2011-05-04 Unicredit Euro Compass - How Long Before The Next Cyclical Downturn

May 2011 Economics & FI/FX Research
Euro Compass
How long before the next cyclical downturn?

■ The eurozone recovery is strengthening and broadening. After solid 0.8%
qoq growth in 1Q, we have revised up our full-year GDP forecast from
1.7% to 2.1%. In this issue of the Euro Compass, we take a medium-
term approach to analyzing the eurozone business cycle. Our aim is to
identify the current stage of the recovery and provide an approximate
timing for the beginning of the next downturn. Based on past regularities,
we find that this cyclical upswing is unlikely to end soon. With the
exception of inflation, all the indicators we looked at suggest the turning
point of this cycle could be around mid-2013. We feel comfortable with
this result, also because it is very much consistent with the average
length of eurozone business cycles in the last twenty years.
■ In recent months, core inflation (ex food, energy, alcohol and tobacco)
has exceeded our expectations. At 1.6% in April, it is twice as high as in
early 2010, when it bottomed out. However, the April reading was
distorted upwards by the late timing of Easter and the new seasonality of
clothing/shoes prices after a methodological change in the way the price
of seasonal items is determined. We expect core inflation to fall back in
May. Our headline CPI forecasts remain on track but, after the latest
developments, the composition of the balance of risk has somewhat
changed: less upside risks from commodities, more from core prices.
■ When the ECB meets on 9 June, we expect a switch to “(strong)

vigilance”, signaling that in July the refi rate will be raised by another
25bp. The risk of a dovish surprise, with Trichet sticking to “very close
monitoring” and therefore further delaying the next rate move, is fairly
low, no more than 20%. With respect to the liquidity strategy, the ECB
should leave the full allotment at the 1W MRO and 1M LTRO in place,
while the decision on the 3M LTRO is a very close call. Pulling the plug
here risks creating an additional source of volatility in an already very
uncertain environment.
■ FI: Risk aversion should remain the key driver for Bunds in the near term,
likely offsetting the effect of the upcoming ECB rate hike. In the US, QE2
will come to an end but, given the recent stream of worse-than-expected
data, we do not forecast significant upward pressure on yields. Over a
longer horizon, we still expect the German curve to bear flatten and
move higher, while the US curve is likely to remain steep until year -end.
■ FX: The delay of the next ECB rate hike to July and Greek debt fears
prompted a heavy EUR-USD sell-off, and a test even below 1.40 cannot Editor
be ruled out before July. However, prospects of widening interest rate Marco Valli
Chief Eurozone Economist
differentials and the commitment of EU countries to adjust the terms of +39 02 8862-8688
Greece's aid program imply that potential for a pullback above 1.50 in marco.valli@unicredit.eu
2H11 still exists.
Editorial deadline
Wednesday 18 May 2011, 15:00
Prices at: Wednesday 18 May 2011, 8:00
Bloomberg
UCGR, UCFR
Internet
www.research.unicreditgroup.eu
UniCredit Research page 1 See last pages for disclaimer.

Euro Compass
Contents
1 How long before the next cyclical downturn?
3 Key Eurozone Forecasts
4 Europe in a nutshell
5 The European Economist
5 How long before the next cyclical downturn?
10 Inflation Watch
10 Less upside risks from commodities, more from core prices
11 UniCredit Inflation Forecasts
12 The ECB Watcher
12 The need for vigilance
14 ECB Most Watched
15 The Eurozone Economist’s Toolbox
19 European Central Banks Watch
19 BoE – On hold despite high inflation
20 SNB – CHF up on EMU debt crisis woes, again
21 Nordics – Norges Bank catching up with Riksbank
22 FI Strategizer
22 Bonds to remain bid for the time being
24 A quick glance at the US and UK
26 FX Strategizer
26 EUR-USD: shell-shocked but not definitively knocked down
29 FX Monitor: G-10 Monthly Change
30 FX Monitor: G-10 Implied Volatility Curves
31 Country Outlook
31 Germany – Already back to pre-crisis high
32 France – Recovery keeps strengthening
33 Italy – Still lagging behind
34 Spain – The recovery remains an export story
35 Austria – Economic growth in 2011 expected to exceed 3%
36 UniCredit Forecasts

Euro Compass
Key Eurozone Forecasts

2010 2011 2012 Annual average
1Q-10 2Q-10 3Q-10 4Q-10 1Q-11 2Q-11 3Q-11 4Q-11 1Q-12 2Q-12 3Q-12 4Q-12 2010 2011 2012
GDP 0.4 1.0 0.4 0.3 0.8 0.5 0.3 0.4 0.4 0.5 0.5 0.5 - - -
GDP (% yoy) 0.8 2.0 2.0 2.0 2.5 1.9 1.9 2.0 1.6 1.5 1.7 1.9 1.7 2.1 1.7
Private Consumption 0.3 0.2 0.2 0.4 0.4 0.3 0.2 0.3 0.3 0.3 0.4 0.4 0.8 1.2 1.2
Government Consumption -0.1 0.2 0.4 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.7 0.4 0.3
Gross Fixed Capital Formation -0.2 2.1 -0.2 -0.5 1.0 0.5 0.5 0.6 0.7 0.8 0.9 1.0 -1.0 1.8 2.9
Change in Inventories* 0.4 0.3 -0.1 -0.1 -0.1 0.0 0.0 0.0 0.0 0.0 0.1 0.1 0.5 -0.1 0.1
Domestic Total Expenditure 0.1 0.6 0.1 0.2 0.4 0.2 0.2 0.3 0.3 0.4 0.4 0.5 0.9 1.1 1.5
Exports 3.1 4.5 2.1 1.6 3.0 2.0 1.3 1.4 1.4 1.5 1.6 1.7 11.0 9.1 6.0
Imports 3.6 4.2 1.5 1.0 2.1 1.6 1.3 1.3 1.4 1.5 1.7 1.9 9.1 7.0 6.1
Net Exports* -0.2 0.1 0.3 0.3 0.5 0.2 0.0 0.0 0.0 0.0 0.0 -0.1 0.8 1.0 0.1
HICP Inflation (% yoy) 1.1 1.6 1.7 2.0 2.5 2.8 2.8 2.8 2.2 2.0 2.0 2.0 1.6 2.7 2.0
Core HICP Inflation (% yoy) 0.9 0.9 1.0 1.1 1.1 1.5 1.4 1.5 1.5 1.6 1.7 1.8 1.0 1.4 1.7
Unit Labour Costs (% yoy) -0.5 -0.6 -0.6 -0.2 -0.5 0.2 0.5 0.4 0.9 0.9 0.9 0.9 -0.5 0.1 0.9
Employment growth 0.0 0.1 0.0 0.2 0.3 0.3 0.2 0.2 0.3 0.3 0.3 0.3 -0.4 0.8 1.1
Unemployment rate (%) 10.0 10.1 10.1 10.0 9.9 9.8 9.7 9.7 9.6 9.5 9.4 9.3 10.1 9.8 9.5
Current Account (% GDP) - - - - - - - - - - - - -0.2 0.1 0.2
Budget Balance (% GDP) - - - - - - - - - - - - -6.0 -4.5 -3.8
ECB Refi rate 1.00 1.00 1.00 1.00 1.00 1.25 1.50 1.75 2.00 2.25 2.50 2.75 - - -
3M Euribor rate 0.63 0.77 0.89 1.02 1.09 1.50 1.75 2.10 2.30 - - - - - -
2yr 0.96 0.60 0.83 0.94 1.42 2.10 2.25 2.50 2.80 - - - - - -
5yr 2.14 1.46 1.48 1.71 2.35 2.83 2.95 3.10 3.25 - - - - - -
10yr 3.09 2.58 2.28 2.63 3.17 3.45 3.55 3.65 3.70 - - - - - -
30yr 3.83 3.29 2.87 3.13 3.61 3.85 3.90 3.95 3.90 - - - - - -
EUR/USD 1.35 1.22 1.36 1.34 1.40 1.50 1.53 1.55 1.52 - - - - - -
EUR effective exchange rate (EER-21) 106.8 100.3 104.9 102.7 103.0 106.0 108.0 109.0 107.0 - - - - - -
All data are % qoq unless otherwise specified; GDP data are working-day adjusted; interest and exchange rates are end of period
*Contribution to growth Source: UniCredit Research

