Focus Austria. Review and Preview 2019 UNICREDIT BANK AUSTRIA ECONOMICS & MARKET ANALYSIS AUSTRIA

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1 Review and Preview 19 UNICREDIT BANK AUSTRIA ECONOMICS & MARKET ANALYSIS AUSTRIA 18

2 Economic boom in Austria International Environment Forecast (GDP, change in %) Euro zone Germany France Italy Spain UK USA Japan (annual average) USD per euro CHF per euro GBP per euro JPY per euro Oil (USD/barrel) y Gov. bond (A) m Euribor Author: Walter Pudschedl Source: UniCredit Research Imprint Published by UniCredit Bank Austria AG Economics & Market Analysis Austria Rothschildplatz 1 1 Vienna Telefon +43 () Fax +43 () econresearch.austria@unicreditgroup.at as of August Rev. 1) 18 Rev. 1) 19 GDP (real, change in %) Inflation (CPI, in %) Unemployment rate (in %) ) Revision since last report Economic growth rose to 3% in 17 with higher momentum than in the eurozone for the first time in three years With an economic growth of 3% in 17, the Austrian economy is back in the fast lane in a European comparison. The acceleration compared to the weaker previous years is primarily attributable to the fact that the momentum of domestic demand caught up with the rest of the eurozone and is now even exceeding it slightly. In addition, the strongly export-oriented economy was given an important growth stimulus by the revival of global trading in 17. Cyclical peak has passed pace of growth remains high The cyclical peak has passed; sentiment and early indicators have now stabilized at a lower level. The excellent export environment has lost its shine since the beginning of 18. Domestic demand is also slowing down. We are assuming an increase in GDP by.8% for 18. As the economic cycle moves towards its end and global support eases off, this means that we can expect a flattening of economic growth at a solid % for 19. The labor market benefited from a good economic cycle in 17 improvement trend tapers off slowly in 18/19 The acceleration of the growth in employment in 17 to almost % compared to the previous year has facilitated a decline in the unemployment rate for the first time since 11. After reaching an average of 9.1% in 16, the unemployment rate fell to 8.5% in 17, and according to Eurostat it fell from 6 to 5.5%. In fact, in the first half of 18, the positive trend continued even more strongly. The improvement in the situation on the labor market will continue, supported by the good economy, but at a slower pace. For 18, we expect an unemployment rate of 7.7% (or 4.8%) and for 19 a rate of 7.6% (4.7%). Inflation climbed to.1% in 17 inflation rate remains at around % in 18/19 After just.9% in 16, the rate of inflation in Austria rose to an annual average of.1% in 17. The upturn was primarily down to the increase in the crude oil price. With an average of 1.9% in the first half of 18, inflation was slightly lower than in the previous year. However, that trend has now reversed. In June, the rate of inflation rose to % year-on-year. The upward trend will continue in the months ahead. The combination of higher oil prices and less support due to the exchange rate will increase inflation to an average of.% in 18. Normalization of monetary policy initiated no interest rate hike expected at least until late summer 19 The higher oil price, but also the economic recovery, which influences wage dynamics, will ensure an upward trend in inflation in the Eurozone as a whole in the months ahead. The expected increase in inflation to an average of 1.7% in 18 will enable the ECB to introduce the normalization of monetary policy. The ECB will allow the assets purchase program to expire as expected at the end of 18 and has announced that it will only consider changing interest rates after the end of the summer of 19 UniCredit Research Page

3 Budget targets eased thanks to a good economic cycle no more new debt planned from 19 The budget deficit was reduced significantly to.7% of GDP in 17, supported by strong economic growth. The draft budget for 18 provides for a general government budget deficit of.4% of GDP. 19 is expected to bring a balanced budget for the first time since the 197s. The declining trend in public borrowing in relation to the economic output that took effect in 16 is expected to continue in the years ahead. For the end of 19, we expect a decline to 7% of GDP, also supported by the further asset reductions at the Bad Bank HETA. The previous peak of almost 85% of GDP was reached in 15. Banking markets gain in momentum loans and deposits growing significantly Alongside the economic recovery, the demand for credit increased in Austria in 17, and also significantly in the first half of 18. The entire lending volume increased as an annual average by.%, with corporate loans largely responsible for the gain in momentum. Despite the generally low interest rates, total deposits in Austria are increasing sharply and the pace of growth did not fall in corporate investments or private households in the first half of 18. The ongoing favorable economic prospects are expected to ensure further increases in the demand for credit in the second half of 18 and 19. On the investment side, the low interest environment will continue to dominate. The investments are expected to be focused on very short-term deposits. The economic situation at a glance Real change in % GDP Private consumption Public consumption Gross fixed capital formation*) Investments in plant and machinery Investments in construction Exports Imports CPI (change in %) HCPI (change in %) Current account (in EUR bn) Current account (in % of GDP) Employment in s**) 3,6 3,33 3,37 3,39 3,416 3,449 3,5 3,573 3,655 3,7 change in % Unemployment rate (nat. def.) Unemployment rate (EU def.) Unemployed (annual average in 1,) General gov. balance (in % of GDP) Public-sector debt (in % of GDP) Nominal GDP (in euro bn) *) excluding changes in inventory **) excluding persons drawing maternity benefits, military service and training Source: UniCredit Research UniCredit Research Page 3

