Weekly Commentary 15 June 2012

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1 Contact your treasury specialist Corporate Treasury or Business Banking Treasury Institutional Treasury Specialised Finance +353 (0) UK Sales Team (within the UK) US Sales Team Keep in touch with the markets, visit Weekly Commentary 15 June 2012 Data section contents (changes on the week) Themes from the week Market awaits further policy easing Headlines for the week ahead Greek Elections, G20 Summit, FOMC and BOE minutes UK rates fall sharply on policy announcements The US dollar fell against most major currencies during the week, with the commodity currencies outperforming, as markets looked to further simulative policy measures. Equities generally advanced, although investors remain nervous ahead of the Greek elections. Spanish bond yields rose sharply again after a Moody s downgrade having initially declined following confirmation that 100bn in official EU funds would be made available to Spain to support its banks, albeit through the sovereign. German yields also rose, perhaps indicating that the market is beginning to discount further German monetary support for the euro zone or a move towards some Eurobond issuance. The UK authorities did announce a major policy initiative, a funding for lending scheme; the UK government will underwrite loans to the banking system from the Bank of England at below market rates in an effort to stimulate lending to the real economy. In addition the Bank of England will activate its Extended Collateral Term Repo facility, providing 6-month funding on wider collateral to the banking sector. Governor King also stated that the case for further QE was growing and the net result of these developments was a sharp fall in market rates, with 2-year swaps falling to a new cycle low of 92bp. Sterling fell on the week against the euro, with the latter trading above 81 pence, but rallied modestly against the US dollar, and the market now awaits the BOE minutes for June and the strength of support among the MPC for further QE. The US data generally came in on the softer side of expectations, prompting more speculation that the Fed will embark on additional policy easing. Retail sales fell for a second consecutive month in May and weekly jobless claims rose, pulling the trend higher. The headline inflation rate slowed to 1.7% from 2.3%, largely due to lower energy costs, and that will provide some support for real incomes. The same can be said for the euro area, as inflation there slowed to a 15-month low of 2.4%. In Ireland the main data release of note was average earnings, showing a modest 0.7% annual rise in Q1 with increases recorded in 9 of the 13 industries surveyed. This suggests that the labour market may be stabilizing after a long period of falling earnings and plunging employment. The Irish bond market has generally not seen the level of volatility experienced elsewhere in the euro zone of late, and 10-year yields were broadly unchanged on the week, so resulting in an narrowing of the spread to bunds to 575bp and as such some 40bp over Spain. Dan McLaughlin. Highlights for the week ahead Sun Greek Elections Commodities Prev Fcst Cons Tues UK CPI 3.0% 3.0% 3.0% Wed Zew Survey (Germany) G20 Meeting Bank of England Minutes FOMC Meeting & Forecasts Bernanke Press Conference Thurs EA Composite PMI Spot rates UK Retail Sales -2.3% 1.2% 1.2% Philly Fed EUR/GBP EUR/CHF EUR/USD EUR/JPY GBP/USD EUR/CAD EUR/SEK EUR/PLN EUR/NOK EUR/ZAR EUR/HUF EUR/CZK year 3 year 5 year 7 year 10 year 15 year 20 year EUR GBP USD Official rates Current Q3 12 Q4 12 Q1 13 Fcst Cons Fcst Cons Fcst Cons EUR GBP USD Recent research View recently published reports at including: The Bulletin (monthly analysis of international and Irish markets) UK View (monthly analysis of trends in the UK economy) The Outlook (quarterly analysis of trends in the Irish economy) Irish Property Review (quarterly analysis of Irish property trends) Market Newsflash (up-to-the-minute analysis of key economic developments) All rates quoted are indicative market rates