Euro Compass
Europe in a nutshell
GDP OUTLOOK INFLATION OUTLOOK CENTRAL BANK OUTLOOK TRADE IDEAS
EUROZONE The economy entered 2011 on a solid footing, growing Inflation accelerated further in April, to 2.8%. The pick- This month’s reference to “very close monitoring”, the FI: recent return of risk aversion has supported safe haven
by a stronger-than-expected 0.8% qoq in 1Q. Although up was totally driven by core prices, which were firmer same as in April, should be read as a sign that the demand, leading to bull flattening of the Bund curve. We
remaining healthy, GDP momentum will probably soften than expected (1.6%) also due to the late Easter. central bank will most likely hold its fire in June, and expect yields to go up but not too soon and not too fast
somewhat in 2Q, mostly due to surging oil prices. We Inflation will probably ease marginally in May, but will probably pull the trigger again in July. We continue to given we do not see a near term decision on Greece.
raised our full-year GDP forecast for 2011 from 1.7% to remain well above the ECB’s comfort zone for see the refi rate at 1.75% at year-end. FX: New ECB rate hikes being frozen until July and Greek
2.1%. We see 1.7% growth in 2012. sometime. We expect CPI at 2.7% in 2011 and 2.0% debt fears may expose EUR-USD to volatile sessions
in 2012. ahead, but in the medium term we still point to a target
above 1.50 in a less EUR-adverse scenario
GERMANY The strong export-driven recovery in industry remains on Underlying inflation has already bottomed out early FI: In the short term Bunds should continue to be the safe-
course, becoming increasingly broad-based. After last year and higher selling price expectations indicate haven FI asset. We continue to see ECB action as the
a strong rebound of +3.5% in 2010, we expect a similar a continuing upward trend in 2011, driven by higher main risk factor for the short end.
growth dynamic this year. commodity prices.
FRANCE 1Q GDP surprised on the upside coming in at 1.0% qoq, Consumer inflation accelerated by 0.1pp to 2.1% in FI: France deficit will be above the average in the core
the highest reading since 2Q-06. We expect that GDP April. Our baseline scenario now foresees inflation group but, as we see little rating risks, the yield pick-up vs.
will soften in 2Q to 0.5% qoq, which is yet a healthy accelerating very gradually until the autumn, before Bunds appears interesting. The 30Y is the area offering
level. This would lift the 2011 annual average to 2.3% falling thereafter. We expect CPI at 2.1% this year. more value vs. Bunds. The 5Y area looks interesting.
ITALY GDP expanded by a meager 0.1% qoq in 1Q, with both Inflation accelerated to 2.6% in April. We expect CPI FI: Italy continues to be the safest of periphery. The recent
industrial production and services activity remaining inflation to remain stable throughout the summer and wave of risk aversion sent the 10Y BTP/Bund spread back
broadly flat. Manufacturing surveys in April did not point accelerate slightly towards year-end, before entering a to the 150bp area, but the pressure on BTPs has been
to acceleration in factory activity at the beginning of the downward trend at the turn of the year. We see much more limited than for the other peripherals. We like
second quarter. inflation at 2.6% and 2.0% in 2011n and 2012. the 10/15Y area on the BTP curve.
SPAIN GDP accelerated 0.3% qoq in 1Q, a tad higher than CPI inflation further accelerated in April, printing at FI: We remain prudent on Spain as the banking system
expected. This lifts mechanically the 2011 GDP forecast 3.5%. In yearly average terms, we see CPI outlook remains uncertain. The focus is going to be on the
from 0.6% qoq to 0.8%. The recovery should gather accelerating to 3.5% in 2011, before easing back to regional debt over the next few weeks and on the
more steam only in 2012: we see GDP expanding 1.4%. 2.5% in 2012. restructuring of banks. We like SPGB Apr21 on the
Spanish curve.
UK We expect GDP growth in 1Q to be confirmed at 0.5%. Headline inflation in April increased to 4.5% from According to the May Inflation Report, the BoE’s FI: Weaker-than-expected growth should keep 2Y Gilts
The main contribution should come from net exports. We 4.0%. This was mostly due to a rise in transport tariffs medium-term view remains pretty much the same as in anchored at low levels. Despite the rise in spot inflation,
expect the other positive contributions to be from related to the late Easter. The other main contribution February: inflation will fall back to target (by 2013), as inflation expectations have not increased significantly, so
consumption and investment while the main drag should came from alcohol and tobacco, which added 0.13pp. the temporary effects pushing up prices are waning and pressure on long-maturities Gilts should remain limited.
come from inventories. We expect GDP to grow 1.5% in We expect inflation to average 4.1% in 2011 and 2.5% as significant spare capacity remains. We continue to FX: The falling EUR-USD and the ongoing BoE policy
2011 and 2.0 in 2012. in 2012. expect the first Bank rate hike in Q3 and the repo rate at dilemma between inflation and growth deflated the recent
1% by the end of this year. EUR-GBP rally above 0.90 and should keep it further
within the 0.87-0.89 band for the time being
SWEDEN Economic activity in 2011 remains strong. Although GDP Headline inflation has further accelerated above 3% in The Riksbank is expected to keep hiking rates during FX: Assaults & retreats should continue to characterize
may decelerate from 0.7% qoq in 1Q11 to 0.4% in 4Q, April. Indeed, annual inflation in 2011 is now expected the remaining meetings this year, bringing the repo rate EUR-SEK: we confirm our final target at 8.65, but it may
2011 growth should still come in at 4.0%. to exceed the Riksbank’s 2% inflation target by 0.5pp. to 2.75% by year-end. take time to reach it
NORWAY Economic activity is seen picking up. 1Q Mainland GDP Inflation in Norway although accelerating still remains The Norges Bank should remain on hold at the June FX: Higher inflation may offer the NOK some support, but
should print at 0.8% and 2011 growth should accelerate below 2%. The resumption in the Norges Bank rate meeting, but bring the rate to 2.75% at year-end. the path towards our medium-term target at 7.70 will be
to 2.6% from 2.2% in 2010. hike cycle may keep the annual reading below 2% too. paved with large swings.
SWITZERLAND Backed by robust domestic demand, the small, open The CHF strength has a strong dampening effect on Despite the V-shaped economic recovery and the FX: The franc should remain strong reflecting the weak
economy is experiencing a V-shaped recovery. After consumer prices. Hence, despite the strong economy turnaround of the ECB, the pressure on the CHF USD and EMU uncertainty. Resuming ECB rate hikes from
+2.6% this year, we expect GDP growth to decelerate and higher commodity prices, the short-term outlook remains strong. With EMU debt crisis woes continuing, July onwards should help EUR-CHF but the 1.35 area will
only slightly to 2½% in 2011. for inflation still remains comparatively relaxed. the SNB is likely to pause for somewhat longer. remain seriously capped