4 Cyclical peak in Austria passed challenges increasing Increase in GDP of 3% brings Austria back to the fast lane in Europe in 17 Cyclical peak passed, but growth stabilizing solidly Domestic demand remains the driving force, despite the slight loss of momentum in investment growth Protectionist tendencies in trading and geopolitical tensions result in falling support from foreign demand We expect economic growth of.8% for 18 and a slowing economy with an increase in GDP of % for 19 Focus: Are protectionist measures putting a strain on Austria s economy? Economic growth of 3% in 17 stronger than in the eurozone for the first time in three years Consumption and capital expenditure resulted in economic momentum speeding up in Austria Austria back in the fast lane in 17 With economic growth of 3%, the Austrian economy is back in the fast lane in a European comparison for the first time since 17. While the Austrian economy has consistently grown at a rate considerably above average since the introduction of the euro through to the financial crisis and also immediately afterwards in the phase of the economic upturn, the momentum in Austria since the beginning of the economic recovery after the euro crisis in the middle of 13 until the end of 16 has continually been below the growth trend in the eurozone. This was primarily due to the comparatively slow development of domestic demand. On average in these three years, domestic demand in the eurozone provided almost one percentage point more growth per year than in Austria. Nearly two-thirds of this are a consequence of the very weak economic momentum during these years. The acceleration of economic growth in 17 in Austria is mainly attributable to the fact that the momentum of domestic demand caught up with the rest of the eurozone and is now even exceeding it slightly. The stimulus from the German tax reform in 16, in combination with the improvement in the situation on the labour market have led to a permanent improvement in consumer sentiment, which is reflected in persistently high growth in the consumer segment. Furthermore, the improvement in sentiment and strong growth in orders have helped break the investment slump and triggered the investment boom supported by the good liquidity situation and low interest level. A further important growth stimulus for the strongly export-oriented Austrian economy in 17 was the revival of global trading. AFTER THREE WEAKER YEARS, GROWTH MOMENTUM IN AUSTRIA IS NOW BACK ABOVE THE EUROZONE LEVEL GDP (real, yoy in %) Euro area Austria GDP growth in comparison (contribution of demand components to GDP change in %) 3 1 Private consumption Public consumption Investment A EA A EA A EA A EA Net exports UniCredit Research Page 4

5 Private consumption gaining in momentum since the 16 tax reform Easing on the labour market ensures ongoing tailwind Domestic demand as the driving force: Recovery of private consumption continues With an increase of 1.4% in 17 compared to the previous year, private consumption reflected the strong rate of expansion set in motion by the 16 tax reform, which, after almost four years of virtual stagnation, resulted in an increase of 1.5%. The levelling off of the positive effects of income tax reform was balanced out on the one hand by the improvement in consumer sentiment, which is reflected in increased consumer spending, which was apparent in the reversal of the rising trends in the savings rate, among other things. The savings rate fell to an all-time low of 6.4% in 17. On the other hand, the improvement in the situation on the Austrian labour market driven by the economic situation, which was reflected in very high employment dynamics of around % on a year-on-year basis, provided an ongoing stimulus for private consumption even without new fiscal stimuli. We assume that private consumption will again show strong growth momentum in 18. In the first half of 18, the tailwind from the high employment dynamics brought about by the good economic situation was even stronger in fact. The slight acceleration in wage growth also provided further support. After an increase by 1.5% on average in 17, wage rates are showing a clear upward trend with a year-on-year increase of more than % in the first months of 18. In addition, we assume that the savings rate will still show a slightly declining trend in 18. Driven by the good situation on the labour market and the above-average sentiment among consumers, demand for durable consumer goods will remain strong. New passenger car registrations rose more than 3% year-on-year in the first half of 18. However, comparatively high inflation continued to limit support for private consumption. In comparison to the average performance in the eurozone and also in neighbouring Germany, inflation is resulting in lower real wage increases, which will somewhat limit the momentum of consumption growth during the year, especially as the high employment dynamics will not continue on this scale. However, private consumption, which accounts for a share of around 5% of the total economic output, will remain one of the most important pillars supporting economic growth with an expected year-on-year increase of 1.8% in 18. GOOD SENTIMENT REFLECTED AMONG AUSTRIAN CONSUMERS SINCE THE 16 TAX REFORM Consumer sentiment (standardized) Germany Austria Euro area Private consumption (real, yoy in %) average High investment dynamics promote economic growth in Austria for the third year in a row Investment boom goes into overtime In addition to consumption, a strong expansion of capital expenditure also provided plenty of support for economic growth. In 17, the gross fixed capital formation rose by 4.9% year-on-year. Thus the strong investment cycle has now lasted for a third year in a row after a severe investment slump between 1 and 14, despite low interest rates. From the middle of 15, the investment backlog began to break and the Austrian business sector began to make deferred replacement investments. Only thereafter did the investment boom pick up speed due to extension investments. UniCredit Research Page 5