2 Data section contents Data section showing % changes on the week Long term fixed rates Commodity prices Europe Draghi says serious downside risks to the economic outlook In remarks on Friday, the ECB President, Mario Draghi, noted that economic conditions have worsened since the Bank s last set of macroeconomic projections - which were based on data available up to May 24 th - and said there are now serious downside risks to the outlook. Perhaps this is an indication that the Bank will cut its main interest rate (currently 1%) next month, though the Bank may be called into some kind of action before that, depending on developments following the Greek elections on Sunday. Another member, the head of the Austrian central bank, said the ECB had discussed cutting the deposit rate (the rate the ECB pays on commercial banks deposits) to 0% from the current 0.25%, which he said might make banks less inclined to hoard cash with the ECB. Presumably, any such cut would be in the context of a reduction in its main interest rate as well. The economic data published this week were poor enough, with industrial output in the zone falling by 0.8% in April and employment declining by 0.2% in Q1, marking a third consecutive quarterly decline. Inflation, meanwhile, fell further in May, to 2.4% from 2.6% in April and 2.7% the previous month. On the markets, the euro performed surprisingly well considering the proximity of the Greek elections and rebounded from an intra-week low of sub $ against the dollar to trade at over $1.26 on Friday, while equity markets rose again this week, by a little less than 2%. Spanish 10-year bond yields soared though, rising by more than 60bps to around 6.85%, despite or perhaps because of the bank bailout for the country announced last weekend. Italian yields rose by about 20bps to 6%, with a decent bond auction on Thursday helping to bring them down from intra-week high of 6.20%. Ireland Earning data shows signs of stabilisation The Q1 labour market data last week was disappointing, showing that employment had dropped again in Q1. However, overall the picture is one of stabilisation as the pace of decline in employment has slowed, with the average quarterly decline over the 4 quarters to Q1 12 around 4k. This week there was further data that indicates that the labour market may be stabilising. Earnings data shows that gross average weekly earnings rose by 0.7% year-over-year in Q1. According to the CSO, 9 of the 13 different economic sectors showed wage increases in the year to Q1 with Professional, scientific and technical increasing the most (11.2%) while construction earnings continue to fall, down 3.8% in the same period. Wages increases are making a welcome return after a slow modest decline over the past 3 years, with the data showing that weekly earnings have fallen by 2.5% in the period Q1 09 to Q1 12. The figures also show that average hours worked also increased in the year, up to 31.2 hours per week in Q1 12 from 30.9 in Q1 11, perhaps a signal that the demand for labour is picking up, albeit very modestly. Also in evidence was the impact of the Government public sector rationalisation measures, with the numbers in the public sector dropping 5.5% in the year to Q1 compared to an increase of 1.3% in numbers employed in the private sector (this includes the impact of the large scale retirements from the public service in February of this year). Overall public sectors numbers have fallen 8.2% in the 3 years to Q1 12. United Kingdom King signals more QE on the way Governor King gave a strong signal this week that the Bank of England is preparing to ease monetary policy further and ramp up asset purchases once again. In his annual mansion house speech, he said the case for further monetary easing is growing as the economic outlook deteriorates amid the increasing downside risks from the crisis in the Euro area. He noted that in the past month, since the last inflation report, conditions in the UK have deteriorated with weakening business surveys, a downward revision to measured output, and further slowing in economies overseas. He pointed to problems created by the euro crisis such as higher funding costs for UK banks and a black cloud of uncertainty. Further monetary easing could alleviate some of this pressure and King said, in his view, further easing was not pushing on a string as the creation of money by the Bank of England has prevented an extremely damaging contraction in the money supply. King also said today s exceptional circumstances create a case for a temporary bank funding scheme to bridge to calmer times and announced that the Bank of England and the Treasury are working together on a funding for lending scheme that would provide funding to banks for an extended period of several years, at rates below current market rates (market funding rates for banks are relatively high largely because of the uncertainty caused by the euro crisis) and linked to the performance of banks in sustaining or expanding their lending to the UK non-financial sector. King was clearly signalling that further asset purchases are on the way, the question is when and by how much? Most likely, having been almost explicit in his support for more measures in his 2 Bank of Ireland Global Markets