Euro Compass
The European Economist

How long before the next cyclical downturn?
Chiara Corsa Two years after exiting from recession, the eurozone recovery is in good shape, as confirmed
(UniCredit Bank Milan)
+39 02 8862.2209 by the solid 0.8% qoq GDP reading for 1Q 2011. Moreover, the current high level of business
chiara.corsa@unicredit.eu surveys suggests that the growth dynamics, although easing somewhat, should remain
healthy in the near term. What is less clear at this stage is how long this cyclical upswing
Marco Valli (UniCredit Bank Milan)
+39 02 8862 8688 will last. In the following, we take a medium-term approach to analyzing the eurozone
marco.valli@unicredit.eu business cycle: our aim is to identify the current stage of the recovery and, based on
regularities from the past, provide an approximate timing for the beginning of the next
downturn.
The first step of this analysis consists of measuring the average length of cyclical recoveries
in the eurozone for the time span for which official data are available. There are different ways
to pinpoint the beginning and the end of a cyclical upswing: in our view, an output-gap
approach outperforms a standard GDP-based approach, as the former allows separating the
cyclical component of economic growth (the one we are interested in) from the trend.
Following this approach, we define a cyclical recovery as the phase of the business cycle that
1
sees a narrowing of the output gap (i.e. GDP grows above potential) . Using OECD data, we
find that in the last twenty years the length of the business cycle has varied considerably.
Sometimes it is even hard to pinpoint the beginning and the end of a cyclical recovery (see
chart on the right). For example, the four quarters of recovery between 1Q 1997 and 1Q 1998
and the subsequent two/three quarters of modest slowdown can either be considered as a
stand-alone mini cycle, or (as we prefer) as part of the four-year-long expansion phase that
ended with the bursting of the dot-com bubble. The last cyclical recovery was somewhat
shorter and lasted three years: from 1Q 2005 to 1Q 2008. All in all, we assume that a
The average length of the cyclical reliable estimate for the average length of a cyclical recovery in the eurozone is around
recovery is about three years
three years. Given that in this cycle the output gap started to narrow in 2Q 2010, if history
were to broadly repeat itself, this recovery would last until approximately mid-2013.
The next step is to look at a set of indicators which tend to display some regularities in their
cyclical fluctuations, therefore providing valuable information about the current stage of the
cyclical recovery. We identify four indicators:
1) The financing gap of non-financial corporations (NFCs). This gauge, constructed as the
difference between corporate savings and investment, measures the corporate sector’s
reliance on external financing to fund investment plans.
BUSINESS SURYES REMAIN IN GOOD SHAPE DATING EUROZONE CYCLICAL RECOVERIES
EC Economic Confidence Output gap (In % of potential GDP)

120 3.0
6 quarters 15 quarters 12 quarters
115 2.0
110
1.0
105
0.0
100
95 -1.0
90 -2.0
85
-3.0
80
75 -4.0
70 -5.0
Jan-90 Jul-93 Jan-97 Jul-00 Jan-04 Jul-07 Jan-11 Q1 1991 Q4 1993 Q3 1996 Q2 1999 Q1 2002 Q4 2004 Q3 2007 Q2 2010
Source: Markit, OECD, UniCredit Research
1
Admittedly, official output gap data are often revised significantly over time, but this is a major problem only in case of real-time analyses that focus mostly on the
absolute level of the output gap, like for example the estimation of a Taylor Rule. Given that here we have a backward-looking approach and we are interested in the
change rather than the level of the output gap, revisions do not pose a major problem.

Euro Compass
For the eurozone as a whole, these data are available only from 1999 onwards. The left chart
shows that the financing gap is highly cyclical, with turning points in correspondence of the
main junctures of the business cycle. This is not surprising, as the investment cycle – the key
driver of a sustainable recovery – usually turns upwards after a significant improvement of the
financing gap position (which becomes positive/less negative). Afterwards, the strengthening
of the investment recovery tends to lead to higher borrowing needs, and the peak of the
investment cycle usually occurs when the reliance on external financing approaches elevated
levels, largely increasing firms’ vulnerability to shocks. Following an aggressive adjustment
during the credit crisis, corporate balance sheets in the euro area now appear to be in good
Corporate sector’s balance sheets shape (the last available data refer to 4Q 2010), and the broadly-balanced financing gap
are in good shape indicates that we are still far from a vulnerable end-of-cycle position, like the one
recorded in 2000 (-8% of gross value added) and 2008 (-6%). This implies that the non-
financial corporate sector can still count on a good buffer against shocks like a potential
demand slowdown, high commodity prices and tighter financial conditions. One note of
caution: while the financing gap (a flow variable) depicts a bullish outlook, corporate debt (a
stock variable) still significantly exceeds the level prevailing at the beginning of the
2005-2007 recovery. This does not challenge our view that this investment upswing is bound
to last for several more quarters, but it does suggest that, in this cycle, the vulnerability
threshold for the financing gap will probably be lower (in absolute value) than in 2000 and
2008. For the sake of comparison, assuming a -4% vulnerability threshold for the financing
gap and the same pace of deepening of the gap recorded in the last recovery, alarm bells for
the investment (and business cycle) outlook would start ringing sometime in 2H 2013.
2) Unit labor costs. The investment recovery is spilling over to the labor market, and this is
definitely good news. However, this may also raise some concerns that the economic upswing
is already entering an advanced stage, particularly because we showed that the current pace
of employment growth may be as good as it gets in this cycle (see “Labor market moving in
the right direction”, April Euro Compass). We think that this fear is overdone, as we are not
yet at the late stage of the cycle when wage growth starts accelerating meaningfully, putting
corporate margins under pressure. As a matter of fact, productivity is still rising healthily and
the wage dynamics remains subdued, leaving unit labor costs (ULCs) in negative territory,
ULCs: far from a typical end-of-
i.e. very close to this cycle’s lows and quite depressed by historical standards. The
cycle development
chart on right shows that high ULCs are a typical end-of-cycle development, and we are
2
currently far away from this environment .
3) The credit cycle. The idea of looking at regularities of past credit cycles may seem odd
after an unprecedented banking crisis, which is still negatively affecting lending standards and
forcing several eurozone countries to deleverage aggressively.
FINANCING GAP TRACKS THE BUSINESS CYCLE ULC S REMAIN DEPRESSED
3.0 Output Gap - LS 7.0

2.0 2.5
1.0 ULC (% chg, yoy) - RS 6.0
2.0
1.5
0.0 5.0
0.5 1.0
-1.0
4.0
-2.0 -0.5 0.0
-3.0 3.0
-1.5 -1.0
-4.0 2.0
-5.0 -2.5 -2.0
1.0
-6.0 -3.5 -3.0
0.0
-7.0 Financing Gap (in % of GVA) - LS
-4.5 -4.0 -1.0
-8.0 Output Gap - RS
-9.0 -5.5 -5.0 -2.0
1999Q4 2001Q3 2003Q2 2005Q1 2006Q4 2008Q3 2010Q2 Q1 1996 Q3 1998 Q1 2001 Q3 2003 Q1 2006 Q3 2008 Q1 2011
Source: Eurostat, OECD, UniCredit Research
2
This should remain the case even when assuming that Eurostat data underestimate the actual pace of employment growth in this recovery (as we suspect), as
indicated by the unusually large gap between surveys of hiring intention and official employment data.