6 Good prospects for the continuation of the investment boom at a slightly lower tempo The investment boom is especially evident in the development of the investments in equipment, which increased by 8.% year-on-year in 17, but this meant that the momentum from the previous year could not quite be achieved once again. This is due to the noticeable decline in the growth of capital expenditures in vehicles, which halved to a still impressive level of 6.% in 17. In contrast, capital expenditures in machinery and equipment posted an increase in momentum in 17 to 8.9% (16: 6.7%). After a long period of stagnation, construction investments also increased substantially again for the first time in 17. Both in residential buildings and other buildings, there was a significant upward trend with an average increase of.6%. Due to the length of the investment cycle, the probability of investment growth weakening in 18 is clear. After the increase of 5.3% in the first half of 18, the real momentum for the full year of 4.7% will be nearly as high as in the previous year. Supported by the low interest rates and high average liquidity, Austrian companies continue to plan a strong expansion of investment activities for 18. In particular, the metal industry, chemical industry and building suppliers are very optimistic about expanding their production capacities due to strong demand. This is borne out by the currently high utilisation of local industry, which is around percentage points above the longterm average. AT 3.5%, AUSTRIA HAS THE FOURTH HIGHEST INVESTMENT RATIO IN THE EU, AND THE BOOM CONTINUES Investment ratio in the European Union (17 in %) CZ SD EE AT IE BE RO FI FR HU MT SK CY EA ES DK DE NL EU LV HR BG LT SI PL IT LX UK PT EL Gross fixed capital formation (real, yoy in %, with contributions of investments in equipment and buildings) Equipment Buildings Gross fixed capital formation Exporting momentum accelerated strongly year-on-year to 8.% in 17 Global trade fuels Austrian foreign trade The acceleration of global trading in 17, supported by the synchronous, increasingly investment-driven economic upswing in industrialised and emerging markets, has given demand for Austrian export products a strong boost. The goods exports rose by a nominal amount of 8.%, reaching EUR billion in 17. The goods export quota climbed to 38.4% of GDP. Due to strong consumption and investment demand, the Austrian economy s demand for imports even increased by 8.8% to EUR billion in 17. While trade with the most important partner Germany (share of exports over 3%; share of imports almost 37%) developed slightly below average, foreign trade with the countries directly below it on the list the US, Italy and France increased. Foreign trade with the emerging markets in Central Eastern Europe, which take almost % of Austrian exports, also increased at a disproportionate level, supported by the economic upward trend in the region. The trade deficit was more than balanced out by a surplus in services, propped up by tourism, in 17. A new record of million overnight stays contributed to this. With a surplus of 1.9% of GDP, the current account balance was still slightly below the value of the year before in 17. UniCredit Research Page 6

7 After a break for a year, foreign trade once again made a positive contribution to the growth of the Austrian economy in 17. Around 15% of the GDP increase was down to net exports. Foreign trade should provide a net contribution to economic growth again in 18. Due to a more moderate demand for imports in view of the slight slowdown in the investment momentum, it could even make a somewhat greater contribution than in 17. The level of growth will remain high in 18, but will continue to lose more in momentum over the course of the year. In our opinion, there are three reasons for this. Firstly, the UniCredit Global Leading Indicator, which combines a number of macroeconomic early indicators from different countries and sectors to form a number, already indicates a slowdown in global trade. Secondly, the headwind due to the stronger euro in relation to the US-Dollar compared to the previous year will become noticeable. After around USD 1.13 for EUR 1 on average in 17, the downward convergence of the US dollar will continue towards equilibrium. At the end of 18, the exchange rate of the euro compared with the US dollar is expected to increase to 1., supported by rising portfolio inflows and the decrease in risk assessment for Europe. Thirdly, the concerns about possible consequences of the protectionist policy of the USA are increasing, even though we believe the effects on the Austrian economy will be manageable at the current level. However, a vicious circle is impending of reciprocal protectionist measures, which are likely to have a negative impact on the momentum of global trade. Global economic growth is likely to suffer as a result of this, which would not be without a noticeable impact on the growth prospects for Austrian foreign trade. IN SPITE OF HIGH EXPORTS, THE TRADE DEFICIT ROSE IN 17, WITH THE CURRENT ACCOUNT SURPLUS LOWER Export and import volume (monthly values, in EUR mn) 13,5 13, 1,5 1, 11,5 11, 1,5 Exports, s.a. Exports, trend Imports, s.a. Imports, trend 1, 1/15 7/15 1/16 7/16 1/17 7/17 1/18 Current account balance (in % of GDP) Goods Primary income Current account Services Secunary income Export growth burdened by decreasing momentum in global trading, strength of the euro and concerns about increasing protectionism Industrial and consumer sentiment reach their peak since the financial crisis, but export environment loses its shine a little The good times are not over but cyclical peak has passed and risks are on the rise The jubilant mood in the domestic economy is continuing in the summer of 18. The UniCredit Bank Austria economic indicator stands at 3.6 points in July posting a decline for the seventh month in a row from the all-time high at the end of 17, but is still above average in a long-term comparison. The cyclical peak has now passed. The excellent Austrian export environment lost its shine somewhat in the first half of 18. The indicator for the global industry sentiment weighted with the domestic foreign trade shares has clearly fallen. The upward trend in the key markets of Germany and France and in some Eastern European countries in particular has ended. Nevertheless, the domestic industry remains optimistic in view of the high volume of orders. UniCredit Research Page 7

