor sentiment turned for the worse in May, leading to increased government bond yields across the world The debt-to-gdp ratios in G7 countries are expected by IM s forecast to remain above 1 until 18 as a result of fiscal stimulus programmes, increasing social expenditures made necessary by economic and demographic reasons and declining tax revenues attributable to slower economic growth, which generates considerable demand for refinancing funds in global markets (Chart 1). The United States continues to heavily rely on the foreign buyers of US debt, primarily coming from the Far East (Chart 2), and US treasury securities are invariably considered popular and relatively low-risk assets. Although the abundance of liquidity keeps the demand for US and German government bonds high, yields began to rise in May, as indications that the Fed s asset purchase programme will end strengthened, also driving bond yields up in emerging markets and the PIIGS economies (Chart 3). In the eurozone, government bond yields fell and convergence strengthened until 1-year yields turned upward in May, accompanied by a more varied bond performance (Chart 4). Until now, the European Central Bank has been successfully preventing Italian and Spanish government bond yields from reaching a level that cannot be financed any more (Charts 5-6). The new wave of yield growth, which started in May, may be addressed in two ways in the short term: either the ECB may be compelled to act again, or the two states may request the ECB to engage in Outright Monetary Transactions (OMT) under its programme for purchasing assets without limits, unless the repeal of the OMT programme is initiated under a decision to be adopted by the German Constitutional Court in the autumn. Chart 1: General government gross debt as percent of GDP Chart 2: Geographical distribution of US government securities in foreign ownership and the size of the Chinese currency reserves 14 1 % % % 4 Sources: IMF, MFB Eurozone CIS Latin America and the Caribbean Sub-Saharan Africa Central and Eastern Europe Developing Asia Middle East and North Africa G7 countries 14 1 % % % 4 $ billion Other Brazil Oil exporters Caribbean banking centres Japan China Official reserves of China Sources: U.S. Department of the Treasury, People's Bank of China, MFB $ billion 4, 3,7 3,5 3,2 3, 2,7 2,5 2,2 2, 1,7 1,5 1,2 1, 9% 1.1 Chart 3: Reference yields on 1-year government bond and the VIX index Chart 5: Reference yields on 1 and 3-year government bond in Italy and Spain announcement of liquidity tender of ECB USA (LHS) Germany (LHS) VIX index (RHS) LTRO 1 LTRO announcement of OMT decreasing global risk appetite Italian (1-year) Spanish (1-year) Italian (3-year) Spanish (3-year) point, inverted scale 9% 1 1 billion 1.13 Chart 4: Reference yields on 1-year government bond France Germany Greece Portugal Spain Italy Ireland Chart 6: Changes in total amount of governemnt bonds (m/m) held by eurozone's, Spanish and Italian banks (January 9 - May 13) 1 1 Italy Spain Eurozone Sources: ECB, MFB billion 14

15 Exchange rates I Economic growth prospects continue to favour the strengthening of the dollar As a sign of sustained fears over the European debt crisis, the euro has been undervalued relative to the dollar since late 11 despite a relatively positive global investor sentiment, which is attributable to pricing of the eurozone debt crisis. In the first six months of 13, the exchange rate of the euro against the dollar essentially remained within the USD/EUR range (Chart 1). Global economic slowdown keeps global oil prices under pressure by holding back the demand for crude oil, and simultaneously making the US dollar more attractive as a safe haven currency (Chart 2). In addition to global growth risks, the common European currency is weakened by the gap between the US and the euro area in terms of economic growth: while the GDP is likely to shrink in the eurozone this year, as it did last year, the US economy is expected to grow by around in 13 (Chart 3). US investors facing deteriorating growth prospects and relatively high labour costs in the euro area are increasingly turning their attention to Asia and China, and the balance of FDI inflows and outflows also points toward a falling European surplus, moving the euro in the direction of depreciation (Chart 4). For the time being, the common European currency can benefit from the interest rate differential that arises from the ECB s keeping the prime rate at.5 while the Fed policy rate is -.2. Although the 2-year German bond yield is lower than the corresponding US government bond yield (Chart 5), most eurozone Member States offer higher yields than the US. The common European bank supervisor becoming operational in the spring of 14 may support the appreciation of the euro over the medium term by improving the risk position of the European banking system directly and of the euro indirectly (Chart 6). Chart 1: The global risk appetite and the USD/EUR exchange rate ( ) Chart 2: The WTI crude oil price and the USD/EUR exchange rate point VIX index (LHS) euro strengthening increasing global risk appetite Sources: Reuters, ECB USD/EUR (RHS),,9 1, 1,1 1, 1,3 1, 1,5 1, 1,7 inverted scale $/barrel euro strengthening WTI crude oil price (LHS) 1.8 Sources: Fed, Reuters, MFB USD/EUR (RHS) 1,7 1, 1,5 1, 1,3 1, 1,1 1,,9, Chart 3: The USD/EUR exchange rate and the difference in growth rates* Chart 4: FDI inflow from the US to the eurozone and the USD/EUR exchange rate 1,65 1, 1,55 1,5 1,45 1, 1,35 1,3 1,25 1, 1,15 1,1 1,5 Q3 4 Q1 5 Sources: ECB, Eurostat, MFB Q3 5 Q1 6 Q3 6 Q1 7 Q3 7 Q1 8 Q3 8 * difference in growth rates, adv. 3 quarters Q1 9 Q3 9 Q1 1 Q3 1 Q1 11 Q3 11 Q1 12 Q3 12 Q1 13 Q3 13 Difference in growth rates* (eurozone - USA, RHS) USD/EUR (quarterly average, LHS) 2,5 2, 1,5 1,,5, -,5-1, -1,5-2, -2,5-3, -3,5 percentage point $ million Sources: BEA, ECB, MFB Q1 2 Q3 2 Q1 3 Q3 3 Q1 4 Q3 4 Q1 5 Q3 5 Q1 6 Q3 6 Q1 7 Q3 7 Q1 8 Q3 8 Q1 9 Q3 9 Q1 1 Q3 1 Q1 11 Q3 11 Q1 12 Q3 12 Q1 13 FDI (LHS) USD/EUR (quarterly average, RHS) 1,7 1, 1,5 1, 1,3 1, 1,1 1,,9, percentage point Chart 5: Interest rate difference* and USD/EUR exchange rate 2,5 2, 1,5 1,,5, -,5-1, -1,5-2, 1.4 Sources: ECB, Reuters, MFB euro strenghtening * difference between yields on 2-year bonds , 1,55 1,5 1,45 1, 1,35 1,3 1,25 1, 1,15 Difference between yields on 2-year German and US government bond (LHS) USD/EUR (RHS) basispoint, inverted scale 3 7 Chart 6: Eurozone banks' 5-year CDS spread and the USD/EUR exchange rate rising risk premium euro weakening Eurozone banks' 5-year CDS spread (LHS) Sources: Reuters, ECB, MFB USD/EUR (RHS) 1, 1,5 1, 1,3 1, 1,1 1,,9 15