Euro Compass
However, both the crisis and the following developments showed clearly that demand remains
the key driver of the lending cycle, while supply-side effects tend to matter less. Therefore, it
can be useful to compare current lending dynamics with past credit cycles. What hard data tell
us is that lending has only just started to recover. The growth rate of lending to the private
sector is currently 2.5% yoy (cyclical low: -0.7% in 1Q 2010), which is well below the cyclical
highs recorded since the beginning of the time series in 1980. However, due to the peculiarity
of this cycle, this time around credit growth per se may be less informative than usual, and
here we focus on the average length of past credit cycles and the timing of turning points of
household and corporate lending. The last 30 years have seen four credit cycles (excluding
the one that has just started), with the recovery leg posting an average duration of 12
quarters. Household lending tends to turn earlier than corporate lending (the average lead is
one year). If all these regularities were to be replicated in the current cycle, the next credit
The next credit downturn will downturn would need to occur around mid-2013, with household lending starting to
probably occur in mid-2013 lose momentum already at the end of 2012 and corporate lending following suit after
three/four quarters.
4) Inflation. As inflation tends to react to economic growth with a lag, and therefore is more
likely to pick-up at an advanced stage of the recovery, it may become natural to infer that the
current high inflation rate could prelude an economic downturn in the not-too-distant future. At
least this is the message that seems to emerge from the last twenty years of history (see the
right chart). However, it looks like this time around we are experiencing unusually high
inflation at an early stage of the cyclical recovery, when there is still a large amount of
spare capacity in the economy. We see two main reasons for this peculiar development:
- The unprecedented monetary policy easing by the major central banks, particularly by the
Fed. This contributed to an increase of speculative positions in the commodity market, leading
to large price increases in a short time frame;
- A V-shaped recovery in emerging markets, which pushed up strongly demand for

commodities, and hence their prices.
High inflation probably does not Accordingly, our take is that the current high inflation rate reflects cycle-specific factors,
reflect a mature stage of the cycle rather than indicating a mature stage of the business cycle.
Bottom line: Our fundamental analysis based on past regularities shows that an end to this
cyclical recovery is unlikely to materialize in the near term. As a matter of fact, with the
Next turning point? Mid-2013 exception of inflation, all the indicators we looked at suggest that mid-2013 is the most likely
timing for the next turning point. We feel comfortable with this result, also because it is
very much consistent with the average length of eurozone business cycles in the last twenty
years.
A LOOK AT PAST CREDIT CYCLES THIS INFLATION CYCLE MAY BE DIFFERENT
In %, yoy
20.0 3.0 4.5
Lending to the private sector
2.0 4.0
Lending to households
16.0
Lending to NFCs 3.5
1.0
3.0
12.0
0.0 2.5
8.0 -1.0 2.0
-2.0 1.5
4.0
1.0
-3.0
0.0 0.5
Output gap - LS
-4.0 0.0
Inflation - RS
-4.0
-5.0 -0.5
Q1 1981 Q1 1986 Q1 1991 Q1 1996 Q1 2001 Q1 2006 Q1 2011
Q1 1991 Q1 1995 Q1 1999 Q1 2003 Q1 2007 Q1 2011
Source: ECB, OECD, Eurostat, UniCredit Research

Euro Compass
Can monetary policy affect the length of this recovery?
Central bank action can affect the length of the recovery phase if policy rates are left at
a level that is not justified by fundamentals. For example, monetary policy can shorten the
duration of the recovery if accommodation is removed too early, or can artificially prolong the
cyclical upswing if the rate stance is kept overly loose for a prolonged period of time (in the
latter case, increasing the probability of a more abrupt correction later on). In order to gauge
3
the appropriateness of the ECB’s monetary policy stance, we resort to our Taylor Rule , which
suggests that the level of the refi rate probably:
- Was a neutral factor for the length of the 2005-2007 recovery, as the central bank started its
tightening campaign exactly when prescribed by our reaction function;
- Was a dampening factor at the early stages of the 2008-2009 downturn, as the ECB hiked
rates in summer 2008 when our rule pointed to the need for refi rate cuts;
Refi rate not to affect the length - Is a neutral factor for the length of the current upswing, given that the central bank seems to
of the current upswing be moving in a very timely fashion to counter the narrowing of the output gap and the
recovery in lending aggregates, while the provision of unlimited liquidity to banks helps limiting
the systemic risk coming from the periphery.
Given these conclusions, the ECB’s monetary policy stance should not be regarded as a
possible swing factor, and therefore can be neglected for the rest of our analysis.
Another couple of years of healthy growth. What could go wrong?
We have shown that a “physiological” turning point could materialize sometime around
mid-2013, leaving another couple of years of reasonably healthy economic growth ahead. It’s
clear, however, that there are a number of risks to this scenario. Here we focus on
Focus on downside risks
downside risks, i.e. factors that could lead to an “early” turning point in the euro area business
cycle. History shows that major cyclical downturns (and recoveries) tend to be anticipated by
turning points in financial markets. In particular, equity prices, equity market volatility and
4
corporate spreads – the tree variables that are included in our Financial Market Index shown
in the right chart – display the strongest leading properties for eurozone GDP growth,
consistent with the idea that financial market developments are a key driver of the real cycle,
rather than being just its by-product. Therefore, it is natural to expect also the next cyclical
downturn to be heralded by a generalized tightening of financial conditions. Where
could this new financial market shock come from? We see two main possibilities:
TAYLOR RULE: THE ECB IS WELL ON TRACK IN THIS CYCLE FINANCIAL MARKETS HOLD THE KEY
5.0 Financial Market Index

5
4.5
4.0 4
3.5
3
3.0
2
2.5
2.0 1
1.5
Actual 0
1.0
Fitted -1
0.5
0.0 -2
Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 01-Jan-99 01-Jun-01 01-Nov-03 01-Apr-06 01-Sep-08 01-Feb-11
Source: Markit, ECB, Datastream, UniCredit Research
3 Our Taylor Rule is a monthly specification of the ECB’s reaction function. It explains the level of the refi rate as a function of: 1) a PMI-based measure of output
gap; 2) the yearly growth rate of lending to the private sector.
4
The Financial Market Index (FMI) aggregates in one single indicator the signal coming from the VDAX, DJ Euro Stoxx 50 and corporate spread (BBB, 5-7y).
Volatility and spread enter the algorithm with a positive sign, equity with a negative sign. The FMI is negatively correlated with economic growth and leads eurozone
GDP by one quarter and the Ifo expectations index by one month.