8 ECONOMIC SENTIMENT HAS PASSED ITS PEAK; ECONOMIC GROWTH IS SLOWING DOWN Sentiment indicators (standardized) Industry International industry Consumer Construciton Services - 1/15 1/16 1/17 1/18 GDP (real change in %, qoq and yoy) qoq, s.a. (right-hand scale).8 annual average Positive outlook for 18 and 19 with a somewhat slower pace of growth The optimism of domestic consumers is also high in view of the ongoing improvement in the situation on the domestic labour market. The economic sentiment in Austria continuously improved up to the beginning of 18. However, since spring, the upward trend has abated and sentiment has become more inconsistent. In the service sector, sentiment is in fact slightly depressed at this time. Over the rest of the year, the pace of growth of the Austrian economy is expected to slow down slightly. Firstly, the economic tailwind generated by foreign demand appears to be easing off. The effects of the strength of the euro compared with the US dollar as well as the rising tension over trade policy are expected to become apparent. The interest-rate hike in the USA could have an unfavourable effect on the flow of capital in the emerging markets and their pace of growth. Secondly, domestic demand is also expected to lose momentum. Investment dynamics in particular are about to slow down. The investment boom is already in its fourth year. The backlog that previously existed has therefore now been covered. However, the high degree of utilisation of the domestic economy reflects a strong momentum in investments in equipment due to capacity expansion in order to cover the high demand. In contrast, thanks to the strong growth in employment and more movement in wages, there is still plenty of stimulus from private consumption. Despite this, at.8%, economic growth in Austria will still be very strong in 18 and will be above the long-term average for the second year in a row. In addition, as in 17, economic growth will be higher than in the eurozone and will also once again surpass that in Germany. For 19, the outlook for the Austrian economy is still favorable, but as the economic cycle moves towards its end and global support eases off particularly from the US, where a number of factors are expected to result in a flattening of economic growth in the year following the tax cut this is likely to result in the economy normalizing on a very solid level of growth of around %. UniCredit Research Page 8

9 US trade policy could exacerbate economic slowdown Protectionist tendencies and the consequences for Austria In early March, US President Donald Trump announced the introduction of increases in import duties on steel and aluminium (5% and 1% respectively). For the Member States of the European Union, the introduction was postponed until 1 May 18, but is now in effect. According to US statistics, the US imports affected goods at a value of around EUR 4 million in 17 from Austria (steel: EUR 4 million, aluminium: USD 16 million). This affects under.3% of total exports in Austria, with a percentage of GDP of just.1%. The direct economic consequences of US levies on steel and aluminium for Austria are therefore manageable. In the event of a widening of trade policy measures to other products as a response to the EU s retaliatory tariffs on some US goods, the potential consequences for the Austrian economy would be significantly higher, however, as a total of about.5% the Austrian value added depends on demand from the USA. According to our calculations, a decline of 1% in Austrian exports to the USA (calculated based on value added) would lower Austrian GDP by around. percentage points. UniCredit Research Page 9

10 Labor market benefits from the good economy In 17, the unemployment rate fell to 5.5% a drop in unemployment in Austria for the first time since 11 Acceleration of the growth in employment in the first half of 18 Improvement on the labor market continues, but pace begins to slacken Unemployment rate to fall to 4.8% in 18 and 4.7% in 19 Focus: Dynamics of the labor supply continue to shape the Austrian labor market In June 18, unemployment reached its lowest level since summer 13 at 7.8% (national method) or 4.7% (Eurostat) Labor market benefits from the good economic situation The economic upturn has now contributed to a striking improvement in the situation on the Austrian labor market. After stabilization in 16, the significant increase in growth in employment in 17 to almost % above the previous year enabled a drop in the unemployment rate for the first time since 11. After an average of 9.1% in 15 and 16, the unemployment rate dropped to 8.5% in 17 according to the national method. The unemployment rate (according to the Eurostat calculation) fell to 5.5% in 17 (16: 6.%). In the first half of 18, the positive development on the labor market became even faster. Employment rose by an average of.6% year-on-year. This corresponds to an increase of almost 95, employees. Of these new jobs, around 6, were on the service sector. In relation to the size, a disproportionately high number of new jobs were created primarily in construction (9,) and industry (4,). In addition, the number of job vacancies increased by almost 15, to a total of about 6,. In the same period, the number of jobseekers fell by 37,. In June, the seasonally adjusted unemployment rate was 7.8% or 4.7% (Eurostat). STARKER ANSTIEG DER BESCHÄFTIGUNG UND DER OFFENEN STELLEN, ARBEITSLOSIKGEIT GEHT ZURÜCK Employment and job vacancies Vacancies (absolute, s.a., right-hand scale) Employment (in 1,, s.a.) 3,7 3,65 3,6 3,55 3,5 3,45 3,4 3,35 3, , 7, 6, 5, 4, 3,, 1, The unemployed Unemployed (change yoy, in 1,, right-hand scale) Unemployment rate (nat. meth. s.a., left-hand scale) 1 Unemployment rate (Eurostat, s.a., left-hand scale) Improvement trend on the labor market continues Given the good economic situation, the improvement in the situation on the Austrian labor market will continue. However, due to declining economic support in the months ahead, somewhat lower growth in employment is to be expected. Given the continuing sharp increase in the number of workers, therefore, the fall in unemployment will slow down. UniCredit Research Page 1