3 Data section contents Data section showing % changes on the week Long term fixed rates Commodity prices statement on Thursday, the decision will come at the next meeting in July and, as it seems that to do 25bn more would underwhelm markets, then the minimum amount we could expect is for an expansion of 50bn, taking the total to 375bn. In the meantime, the Bank, along with all other major central bank, will be keeping a wary eye on developments in Europe next week after the Greek elections this Sunday. United States Speculation Fed to announce further stimulus at nest week s meeting There is speculation the Fed will announce further monetary stimulus following next week s two-day policy meeting (Tues/Wed). One Fed member, Vice Chair Janet Yellen, has contributed to the speculation, noting in a speech that recent labor market reports and financial developments serve as a reminder that the economy remains vulnerable to setbacks, and saying that in our policy deliberations at the upcoming meeting we will assess the effects of these developments on the economic forecast. She added that if the (Fed) were to judge that the recovery is unlikely to proceed at a satisfactory pace (for example, that the forecast entails little or no improvement in the labor market over the next few years), or that the downside risks to the outlook had become sufficiently great, or that inflation appeared to be in danger of declining notably below its 2 percent objective, I am convinced that scope remains for the (Fed) to provide further policy accommodation either through its forward guidance or through additional balance-sheet actions. There are quite a few ifs in that statement, but in terms of any possible further action Yellen seemed to narrow down the options to two, saying if the (Fed) judges that the recovery is proceeding at an insufficient pace, we could undertake portfolio actions such as additional asset purchases (i.e. QE3) or a further maturity extension program (i.e. Operation Twist 2). Meanwhile, the Fed Chairman, Ben Bernanke, has said the main issue facing policymakers is whether economic growth will be sufficient to achieve continued progress in the labour market. As regards the economic forecast mentioned by Yellen, the Fed will publish updated macroeconomic projections following next week s meeting. Given the Q1 GDP outturn - an increase of 0.4% and some more recent data, including this week s retail sales, it will be difficult to achieve growth of 2.7% this year (i.e. over the year to Q4) as projected in April. It would require an increase in GDP of around 0.8% a quarter on average over the three remaining quarters of the year. The latest consensus forecast is for an increase in GDP of just 2.2% over the year to Q4, half a percentage point lower than the Fed s current forecast. So, if the Fed does revise down is forecast for growth, then it may also revise up its forecast for the unemployment rate. Considering Bernanke has also said that he believes some of the gains in employment to date represents payback for excess shedding of workers during the downturn, a process which he says may now have run its course and, hence, any further improvement in the labour market will require stronger GDP growth, then a downward revision to the Fed s forecast throws a spanner in the works in this regard. So, further stimulus may well be announced next week. Perhaps, another Operation Twist (or extending the existing one) might avoid some of the flack that would probably accompany a decision to expand the central bank s balance sheet even further through increased asset purchases. Japan Bank of Japan stands pat but watches events in Europe The Bank of Japan stayed on hold at its June meeting despite further calls for an expansion to its asset purchase and credit schemes. Governor Shirakawa played his cards close to his chest regarding what was discussed at the meeting but said the BoJ would pay particular attention to global markets in the aftermath of Greek elections this weekend. He added that central banks are always in close contract and share the view that financial stability is important. The Bank is undoubtedly concerned about the impact on the Yen from further turmoil in the Euro area. The Yen s status as a safe haven has brought unwelcome strength to the currency and it appreciated to around Y78.75 to the dollar after the BoJ meeting when the Bank took no further easing action. Meanwhile there is continued domestic pressure on the bank to expand stimulus measures. The Government has been in very public disagreement with the Bank over the perceived limited amount of quantitative easing measures and this week nominated two strongly pro-stimulus candidates to fill empty board seats. This may well see a much more diverse makeup in the board structure in the year ahead if these economists do take up the seats in due course. 3 Bank of Ireland Global Markets