Euro Compass
Risk #1: a sovereign credit event 1) A sovereign credit event in one or more of the peripheral countries. However, we
in the periphery
have been arguing for a long time that a unilateral (or “unfriendly”) debt restructuring would do
more harm than good if the following conditions are not met:
- eurozone banks are sufficiently re-capitalized;
- troubled countries are back to growth, start seeing the results of the implemented structural
reforms, and are able to generate a stable primary surplus.
As none of these conditions are currently being met and probably won’t be for several more
quarters, we remain confident that European policymakers will eventually opt for the less
costly solution, which is buying more time by extending the lifeline to Greece. Talks of a
second rescue package worth EUR 60bn go in this direction, and would allow the country to
cover financing needs through 2013. Our baseline scenario remains that unilateral debt
restructuring will become an option only under the ESM umbrella, i.e. from mid-2013
onwards. If we are right on this, the probability that the eurozone recovery will be prematurely
derailed by a sovereign credit event should be reasonably low.
Risk #2: a sharp growth 2) A sharp growth deceleration in emerging markets, particularly China. Tighter monetary
deceleration in emerging markets
policy and government intervention aimed at taking some steam off the growth dynamics in
these countries does increase the risk of hard-landing down the road, but we remain
fundamentally optimistic. So far, the attempt to prevent an overheating of the economy and
the creation of asset bubbles seems to have been successful, while the vast majority of the
emerging economies can still enjoy healthy balance sheets both in the private and the public
sector, with only a relatively small number of countries showing a vulnerable current account
position. This should be sufficiently reassuring that downside risks for the eurozone
stemming from the emerging market channel could remain contained for some time.

Euro Compass
Inflation Watch
Less upside risks from commodities, more from core prices
Marco Valli (UniCredit Bank Milan) In April, eurozone inflation picked-up by 0.1pp to 2.8% yoy, the highest reading since October
+39 02 8862.8688
marco.valli@unicredit.eu 2008. In contrast to recent developments, this time core prices drove the inflation
acceleration, while energy inflation had a dampening impact on the headline (-0.05pp) and
food inflation was neutral. The spike in core CPI (ex-food, energy, alcohol and tobacco) from
1.3% yoy to 1.6% deserves attention. The current pace of core prices growth exceeds our
expectations and is twice as high as in early 2010, when core inflation hit the cyclical low.
However, there are two factors that “distorted” upwards the April reading:
April core CPI distorted upwards 1) The late timing of Easter, which boosted the price of holiday-sensitive spending items
compared to last year. The effect was particularly visible in transport fares (air transport:
+10.3% mom, 6.6% yoy; water transport: +12.1% mom, 15% yoy), also because companies
did not miss the opportunity to pass onto consumers part of the recent strong increase of oil
prices. In May, we expect a price reversal in all these spending items.
2) A further 2.6% mom increase in the price of clothing/shoes, after a 15.1% jump in
March. This is stronger than we had projected, but we are still learning when it comes to
detecting the new seasonality of clothing/shoes prices following a methodological change in
the way the price of seasonal items is determined. The strong April reading increases the
probability that in May clothing/shoes prices will be softer than initially thought.
We expect core inflation to These considerations suggest that the underlying trend in core inflation, while turning out
decelerate in May
somewhat firmer than we had previously expected, is probably not as strong as
implied by the last official number. In May, we have pencilled in a technical deceleration to
1.4% yoy, which will help ease the pressure on headline inflation.
Energy and food prices: easing Besides a likely slowdown in core inflation, May will probably also see a monthly decline in
upside risks?
energy prices, the first such move since August 2010. This reflects the recent pull-back in
Brent prices, although it is worth recalling that the 11% drop in oil prices over the last two
weeks looks more moderate when considering euro-denominated prices: -7%. Mechanically,
this subtracts just less than 0.1pp from our CPI projections, definitely not a game changer.
However, note that easing energy pressures come hand in hand with signs of a cooling
down of agricultural commodity prices. After having risen by 40% between mid-2010 and
February 2011, the FAO Food Price Index declined 2.7% mom in March and was up only
0.5% mom in April. This indicates increasing chances of a moderation in food CPI momentum
after the spring, consistent with the working assumptions of our baseline scenario.
Bottom line: Our headline CPI forecasts (2.7% in 2011 and 2.0% in 2012) remain on track
but, after the latest developments, the composition of the balance of risk has somewhat
changed: less upside risks from commodities, more from core prices.
CORE INFLATION SHARPLY UP FOOD COMMODITIY PRICES START COOLING DOWN
Core CPI (in %, yoy) FAO Food Price Index (in %)

3.0
10 60
8 50
2.5 6
40
4
30
2
2.0 20
0
-2 10
1.5 -4 0
-6
-10
-8 mom - LS
1.0 -20
-10 yoy - RS
-12 -30
0.5 -14 -40

Jan-00 Apr-01 Jul-02 Oct-03 Jan-05 Apr-06 Jul-07 Oct-08 Jan-10 Apr-11 Sep-05 Aug-06 Jul-07 Jun-08 May-09 Apr-10 Mar-11
Source: Eurostat, FAO, UniCredit Research

Euro Compass
UniCredit Inflation Forecasts

Core
EMU HICP HICP ex tobacco (unrevised) (Eurostat) France CPI ex tobacco Italy FOI ex tobacco
Index mom Yoy Index Mom Yoy yoy Index Mom yoy Index Mom Yoy
Jan-10 107.99 -0.8 0.9 107.75 -0.8 0.9 0.8 118.32 -0.2 1.0 99.1 0.1 1.3
Feb-10 108.33 0.3 0.8 108.02 0.3 0.7 0.8 118.99 0.6 1.2 99.2 0.1 1.3
Mar-10 109.53 1.1 1.6 109.09 1.0 1.3 1.2 119.58 0.5 1.5 99.4 0.2 1.5
Apr-10 109.98 0.4 1.6 109.58 0.4 1.4 0.9 119.90 0.3 1.6 99.8 0.4 1.6
May-10 110.10 0.1 1.7 109.71 0.1 1.5 0.9 120.04 0.1 1.6 99.9 0.1 1.5
Jun-10 110.10 0.0 1.5 109.70 0.0 1.3 1.0 120.02 0.0 1.4 99.9 0.0 1.3
Jul-10 109.63 -0.4 1.7 109.32 -0.3 1.7 1.0 119.68 -0.3 1.6 100.2 0.4 1.7
Aug-10 109.85 0.2 1.6 109.54 0.2 1.5 1.0 119.97 0.2 1.3 100.4 0.2 1.5
Sep-10 110.19 0.3 1.9 109.77 0.2 1.7 1.2 119.88 -0.1 1.5 100.1 -0.3 1.6
Oct-10 110.52 0.3 1.9 110.15 0.3 1.8 1.1 120.03 0.1 1.5 100.4 0.2 1.7
Nov-10 110.62 0.1 1.9 110.27 0.1 1.8 1.1 120.09 0.0 1.5 100.4 0.1 1.7
Dec-10 111.29 0.6 2.2 110.93 0.6 2.1 1.0 120.61 0.4 1.7 100.8 0.4 1.9
Jan-11 110.50 -0.7 2.3 110.11 -0.7 2.2 1.1 120.32 -0.2 1.7 101.2 0.4 2.2
Feb-11 110.96 0.4 2.4 110.57 0.4 2.4 1.0 120.90 0.5 1.6 101.5 0.3 2.3
Mar-11 112.47 1.4 2.7 112.11 1.4 2.8 1.3 121.90 0.8 1.9 101.9 0.4 2.5
Apr-11 113.10 0.6 2.8 112.75 0.6 2.9 1.6 122.32 0.3 2.0 102.4 0.5 2.6
May-11 113.07 0.0 2.7 112.71 0.0 2.7 1.4 122.50 0.1 2.0 102.4 0.0 2.5
Jun-11 113.11 0.0 2.7 112.74 0.0 2.8 1.4 122.58 0.1 2.1 102.4 0.0 2.6
Jul-11 112.65 -0.4 2.8 112.26 -0.4 2.7 1.4 122.37 -0.2 2.2 102.8 0.3 2.6
Aug-11 112.90 0.2 2.8 112.50 0.2 2.7 1.3 122.72 0.3 2.3 103.0 0.2 2.6
Sep-11 113.44 0.5 2.9 113.04 0.5 3.0 1.5 122.58 -0.1 2.3 102.9 -0.1 2.7
Oct-11 113.71 0.2 2.9 113.31 0.2 2.9 1.5 122.80 0.2 2.3 103.2 0.3 2.8
Nov-11 113.72 0.0 2.8 113.31 0.0 2.8 1.5 122.77 0.0 2.2 103.1 -0.1 2.7
Dec-11 114.15 0.4 2.6 113.74 0.4 2.5 1.5 123.13 0.3 2.1 103.4 0.3 2.6
Jan-12 113.08 -0.9 2.3 112.63 -1.0 2.3 1.4 122.84 -0.2 2.1 103.5 0.1 2.3
Feb-12 113.40 0.3 2.2 112.94 0.3 2.1 1.4 123.29 0.4 2.0 103.7 0.2 2.1
Mar-12 114.78 1.2 2.1 114.34 1.2 2.0 1.6 123.93 0.5 1.7 103.9 0.2 2.0
Apr-12 115.23 0.4 1.9 114.79 0.4 1.8 1.6 124.20 0.2 1.5 104.3 0.3 1.8
May-12 115.32 0.1 2.0 114.87 0.1 1.9 1.6 124.40 0.2 1.6 104.3 0.0 1.9
Jun-12 115.37 0.0 2.0 114.92 0.0 1.9 1.7 124.49 0.1 1.6 104.5 0.1 2.0
Jul-12 114.89 -0.4 2.0 114.41 -0.4 1.9 1.7 124.25 -0.2 1.5 104.8 0.3 1.9
Aug-12 115.16 0.2 2.0 114.68 0.2 1.9 1.7 124.73 0.4 1.6 105.0 0.2 2.0
Sep-12 115.72 0.5 2.0 115.24 0.5 1.9 1.8 124.68 0.0 1.7 104.9 -0.1 2.0
Oct-12 115.99 0.2 2.0 115.51 0.2 1.9 1.8 124.89 0.2 1.7 105.2 0.3 2.0
Nov-12 116.01 0.0 2.0 115.52 0.0 2.0 1.8 124.87 0.0 1.7 105.2 0.0 2.0
Dec-12 116.45 0.4 2.0 115.96 0.4 2.0 1.9 125.29 0.3 1.8 105.5 0.3 2.0
2010 1.6 1.5 1.0 1.5 1.6