11 Further decline in the unemployment rate in 18/19 but at a slower pace For the full year 18, we are expecting employment growth of just over %, with a drop in the annual average unemployment rate to 7.7% (national method) or 4.8% (Eurostat). In 19, the positive trend on the labor market is expected to slow down in view of the more moderate pace of growth in the economy. In comparison to 18, there will only be a very slight drop in unemployment rates by around one tenth of a percentage point. STRONG INCREASE IN EMPLOYMENT IN CONSTRUCTION AND IN INDUSTRY SUPPORTS THE DROP IN UNEMPLOYMENT Employment trend by sector (in 1,) Services Industry Unemployed -9.8 Construction Primary sector Employeesd Workforce (in 1.) Unemployed (change against previous year) Employed (change against previous year) Unemployment rate (in % - right-hand scale) (in %) Increase in employment by around 5, annually needed for the rising supply of labor on the labor market Supply of labor: the dominant factor on the domestic labor market With the start of the full free movement of workers in Austria for employees from Central and Eastern European countries acceding to the EU in May 11 (Hungary, Poland, Czech Republic, Slovakia, Slovenia and Baltic States) as well as from 14 (Romania and Bulgaria), there has been strong labor migration to Austria, which has increased the supply of labor significantly up to the middle of 18. The supply of labor in this period rose by 6% or, people. About 8% of this increase is attributable to foreign employees. The increase in the labor supply from an annual average of around 5, up to 6, persons means that in Austria, employment has to rise at least as much to reduce unemployment. This was not the case until 17 the first time since the labor market opened up to employees from the new EU Member States. Due to an increase of around 7, workers, the number of jobseekers fell year-on-year by almost 17,. In addition to economic development in Austria, therefore, the extent of the increase in the labor supply is decisive for the development of the unemployment rate and must therefore be taken into consideration for further assessing the situation on the labor market. UniCredit Research Page 11

12 Inflation in Austria remains at around % Rate of inflation climbed to.1% in 17 primarily caused by the rise in the oil price Slightly lower inflation in the first half of 18 supported by the strength of the euro Higher oil price, strong domestic demand and more significant wage growth result in expected inflation of.% for 18 and % for 19. Normalization of monetary policy brings an end to the zero interest rate policy after the summer of 19 Focus: How the exchange rate affects oil price dynamics Oil price-related increase in inflation in 17 to.1% Slight fall in inflation in the first half of 18 due to a strong euro, but the trend has reversed Oil price caused increase in inflation in 17 After.9% in 16, the average rate of inflation in Austria in 17 rose to.1%. The upturn was primarily down to the increase in the crude oil price from an average of USD 45.1 in 16 by more than %, reaching USD 54.9 per barrel in 17. This made the Transport product division, which includes the fuel prices and which had dampened inflation in the previous years, one of the biggest price drivers. 19.4% of overall inflation, i.e. around.4 percentage points, is down to this, while it represents only 1.9% of the basket of goods (see diagram below). In addition, the stronger demand also pushed prices up. This is reflected on the one hand in the product group Restaurants and Hotels, where prices for hosting services rose by almost 3%, and apartments for rent, which rose by more than 4% year-on-year, although the category Housing and Energy posted a below-average rise in inflation. The only relative and simultaneously absolute price damper category in 17 was Communications. With an average of 1.9% in the first half of 18 compared to the previous year, inflation in Austria was slightly lower than in the previous year. The comparatively lower price increase in crude oil and the weakening of the US dollar against the euro contributed to this. However, that trend has now reversed. In June, inflation rose to % year-on-year. Due to the uncertainty surrounding the termination by the US of the nuclear deal with Iran, the oil price is around % above the level at the beginning of the year and even 5% higher than one year ago. In addition the dampening effect of exchange rate trends, which has been significant to date, has abated, as the euro has lost around 5% against the US dollar since the spring. INFLATION IN 17 DRIVEN BY TRANSPORT, HOSTING SERVICES AND A PRICE INCREASE FOR LEISURE AND CULTURE Price drivers in 17 Tobacco&Alc. beverages Recreation&Culture Food Restaurants & Hotels Transport Impact on inflation in % Weight in % Factors with a (relative) price dampening effect 17 Housing&Energy 15.. Misc. goods Health Clothing Furnishing. 7. Education Communications -1.3 Impact on inflation in % Weight in %.1 UniCredit Research Page 1

