Economic forecasts. Summary. December 2014

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1 December 2014 Summary The US economy has maintained momentum through the third quarter, once again led by investment and consumption. The solid employment growth of recent months suggests that wage pressures in certain sectors may become more widespread in the quarters ahead. The first rate hike will likely come in the next twelve months, but for now, the Federal Reserve (Fed) can hold policy stable as inflation expectations slide further due to lower oil prices and a higher dollar. There has been little improvement in the eurozone, as growth and inflation continue to flounder. The European Central Bank (ECB) has implemented a wide selection of policies to revive inflation expectations with little success. Investors expect more, and recent comments from Mario Draghi and other ECB sources indicate that full-blown quantitative easing (QE) could begin in early Growth has been robust in the UK, but momentum appears to be waning. The collapse in the inflation profile in recent months caught the Bank of England s Monetary Policy Committee (MPC) off guard, and there has been little objection from committee members to the market s expectations for a later lift-off in policy normalisation than expected earlier in the year. Japan has stepped up its QE programme after a disappointing rebound in growth following April s consumption-tax hike. Prime Minister Abe was concerned enough to propose pushing out the next increase by 18 months. Forecasts are revised lower once again in a number of emerging market (EM) economies, and we remain vigilant to the possible knock-on effects of the rebalancing of the Chinese economy away from investment and towards consumption. One such effect is weaker commodity prices, where we have seen accelerated declines in recent weeks. While on the face of it this should be positive for global growth, the disruptive impact on markets must be monitored closely. J21855 Issued December 2014 Valid to end March For investment professionals only

2 US GDP (year/year) Headline Inflation (year end) Core Inflation (year end) Official Rates¹ (year end) ¹ ¹ 10-year bond yield EUR/USD (year end) USD/JPY (year end) Earnings Growth Updated 17 November 2014, ¹consensus = derived from market expectations Changes to Threadneedle forecasts: GDP from 2; GDP from 2.5-3; Headline inflation from 2.0; Headline inflation from 1.9; EURUSD from 1.15; USDJPY from 110; USDJPY from 120; End year bond yield 2.40 from 2.75; End year bond yield 2.75 from 3.3 Economy back on track for now In line with the robust GDP data, general trends remain favourable; notably, small businesses remain at their most optimistic since the financial crisis, which should bode well for further job gains. To date, the improving employment picture has created pockets of wage pressure, particularly in the energy and transportation sectors, but average earnings for the broader economy remain muted. The continued inability of many businesses to fill open positions may change this picture in the coming months. The Fed will be watching this closely, with a number of members already calling for a commencement of policy normalisation. The relative economic outperformance of the US has led to further divergence in the expected path of monetary policy. This has aided the recent strengthening of the dollar and has coincided with weaker prices across the commodity spectrum. The Fed is content to keep rates at the zero bound for now, recently restating its intention to remain on hold for a considerable period following the end of QE. This seems sensible, as inflation expectations have fallen away in recent months. Whilst we continue to forecast a positive outlook, we expect the pace to be somewhat slower than in the last couple of quarters. We will be watching the drivers of investment, as much of the strength to date has been related to the energy sector; if oil continues to slide, we may see a reduction in activity. One would hope that this can be offset by the savings made by the consumer at the pump. J21855 Issued December 2014 Valid to end March For investment professionals only

3 Euro Area GDP (year/year) Headline Inflation (year end) Official Rates (year end) year bond yield EUR/USD (year end) EUR/JPY (year end) Earnings Growth Updated 18 November 2014 Changes to Threadneedle forecasts: GDP from ; inflation from 0.75; inflation from 1.3; End year bond yield 0.9 from 1.25; End year bond yield 1.25 from 1.75; EURUSD from 1.15; EURJPY from 127; EURJPY from 132 Crunch time for the ECB Despite a positive outturn in the third quarter, the eurozone economy is still struggling to get out of first gear after two years of contraction. Within the detail, domestic consumption is on an improving trajectory, but investment has been a big drag through the middle of It is possible that there are one-off data anomalies that can be discounted but also likely that low growth and geopolitical concerns are affecting medium-term confidence. Looking ahead to 2015, lower energy prices and increased monetary stimulus should have a positive impact, but it is difficult to envisage growth of much more than 1%, especially in Italy and France, where structural impediments are the most oppressive. Against this backdrop, painfully low inflation appears chronic and underlines the need for bolder monetary and possibly even fiscal policy. Alongside the raft of monetary policy initiatives already announced, sovereign bond purchases are likely to be required in early 2015 as the ECB attempts to boost the money supply by any means possible. Although the economic benefits are questionable, the bold commitment to unconventional measures should boost confidence that the governing council is committed to avoiding a slide into deflation. Interest rates will remain at current low levels long after other central banks have begun hiking cycles but this is largely discounted, with market pricing implying that eurozone rates will remain below 1% until In summary, the onus remains on the ECB to prove deflation fears wrong, and 2015 may well prove to be crunch time. J21855 Issued December 2014 Valid to end March For investment professionals only