2011 2.7 2.7 1.4 2.1 2.6
2012 2.0 2.0 1.7 1.7 2.0
Source: Eurostat, INSEE, ISTAT, UniCredit Research
Marco Valli (UniCredit Bank Milan) Tullia Bucco (UniCredit Bank Milan)
+39 02 8862.8688 +39 02 8862.2079
marco.valli@unicredit.eu tullia.bucco@unicredit.eu

Euro Compass
The ECB Watcher

The need for vigilance
Marco Valli (UniCredit Bank Milan) When the ECB meets on 9 June, we expect a switch to a “(strong) vigilance” posture, a clear
+39 02 8862.8688
marco.valli@unicredit.eu signal that in July the refi rate will be raised by another 25bp. In our view, the risk of a
dovish surprise, with Trichet sticking to “very close monitoring” and therefore further delaying
the next rate move, is fairly low, no more than 20%. We see three main reasons for this.
1) First, the ECB was not particularly enthusiastic about the dovish market reaction to
the May press conference. Right after 5 May, with the German 2Y yield and the EUR trading
well below pre-meeting levels, some GC members were quick to point out that the central
bank’s stance had not changed and the market had overreacted to Trichet’s words. We tend
to agree on both points: the ECB’s decision to remain on hold in June is simply an indication
ECB seems happy with the refi that the central bank is happy with another 50bp of tightening by year-end, and certainly not a
rate at 1.75% at year-end
sign of deep strategy rethinking. In fact, it would probably take a significant degree of
stress in financial markets for the ECB to materially change its mind about the need for
further rate hikes down the road. With the market squarely positioned for a 25bp increase
in July and another move sometime in 4Q, a dovish surprise on 9 June would lead to an
aggressive re-pricing of ECB rate expectations. We seriously doubt that the ECB would like
that: as the early start to the tightening cycle was intended to send a strong credibility
message to the market and firmly anchor inflation expectations, any sign of “back-pedalling” in
the absence of financial market disruption would create unwelcome volatility in rate and CPI
expectations.
New macroeconomic
2) At the next meeting, the ECB will publish a new set of macroeconomic projections,
projections: another hawkish which once again will be revised in a hawkish direction. After the stronger-than-expected
revision growth performance in 1Q, the central bank will probably raise its 2011 GDP forecast from
1.7% to 2%, most likely confirming the 1.8% call for next year. This implies three years of
above-potential growth after the exit from recession. Upward revisions will occur also on the
inflation front: the 2011 forecast will probably be lifted significantly, from 2.3% to 2.7%, while
the number for 2012 should look slightly firmer at 1.8% vs. 1.7%. While the bulk of the
revision for this year will stem from higher commodity prices, it is fair to state that the trend of
core CPI is also proving somewhat stronger than the ECB (and we) was previously expecting
– see the Inflation Watch section for more details. Given this macroeconomic landscape, it
would be a major surprise if Trichet were to miss the opportunity of the June meeting to pre-
announce a further removal of monetary accommodation.
3) Although not pre-committing, the ECB wants to remain predictable. Therefore, the
ECB wants to remain decision to start this tightening campaign using the same code words of the past hiking cycle
predictable suggests that the central bank intends to stick as closely as possible to the semantic pattern
followed in 2005-2007.
DOVISH REACTION TO THE MAY PRESS CONFERENCE ECB TO PROJECT STRONGER GROWTH, HIGHER INFLATION
2.60 March ECB Projections

2.40 GDP CPI
2.20 2011 2012 2011 2012
2.00 1.7 1.8 2.3 1.7
1.80
1.60 UniCredit assessment of the June ECB Projections

1.40
1.20 GDP CPI

1.00 2011 2012 2011 2012
Strip @ 05-May-11 Strip @ 04-May-11 keyrate (e)
0.80 2.0 1.8 2.7 1.8
5-May-11 1s t (Jun11 ) 2nd (Sep11 ) 3rd (Dec11 ) 4th (Mar12 )
Source: Bloomberg, ECB, UniCredit Research

Euro Compass
In the early stages of that tightening cycle, the reference to “very close monitoring” was never
used for three consecutive months, hinting that in June a step-up in rhetoric is very likely.
Focus on liquidity strategy Apart from the near-term policy message, the June meeting will bring important decisions
on the liquidity strategy because, as usual, the ECB will announce the calendar of
refinancing operations for the upcoming quarter. We consider it likely that the ECB will
leave the full allotment at the 1W MRO and 1M LTRO: this is required to leave a safety
valve in case of market tensions. Furthermore, with the level of the refi rate rising, the full
allotment at the 1W MRO would allow keeping the EONIA subdued. This would ease banks
funding costs. During the second quarter, the net rollover at the 1W MRO has been positive
(+EUR 7bn on average), suggesting that banks are actually using this facility.
Full-allotment at 3M LTRO is a The decision with respect to the 3M LTRO is a much closer call. During the second
close call quarter, banks have tended to bid at this facility less than the expiring amount (-EUR 14bn on
average in April and May), a sign that demand is dropping. However, this facility still accounts
for the bulk of ECB liquidity provision (EUR 232bn, almost 55% of the total). Pulling the plug
here risks creating an additional source of volatility. All in all, a further extension of the full
allotment also at the 3M LTRO seems a more prudent choice.
A long road to neutrality One final remark. In the European Economist section, we show that a plausible timing for a
turning point in the eurozone business cycle could be around mid-2013. If this reading is
correct, the ECB would have approximately two years to bring the refi rate toward a
more neutral level. Where is neutral? A rule of thumb sets the neutral level of the policy rate
in line with the growth rate of nominal GDP. Assuming that the area’s growth potential after
the crisis (and for at least the next couple of years) does not exceed 1.5%, a neutral refi rate
could be in the 3-3.25% area. We expect the ECB to get there in 1H 2013.