13 Inflation in 18/19 at around % year-on-year Asset purchase program ends at the turn of the year, movement in interest rates at the earliest after summer 19 Stable inflation and normalization of monetary policy in sight Due to the low price basis in the summer of 17, the price of oil will provide for a moderate increase in inflation from the middle of 18 beyond the % mark year-onyear, despite the ongoing dampening effect of the euro, which is stronger compared to the previous year. The annual average inflation for 18 of.% is expected to be slightly higher than in the previous year. In 19, due to ongoing price pressure, especially for services, we expect inflation in the area of around %, especially as the improvement in the situation on the labor market is expected to ensure a moderate acceleration in wage growth. With an average of.3%, the HICP in Austria in 18 will be above inflation in the eurozone for the tenth year in succession. The higher oil price as well as the economic recovery, which influences wage dynamics, will ensure an upward trend in inflation in the Eurozone as a whole in the coming months. The increase in inflation to an average of 1.7% in 18 will enable the ECB to introduce the normalization of monetary policy. The ECB will allow the asset purchase program to expire as expected at the end of 18 and has announced that it will only consider changing interest rates after the end of the summer of 19. IL PRICE FLUCTUATIONS PRIMARILY AFFECTING INFLATION THROUGH TRANSPORTATION Oilprice and FX Oil price/barrel in euro Oil price per barrel in USD USD/1EUR (right-hand scale) Inflation (with effects resulting from goods contained in the basket) 3.% 3.% Transportation Housing.5% Food others.5%.% CPI total.% 1.5% 1.5% 1.% 1.%.5%.5%.%.% -.5% -.5% -1.% -1.% 1/15 1/16 1/17 1/18 1/19 Increase in the price of oil in 18 is only partially offset by the stronger euro How the price of the euro affects oil price dynamics The development of the oil price has a noticeable effect on inflation in Austria. The effect on the development of domestic prices depends not only on the international price fluctuations from crude oil traded in US dollars, but also on the movements of the USD against the euro. Depending on the direction and magnitude of these movements, the effect of the oil price may therefore be exacerbated or attenuated and even completely cancelled out by changes in exchange rates. In our current forecast, we anticipate an increase in the oil price of an average of USD 54.9 per barrel in 17 to USD 73.6 in 18. This corresponds to an increase of around 34%. At the same time, we expect a price increase in the euro compared with the US dollar from 1.13 to 1. on annual average in 18, i.e. an increase by around 6%. As a result, the oil price measured in euro, will only increase from EUR 48.6 to EUR 61.5, not quite 7%. The increase in the oil price is absorbed slightly on the global markets by the rise in the rate of the euro, which means that the effect on inflation is therefore muted. To clarify the influence of oil-price or exchange-rate movements on Austrian inflation, we have calculated alternative scenarios using our short-term inflation model. In the UniCredit Research Page 13

14 oil-price scenario, at the end of 18 we assume an unchanged exchange rate for alternative dollar oil prices of plus or minus 1% compared with our current forecast. This results in inflation that is.3 percentage points higher, or.% lower inflation than in the base forecast. Given unaltered US dollar oil prices, an increase in the exchange rate of the euro by 1% would even result in a somewhat greater fall in inflation by.4 percentage points, while a drop in the exchange rate by 1% against the US dollar would result in inflation that is.5 percentage points higher. Due to the very short time horizon examined (up to the end of 18), only minor deviations emerge from the base forecast. Since the fluctuation in the exchange rate tends to be somewhat more strongly reflected than the oil price fluctuations in US dollars, a 1% increase in the oil price in USD could be more than compensated for according to the model by a 1% strengthening of the euro. A synchronous fall in the euro would in fact more than double the effect on inflation. UniCredit Research Page 14

15 Good economic situation eases budget plans Strong economic growth helped the overachievement of budgetary targets in 17 Budget proposal for 18 provides for deficit reduction to.4% of GDP Balanced budget planned for 19 Public debt falls rapidly as a result of more disciplined budgetary policy and asset reduction at Bad banks Focus: The new government sets its sights on the tax and contributions ratio Budget deficit fell to.7% of GDP in 17 No negative budget balance in 19 for the first time since the 197s Lower budget deficit After the increase in the general government budget deficit to 1.6% of GDP in 16, due mainly to the revenue shortfall as a result of the tariff reform of payroll and income tax, the budget deficit was reduced significantly in 17. At.7% of GDP, the deficit was clearly below the original budget target of 1.% of GDP, supported by the good economic cycle with economic growth of 3% instead of the original draft budget s forecast of 1.5%. Revenues were significantly above target. The positive trends in taxes and duties paid, particularly corporation tax and higher contributions to unemployment insurance due to strong employment growth contributed to this. In contrast, income from valueadded tax and payroll and income tax was below the official expectations. The expenses in 17 were above the target specifications due to payments to KA Finanz AG and the repurchase of afflicted bonds from HETA. In contrast, the expenses for pension insurance and unemployment insurance were below target. GOOD ECONOMIC SITUATION ENSURES STRONG REVENUE GROWTH OF OVER 4% IN THE FIRST HALF OF 18 Tax receipts (Average monthly revenue, 1=1) Tax and contributions ratio in comparison (16, in % of GDP) Taxes (total) Income tax 9 Corporate tax Value added tax 8 1/15 1/16 1/17 1/ FR DK BE SW FI AT IT EL Euro DE EU LX HU NL HR PT SI UK CZ EE PL ES CP MT SK LV LT BG RM IE No negative budget balance in 19 for the first time since the 197s No new debt planned for 19, total public debt declining significantly After the late election date, the budget for 18 was decided simultaneously with the estimate for 19 at the end of April 18. The current draft provides for a budget deficit of.4% of GDP for 18 and a balanced budget for 19. The draft of the budget contains no significant structural changes. In the areas of education, research and security, financial priorities are being set, while moderate cuts are planned for expenses incurred in connection with labor market and integration policy. For,- an income tax reform was announced for, which is intended to reduce the tax and contribution ratio to 4% of GDP. In view of the positive economic trend and the low interest rates, the planned budgetary targets should be within range. In the first half of the year, the payments in increased by more than 4% compared with the previous year and are therefore better than expected. UniCredit Research Page 15