4 Data section changes on the week EUR/GBP Spot % 1M 3 3M 10 6M 20 12M 43 EUR/USD Spot % 1M 3 3M 10 6M 25 12M 63 GBP/USD on the week Spot % 1M -2 3M -6 6M -7 12M -7 EUR currency pairs EUR/CAD % EUR/AUD % EUR/NZD % EUR/CHF EUR/JPY % EUR/SEK % EUR/NOK % EUR/HUF % EUR/PLN % EUR/ZAR % EUR/CZK % USD currency pairs USD/CAD % USD/AUD % USD/NZD % USD/CHF % USD/JPY % USD/CNY % USD/MXN % USD/SGD % USD/BRL % USD/THB % USD/ZAR % GBP currency pairs on the week GBP/CAD % GBP/AUD % GBP/NZD % GBP/CHF % GBP/JPY % GBP/SGD % GBP/MYR % GBP/NOK % GBP/HKD % GBP/SEK % GBP/DKK % GBP/ZAR % on the Week Base O'night 1 week 2 week 1 M 2 M 3 M 6 M 9 M 12 M EUR GBP USD on the Week 2 year Chng 5 year Chng 7 year Chng 10 year Chng EUR GBP USD Government bond yields (YTM) on the Week 2 year Chng 5 year Chng 10 year Chng 30 year Chng Ireland Germany US UK Prime Rate Bank of Ireland prime rate 0.98 on the Week ISEQ % DOW Jones % S&P % SMI % Nasdaq % FTSE % Eurostoxx % Nikkei % Commodities on the Week Brent % WTI Cushing % Gold % Wheat % Emissions Allowance Bank of Ireland Global Markets

5 Contacts Economic Research Unit (ERU) To discuss any aspect of this report, contact your treasury specialist or our Economic Research Unit (ERU): Chief Economist, Bank of Ireland: Dr. Dan McLaughlin Tel: +353 (0) Senior Economist: Michael Crowley Economist: Patrick Mullane Contact your treasury specialist Corporate Treasury or Business Banking Treasury Institutional Treasury Specialised Finance +353 (0) UK Sales Team (within the UK) US Sales Team Our Offices Dublin 2 Burlington Plaza, Burlington Road, Dublin 4, Ireland Tel +353 (0) London Bow Bells House, 1 Bread Street, London EC4P 4BP, UK Tel +44 (0) Belfast 1 Donegall Square South, Belfast, BT1 5LR, UK Tel +44 (0) Stamford (US) 300 First Stamford Place, Stamford CT 06902, US Tel Keep in touch with the markets, visit Market data supplied by Thomson Reuters Disclaimer This document has been prepared by the Economic Research Unit at Bank of Ireland Global Markets ( GM ) for information purposes only and GM is not soliciting any action based upon it. GM believes any information contained herein to be accurate but GM does not warrant its accuracy and accepts no responsibility, other than any responsibility it may owe to any party under the European Communities (Markets in Financial Instruments) Regulations 2007 as may be amended from time to time, and under the Financial Services Authority rules (where the client is resident in the UK), for any loss or damage caused by any act or omission taken as a result of the information contained in this document. No prices or rates mentioned are bids or offers by GM to purchase or sell any currencies, securities or financial instruments. Except as otherwise may be specifically agreed, GM has not acted nor will act as a fiduciary, financial or investment adviser with respect to any currency or derivative transaction that it has executed or will execute. Any decision made by a party after reading this document shall be on the basis of its own research and not be influenced or based on any view expressed by GM. This document does not address all risks. Any party should obtain independent professional advice before making any investment decision. Any expressions of opinion reflect current opinions as at 15 June This publication is based on information available before this date. This document is property of GM. The content may not be reproduced, either in whole or in part, without the express written consent of a suitably authorised member of GM staff. Bank of Ireland is regulated by the Central Bank of Ireland. In the UK, Bank of Ireland is authorised by the Central Bank of Ireland and authorised and subject to limited regulation by the Financial Services Authority. Details about the extent of our authorisation and regulation by the Financial Services Authority are available from us on request. Bank of Ireland incorporated in Ireland with limited liability. Registered Office - Head Office, 40 Mespil Road, Dublin 4, Ireland.Registered Number - C-1. Bank of Ireland Global Markets