Euro Compass
ECB Most Watched

Marco Valli
■ In 1Q, GDP growth accelerated strongly to 0.8% qoq (2.5% yoy). We suspect that
marco.valli@unicredit.eu domestic demand was a key driver of the positive performance. Business surveys suggest
that momentum remains healthy so far in 2Q.
■ The trade-weighted euro declined 1.5% since mid-April, while euro-denominated Brent
prices dropped by 10.4%.
■ Inflation accelerated to 2.8% yoy in April, driven by core prices (see the Inflation Watch
section). The inflation rate will probably ease marginally in May, and should approach the
3% area in the late summer.
■ In March, M3 yearly growth picked-up to 2.3% from 2.1%. Loans to the private sector
expanded 2.5% yoy vs. 2.6%, with lending to NFCs accelerating to 0.8% vs. 0.6%, and
household credit improving to 3.4% yoy vs. 3.0%.
ECB Forecasts ECB Key exogenous variables

Euro-denominated Brent - LS
100 117
March ECB Projections EUR TW - RS
90 115
Growth Inflation
113
80
2011 2012 2011 2012 111
70
1.7 1.8 2.3 1.7 109
60
107
UniCredit Forecasts 50
105
Growth Inflation 40
103
2011 2012 2011 2012 30 101
2.1 1.7 2.7 2.0 20 99
15-Sep-08 23-Mar-09 28-Sep-09 5-Apr-10 11-Oct-10 18-Apr-11
UniCredit Composite PMI & GDP Growth Inflation

63
1.8 5.0
1.4 HICP (in %, yoy)
1.0 58 4.0 Core (in %, yoy)
0.6
3.0
0.2 53
-0.2
2.0
-0.6
48
-1.0
1.0
-1.4
GDP qoq (in %) - LS 43
-1.8 0.0
UniCredit Composite PMI (qtr avg) - RS
-2.2
-2.6 38 -1.0
Sep-98 Jun-00 Mar-02 Dec-03 Sep-05 Jun-07 Mar-09 Dec-10 Feb-99 Jul-01 Dec-03 May-06 Oct-08 Mar-11
M3 Dynamics Credit Dynamics

M3 (in %, yoy) 18 Loans to households: total (in %, yoy)
14
16 Loans to households: mortgage (in %, yoy)
12 14 Loans to non-fin. corp. (in %, yoy)
10 12
10
8
8
6 6
4 4
2
2
0
0
-2
-2 -4
Jan-99 Jun-01 Nov-03 Apr-06 Sep-08 Feb-11 Feb-00 Apr-02 Jun-04 Aug-06 Oct-08 Dec-10
Source: Datastream, ECB, Eurostat, Markit, UniCredit Research

Euro Compass
The Eurozone Economist’s Toolbox

Chiara Corsa 1. GDP
+39 02 8862.2209 UniCredit Composite PMI
chiara.corsa@unicredit.eu
■ The manufacturing PMI in April rose to 57.7 from 57.5, while the services index declined
Marco Valli
slightly to 56.9 vs. 57.2. As a result, our Composite PMI eased only marginally to 57.1 from
+39 02 8862 8688 57.2, a level still consistent with a healthy pace of growth at the beginning of 2Q.
marco.valli@unicredit.eu
GROWTH MOMENTUM REMAINS HEALTHY
63
1.8
1.4
1.0 58
0.6
0.2 53
-0.2
-0.6
48
-1.0
-1.4
GDP qoq (in %) - LS 43
-1.8
UniCredit Composite PMI (qtr avg) - RS
-2.2
-2.6 38
Sep-98 Jun-00 Mar-02 Dec-03 Sep-05 Jun-07 Mar-09 Dec-10
Source: Markit, Eurostat, UniCredit Research
UniCredit GDP Tracker

■ Our GDP Tracker did a good job in predicting 0.8% qoq growth in 1Q. Industrial production
remained on a solid footing, while construction rebounded after the weather-related drop in
4Q. The consumption leg of our indicator points to an acceleration in private consumption.
SOLID GROWTH IN 1Q
1.4
1.0
0.6
0.2
-0.2
-0.6
-1.0
-1.4
Actual GDP
-1.8
GDP Tracker
-2.2
-2.6
Q2 1995 Q4 1997 Q2 2000 Q4 2002 Q2 2005 Q4 2007 Q2 2010
Source: European Commission, Eurostat, ECB, National Sources, UniCredit Research
The UniCredit Composite PMI is a weighted average of manufacturing and services PMI (headline), with weights based of the sectors’ share of total GVA.
Weights are updated quarterly. The composite PMI is available starting from 3Q-98 and explains about 70% of the volatility in qoq GDP.
The UniCredit GDP Tracker estimates qoq GDP growth using IP, construction, retail sales and car registrations, plus one index of services confidence to
overcome the lack of hard data in the tertiary sector (ex retail).

Euro Compass
2. Employment
UniCredit Employment Indicator
■ In April, our employment indicator was stable at 0.5 st. dev. above its long term-average,
indicating an ongoing moderate pace of job creation at the beginning of 2Q.
EMPLOYMENT GROWTH CONTINUES AT AN UNEXCITNG PACE
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0 UniCredit Employment Indicator
-2.5 3M-ma
-3.0
Mar-97 Feb-99 Jan-01 Dec-02 Nov-04 Oct-06 Sep-08 Aug-10
Source: European Commission, Eurostat, UniCredit Research
3. Money
■ M3 growth accelerated in March, to 2.3% yoy vs. the previous 2.1%. The growth rate of
loans to the private sector remained broadly stable, at 2.5% yoy vs. 2.6%%, confirming that
the recovery in the credit cycle continues, albeit at a moderate pace.
M3 GROWTH KEEPS ACCELERATING
official M3
14
13 M3 corrected for portfolio shifts
12 loans to private sector
11
10
9
8
7
6
5
4
3
2
1
0
-1
Jan-99 Sep-00 May-02 Jan-04 Sep-05 May-07 Jan-09 Sep-10
Source: ECB, UniCredit Research
The UniCredit Employment Indicator is a weighted average of standardized 12-month-ahead employment expectations in the industrial, construction, and
services sectors, as computed by the European Commission for its monthly survey. Weights are based on the share of total GVA of the three sectors, and
are updated quarterly. The Indicator tracks both qoq and yoy employment growth (national accounts definition), but the latter fit is better.
The ECB estimates the size of portfolio shifts through a univariate time-series model of M3 that includes also a number of dummies and trends (see ECB
Monthly Bulletin, October 2004). The estimate is carried out quarterly. However, given that this adjustment was particular to the nature of the portfolio
shifts that occurred during 2001-2003, the growth rate of M3 corrected has coincided with that of official M3 for some time now, and continues to do so.