16 This is due to growth in income and payroll tax and corporation tax. In addition, the expenses fell by more than % year-on-year, resulting in a net borrowing requirement of EUR.8 billion, which is almost EUR.5 billion less than in the previous year. Total public debt fell to 78.4% of GDP in 17 and is therefore below the 8% mark for the first time since 8. Due to the low new debt in 18 and the balanced budget for 19, supported by the further asset reduction at the Bad Bank HETA, a further decline in public debt is expected in relation to the economic output in the forecast period. We expect a reduction to 7% by the end of 19. DISCIPLINED BUDGET POLICY SUPPORTS DECLINE IN PUBLIC DEBT IN RELATION TO GDP Budget deficit (in % of GDP) total Social security funds Communities (incl. Vienna) Federal states Central state Public debt (in % of GDP) Social security funds Federal states total Communities (incl. Vienna) Central state Austrian tax and contributions ratio has fallen since 15 Further reduction requires intelligent tax and social security contribution adjustments, otherwise there is a risk of government cutbacks The new government sets its sights on the tax and contributions ratio The government program has explicitly set the target of reducing the tax and contributions ratio (taxes and social security contributions in relation to economic output) to 4% of GDP. After over 43% in 15, the ratio fell to 4.7% as a result of the tax reform in 16 and continued to fall to 41.9% in 17. Nevertheless, in an international comparison Austria has a far above-average tax and contributions ratio, which is stated in the government program as an argument for a further reduction. However, in our view, the amount of the tax and contributions ratio itself is not enough to be the sole argument for a reduction. This is the case on the one hand as wealthy countries also tend to have high tax and contributions ratios. Ultimately, only economically successful countries can undertake comprehensive government activities, for example in terms of legal, security or social policy, for its citizens. On the other hand, a reduction in the tax and contributions ratio does not automatically mean a more efficient state that can generate higher economic growth. Instead, a change of the structure of the tax and duties burden is key here. With the reduction in unemployment insurance contributions for low-earners as of 1 July 18 and especially the income tax reform planned for by lowering taxes on labor, the government is not only planning to reduce the tax and contributions ratio further, but also to have a positive influence generally on economic growth. However, government services for citizens will only not be reduced, if it is actually possible to compensate for the revenue shortfall by structural changes and measures that increase efficiency at the same amount. UniCredit Research Page 16

17 Banking market gaining momentum Demand for credit benefits from a good economic situation with. percent increase on average in 17 and further increasing momentum in the first half of 18 Acceleration in corporate credit growth and strong increase in housing loans Despite a low interest environment: strong deposit growth in 17 and in the first half of 18 of around 4% on average for the year, primarily driven by an increase in momentum among corporate customers Focus: A nation of savers, despite negative real interest rates.% increase in demand for credit in 17 with increasing momentum over the course of the year High liquidity of companies leads to strong deposit growth. Despite a low interest environment, even private households are building up their bank deposits Credit demand continued to gain momentum in the first half of 18 Upward trend in loans and deposits Alongside the economic recovery, credit demand in Austria increased significantly in 17. The entire credit volume rose by.% on average for the year and reached over EUR 341 billion or 9.3% of GDP by the end of 17. A significant contribution was made by the positive development in corporate loans, which rose.9% on average, with growth as high as 4.9% at the end of the year. The amount of loans for consumer spending and SMEs also began to rise in 18 even though they stagnated in terms of the annual average. The demand for housing loans remained strong, but the growth of under five percent was relatively moderate compared to previous years. Despite the increasing momentum in corporate loans, a large part of the investment boom is not financed by bank loans, but rather by internal financing and other forms. The high liquidity of Austrian companies is reflected in the strong deposit growth of more than 8% for company deposits. Private households also continued to expand their bank deposits in 17 and they remained the most important investment class by far, even if the volume of new business decreased somewhat compared to 16. The second most important investment class continued to be funds in 17, while bonds and life insurance again went into a new net decline. Furthermore, another insignificant factor in the assessment of private households in Austria is direct share equities. In the course of the first half of the year, credit demand in Austria increased slightly again, with corporate loans making the greatest contribution to the rising momentum. The construction and real estate sectors are de facto solely responsible for the growth in corporate credit. The demand for credit by other sectors in the Austrian economy showed only little growth due to the very good liquidity situation and the increasing significance of alternative financing in light of the excess liquidity of the corporate sector. Following the structure of the Austrian economy, some of the financing came from abroad in the form of intra-group financing, but also from trade credits. Housing loans continued to develop dynamically, but the growth rates barely increased any further over the course of the first half of the year. After years of declining volumes, the financing of consumer spending and SMEs is slightly increasing for the first time in 18. Despite the generally low interest rates, total deposits in Austria are increasing sharply and the pace of growth did not fall in corporate investments or private households in the first half of 18. Short-term deposits are dominant given the low interest rate environment. The demand for funds remained high in the first half of 18, while the attractiveness of life insurance continues to decline. UniCredit Research Page 17