4 Japan GDP (year/year) Headline Inflation (year end) Official Rates (year end) year bond yield USD/JPY (year end) EUR/JPY (year end) Earnings Growth (full year) (e) Updated 21 November 2014 Changes to Threadneedle forecasts: GDP from 1.5; GDP from ; End year bond yield 0.5 from 0.75; End year bond yield 0.85 from 1.0 Japan finds a sweet spot in 2015 Recent weakness in Japanese GDP has been driven by sharp swings in inventories, which should provide some support in the final quarter of More broadly, the combination of unprecedented monetary easing, some fiscal boost, and signs of improvement in the labour market may allow Japan s economy to find a sweet spot in Japanese QE has been 85% of Fed QE annually, but in an economy onethird the size of the US; the latest QQE (qualitative and quantitative easing) policies announced could grow the Bank of Japan s (BoJ) balance sheet by 20 percentage points of GDP by the end of 2015 according to some estimates. On the fiscal side, the delay in the consumption tax, public works on infrastructure, and corporate-tax reform should all be helpful for growth. Wage growth is finally perking up, with year-on-year compensation for employees in nominal terms rising at the fastest clip since the late 1990s. Reflecting this more constructive setting, we raise our forecasts for real GDP growth in 2015 to 2%. Two developments merit attention in this context. First is the delay in the consumption-tax hike by 18 months, which should boost both consumption and GDP. Some estimates suggest a 5 percentage point (pp) increase in consumption growth and 3 pp boost to quarterly GDP growth at the end of next year from this source. The second development to monitor is the wide and widening gap between the consensus inflation forecasts (lower) and those of the BoJ (higher) for both 2015 and Lower oil prices (which feed into Japanese core inflation) and the tax-hike delay could meaningfully lower inflation and given the BOJ s strong focus on reaching a 2% target, may prompt further easing, perhaps in June or October J21855 Issued December 2014 Valid to end March For investment professionals only

5 UK GDP (year/year) Headline Inflation (year end) Official Rates (year end) year bond yield USD/GBP (year end) EUR/GBP (year end) Earnings Growth Updated 21 November 2014 Changes to Threadneedle forecasts: GDP from ; Inflation from 2.5; Inflation from 2.0; Official rates from 1.25; End year bond yield 2.0 from 2.75; 10 year bond yield from 3.3 First rate hike pushed back as economy cools in the first half of 2015 At the recent Quarterly Inflation Report, the Bank of England (BoE) revised down its forecasts for GDP and near-term inflation. UK growth has performed well compared with the majority of developed markets, but activity indicators such as PMIs and the Agents scores indicate that a slowing in the pace of growth is ahead. The markdown in inflation forecasts was expected and the monetary policy sensitive point of the three-year horizon was unchanged; however, BoE Governor Mark Carney was very dovish at the press conference, stressing greatly that it is more likely than not that inflation will be sub-1% in the near future. Past appreciation of sterling, disinflation in Europe and falling commodity prices have subdued inflation and are likely to be continued downward forces in the short term. The benign path of market rate expectations was effectively validated by the MPC, with the first hike not expected until late Q3/Q4 next year and at a pace of around 50 basis points per annum. Wage growth remains a key variable that is being keenly watched by the MPC, and some measures of this have increased from low levels. House-price growth has moderated somewhat of late the mortgage market review has made the application process more arduous, while buyers have been put off by a toppy market and potentially rising interest rates. Going into 2015, we believe that uncertainty surrounding the May election is likely to weigh on the economy. Current expectations are for a hung parliament as the Conservatives and Labour struggle to poll 60% in aggregate; as many as 85 seats (out of 650) could be held by other parties. J21855 Issued December 2014 Valid to end March For investment professionals only

6 Emerging Markets GDP GDP CPI CPI Official Rates Official Rates m 12m T Cons T Cons T Cons T Cons T Cons T Cons Brazil Mexico China India South Korea Russia Turkey Updated 24 November 2014 Changes to Threadneedle forecasts: GDP 2014 Brazil 0.2 vs 0.5, India 5.7 vs 5.9, Russia 0.2 vs 0.4, Turkey 3.0 vs 3.5; GDP 2015 Brazil 0.5 vs 1.0, Mexico 3.5 vs 4.0, South Korea 3.3 vs 3.8, Russia -0.5 vs 0.5; CPI 2014 China 2.3 vs 2.5, India 5.6 vs 8.2, South Korea 1.5 vs 1.6, Russia 7.5 vs 7.0, Turkey 9.0 vs 8.0; CPI 2015 China 2.5 vs 3.0, India 6.0 vs 7.0, South Korea 2.0 vs 2.4, Russia 9.0 vs 6.0, Turkey 7.5 vs 7.0; Official Rates 3m Brazil 12.0 vs 11.75, Turkey 7.75 vs 8.0; Official Rates 12m Turkey 8.0 vs 8.5 Source: Threadneedle, Consensus Economics, November Oil slump divides EMs Emerging economies continue to face growth challenges, but this is little changed from our previous update. The most significant new development since the summer has been the c.30% slump in oil prices. Overall, this should prove a boost to global growth prospects as many countries are set to benefit from low energy costs. However, emerging economies are split between importers that stand to gain, and exporters that will lose out. A key beneficiary of lower oil prices is Turkey, which should experience a reduced current-account deficit, lower inflation and, potentially, freedom to ease monetary policy as a result. Most Asian economies should reap similar rewards. Brazil, already faced with a weak outlook, will neither gain nor benefit, and will need to progress on structural reforms in order to increase potential growth. Russia would face significant fiscal challenges were it not for the fact that the sharp depreciation of the rouble has offset USD-based price falls. All in all, those countries with high dependency on oil exports such as Venezuela, Russia and some Middle-Eastern economies require a higher oil price than previously in order to balance their budgets, and this could lead to political strain if prices fall further. J21855 Issued December 2014 Valid to end March For investment professionals only

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