18 ECONOMIC UPSWING SENDS CREDIT AND DEPOSIT GROWTH IN AUSTRIA SOARING Corporate lending banks (yoy growth adjusted for loan sales and notional cash pooling,) 1% 8% 6% 4% % % -% -4% Corporates Housing Consumption -6% 1/15 1/16 1/17 1/18 Deposits (yoy change in %) Corporates Households total - 1/15 1/16 1/17 1/18 Source: OeNB, UniCredit Research Good economic prospects and favourable financing conditions justify further increases in the demand for credit Fixed interest rates gain in significance at historically low level Majority of new investments with a shortterm nature Sustained favorable economic outlook in the second half of 18 and 19 ensure continuing good demand for credit Despite the solid liquidity situation and financing alternatives on the capital market, corporate loans will increase slightly. We assume that the demand for financing for SMEs will accelerate in the months ahead. In addition, optimistic consumer sentiment is expected to increase the demand for consumer financing slightly once again. Credit growth in housing finance, which is made possible by the continuing low interest rates, the strong demand for housing and at least slightly rising real estate prices, should remain buoyant. The trend towards fixed interest rates hedging the historically low interest rates, which was on average around 1.8 percent for new housing loans in the middle of 18, is likely to continue. The proportion of fixed interest rate loans in the new loans as a whole is now around 6% in Austria. In 15 that figure was only 15%. On the investment side, the low interest environment in private households will continue to dominate. Investments will probably continue to focus on very shortterm deposits, which are expected to be the subject of the majority of new investments, since deposits with longer fixed terms as well as bonds do not offer attractive yields. We expect additional demand for investments in funds. AUSTRIAN HOUSEHOLDS PREFER SAVING DEPOSITS DESPITE REAL LOSSES Real interest rate in Austria (in %, nominal interest rate in new business or return from gov. bonds minus CPI in 1 months excl. tax) savings deposits (overnight) savings deposits with agreed maturity up to years average gov. bond yield (1 years) Return for deposits since 7 (annually, real, households) Change against previous year in % 4% 3% % 1% % -1% -% -3% 4% 47% Share of financial assets in % 6% 4% 7% 5% total, -.3% 6% 4% % % -% -4% -6% Source: OENB, UniCredit Research UniCredit Research Page 18

19 A nation of savers, despite negative real interest rates Austrian households prefer a very conservative investment of their financial assets. Of the more than EUR 5 billion 1) (approx % of GDP), 47% are held as savings deposits, more than half of which are in fact overnight money assets. In 17, just over EUR 1 billion around 4% of financial assets was invested in securities. More than half of this was invested in funds. The proportion of bonds was 7%, while equities accounted for just over %. Nor has the attractiveness of savings deposits for Austrian households subsided in 18 either. In the first few months of the year, investments in deposits rose by an average of just under 4% year-on-year. In view of the years of low interest rates, investments in deposits have particularly low returns. While the annual return of savings deposits was still nominally over percent between 7 and 11, this figure fell from 1 to an average of.7 percent. Taking inflation into account, as well as the capital gains tax of 5%, however, in both cases this means a negative real return of.7 or even 1.%. For the entire period from 7 to 17, this resulted in negative real returns of 1.% (see page 18, graph on the right). In comparison, an investment in securities in this period produced real income growth of 1.% per annum. The investment in equities was particularly profitable with a real increase of 3.3% on average, given a particularly favourable performance from 1 onwards. 1) Financial assets without other proportional values and other receivables. UniCredit Research Page 19

20 Austria at a glance Structural indicators 17 Area (in km²) 83,879 Population (in mn) 8.8 President Dr. Alexander van der Bellen Chancellor Sebastian Kurz Rating (Moody s/s&p/fitch) Aa1/AA+/AA+ Economic performance Gross domestic product (in EUR bn) 37 GDP per capita (in EUR) 4,5 GDP per employee (in EUR) 85,84 GDP per capita (in % of EU7 average, PPS) Gross domestic product (real change against previous year in %) (Ø 13-17) Workforce (in 1,) 3,995 Employed (in 1,) 3,655 3,553 (Ø 13-17) Employment rate (in %) 41.6 Number of unemployed (in 1,) (Ø 13-17) Vacancy rate (in %) 1.4 Monthly average income (gross, in EUR) 3,51 International competitiveness Ranking Trend IMD-World Competitiveness Index 18 IMD Economic Performance 17 IMD Government Efficiency 3 IMD Business Efficiency 14 IMD Infrastructure 14 WEF Global Competitiveness Index 18 WEF Inclusive Development Index 1 Transparancy International Corruption Perceptions Index 16 European Innovation Scoreboard 9 Research&Development Ratio (R&D-expenses in % of GDP) 3. Investment ratio (Investments in % of GDP) 3.5 Tax and levies ratio (Tax and levies in % of GDP) 4.5 Merchandise exports (in EUR bn) 13..8% (Ø 13-17) Export ratio (in % of GDP) (Ø 13-17) Merchandise imports (in EUR bn) % (Ø 13-17) Import ratio (in % of GDP) (Ø 13-17) Foreign direct investment (outward, in EUR bn, 17) (Ø 13-17) Foreign dircet investment (outward, in % of GDP, 17) 3.3 Foreign direct investment (inward, in EUR bn, 17) (Ø 13-17) Foreign direct investment (inward, in % of GDP, 17).5 GDP by sectors 17 Export markets 17 other EU 7.5% others 19.% Switzerland 4.9% Import markets 17 other EU 3.3% others 18.6% Czech Rep. 4.3% Primary sector 1.3% Services 7.6% Switzerland 5.% China 5.8% Industry 1.9% Germany 3.1% US 6.8% Italy 6.4% Construction 6.% Germany 36.8% Italy 6.1% France 5.% Federal states 17 Area (in km²) GDP (real, yoy in %) (Ø 13-17) GDP/capita (in EUR) GDP (in % of Austria) Unemployment rate in % Burgenland 3, , Carinthia 9, , Lower Austria 19, , Upper Austria 11, , Salzburg 7, , Styria 16, , Tyrol 1, , Vorarlberg, , Vienna , Source: Statistik Austria, OeNB, IMD, TI, WEF, EU Commission, UniCredit Research UniCredit Research Page