Euro Compass
4. Inflation
UniCredit Underlying Inflation Index
■ Underlying inflation accelerated further in April, to 1.15% yoy from 0.91% yoy. The late
Easter and a new seasonality for clothing/shoes prices explain most of the rise.
UNDERLYING INFLATION UP FURTHER
4.0 Headline
3.0
2.0 Core
1.0
UniCredit Underlying
0.0
-1.0
Jan-02 Sep-03 May-05 Jan-07 Sep-08 May-10
Source: Eurostat, UniCredit Research
UniCredit Persistence-Weighted (PW) Inflation Index
■ In April, our PW Inflation measure stabilized at 2.4%. Headline CPI accelerated to 2.8% vs.
2.7%, while core inflation (ex food, energy, alcohol and tobacco) rose to 1.6% from 1.3%.
PW INFLATION STABILIZED IN APRIL
5.0
PW Index
4.0 HICP
3.0
2.0
1.0
0.0
-1.0
Jan-99 Jun-00 Nov-01 Apr-03 Sep-04 Feb-06 Jul-07 Dec-08 May-10
Source: Eurostat, UniCredit Research
Our UniCredit Underlying Inflation Index strips out erratic components (food, energy, alcohol) and administrative prices (among the most important:
tobacco, social protection, education, medical, dental and hospital services). It covers 68% of the total HICP basket.
Our UniCredit Persistence-Weighted (PW) Inflation Index is an alternative measure of core inflation that gives more weight to the items of the HICP
basket displaying a higher degree of persistence. At any given point in time, the degree of persistence of each of the twelve HICP sub-components is
simply given by the sum of its autoregressive coefficients, a proxy for the speed with which prices converge toward the mean after a shock. The sum of
autoregressive coefficients (if negative, it is put equal to zero) is then re-scaled to deliver the new, persistence-based and time-varying weight of the item.

Euro Compass
5. Financial Markets
UniCredit FMI
■ The ongoing periphery woes are not affecting broad financial market conditions in any
meaningful way. Our FMI remains supportive for growth.
FINANCIAL MARKET CONDITIONS REMAIN FAVORABLE, DESPITE PERIPHERY WOES
FMI
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
1-Feb-99 1-Jul-01 1-Dec-03 1-May-06 1-Oct-08 1-Mar-11
Source: Bloomberg, UniCredit Research
6. Monetary Policy
UniCredit Coincident Taylor Rule
■ Amid the ongoing narrowing of the output gap and the recovery in the credit cycle, our
coincident Taylor rule points to a fair level of the refi rate of 1.55.
OUR TAYLOR RULE POINTS TO ANOTHER RATE HIKE
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
Actual
1.0
Fitted
0.5
0.0
Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11
Source: ECB, Markit, UniCredit Research
The FMI aggregates in one single indicator the signal coming from the VDAX, DJ Euro Stoxx 50 and corporate spread (BBB, 5-7y). Volatility and spread
enter the algorithm with a positive sign, equity with a negative sign. The FMI is negatively correlated with economic growth and leads eurozone GDP by
one quarter and the Ifo expectations index by one month.
The UniCredit Coincident Taylor Rule is a monthly specification of the ECB’s reaction function. It explains the level of the refi rate as a function of: 1) a
PMI-based measure of output gap; 2) the yearly growth rate of lending to the private sector.

Euro Compass
European Central Banks Watch

BoE – On hold despite high inflation
Chiara Corsa This month’s data confirmed our doubts about the strength of the recovery after the
+39 02 8862 2209 contraction at the end of last year (-0.5%qoq). GDP in 1Q (preliminary figures) posted only
chiara.corsa@unicredit.eu a modest rebound (0.5% qoq). The biggest decline was in the construction sector (-4%),
Mauro Giorgio Marrano while services rebounded (0.9% vs. the previous -0.6%) and IP growth accelerated (to 1.1%
(UniCredit Bank Milan) vs. 0.2%). We expect GDP growth in 1Q to be confirmed at 0.5%. Regarding the expenditure
+39 02 8862 8222 breakdown, which will be published with the second GDP release, the main contribution to
mauro.giorgiomarrano@unicredit.eu
growth should come from net trade, in line with the strong export growth and the sharp
decline in imports shown by trade balance data for 1Q. We expect the other positive
contributions to come from consumption and investment, which we see rebounding
moderately from the contraction in the previous quarter. Within investment, strong capex
growth should be partially offset by a further decline in construction investment. We expect
the main drag on growth to come from inventories. Moving into 2Q, survey data this month
signaled a weaker-than-expected start. The manufacturing PMI fell to 54.6 in April from a
downwardly revised 56.9, the lowest level in seven months. The services PMI plunged to
54.3 in April from 57.1 in March. While both indexes remain at healthy levels, these data
certainly signal a loss of momentum. On a positive note, CBI and BRC retail sales performed
quite well in April, but this seems to be driven by the late Easter-effect.
Headline inflation in April increased to 4.5% from 4.0%. Core inflation accelerated to
3.7% from 3.2%. The ONS estimates that most of this increase was due to a strong rise in
transport tariffs - predominantly air fares (up by 29% mom) - related to the late Easter. This
accounts for all the acceleration in the core and added 0.36 pp to headline inflation. The rest
of the increase came mainly from alcohol and tobacco, which added 0.13pp.
In the May Inflation Report, the inflation profile was revised up in 2011 and 2012 compared to
the February Report, reflecting the recent increases in energy prices, which are expected to
push up domestic prices for gas and electricity. April inflation, thus, should not have come as
a surprise to the BoE, which expects inflation to peak at 5% this year. The outlook for real
GDP growth was revised down in the near term. The big picture for the medium term, the
time horizon relevant for monetary policy, remained pretty much the same as in the
previous report: inflation is expected to fall back to target (by 2013), as the temporary
effects pushing up prices wane and a significant margin of spare capacity remains.
Interestingly, the Bank Rate path assumed in the forecasts envisages only one hike by the
end of 2011 instead of two as in the February Report. This poses downside risks to our
expectations of two rate hikes (the first one in 3Q and another one in 4Q) by the end of this
year. The minutes of the May MPC meeting showed that MPC members did not change their
positions in light of this month’s data and the revised BoE forecasts (the split on the interest
decision remained the same as in April: six in favor and three against the proposal to
maintain Bank rate unchanged).
UK FORECASTS
1Q-10 2Q-10 3Q-10 4Q-10 1Q-11 2Q-11 3Q-11 4Q-11 1Q-12 2Q-12 3Q-12 4Q-12 2010 2011 2012
GDP 0.2 1.1 0.7 -0.5 0.5 0.4 0.4 0.5 0.5 0.5 0.6 0.6 -- -- --
GDP (% yoy) -0.4 1.5 2.5 1.5 1.9 1.2 0.9 1.9 1.8 1.9 2.1 2.1 1.3 1.5 2.0
CPI Inflation (% yoy) 3.3 3.4 3.1 3.4 4.1 4.4 4.3 3.8 2.8 2.4 0.0 0.0 3.3 4.1 2.5
Core CPI Inflation (% yoy) 3.0 3.0 2.7 2.8 3.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 2.9 2.9 2.1
Unemployment rate (%) - - - - - - - - - - - - 7.8 8.0 7.7
Current Account (% GDP) - - - - - - - - - - - - -2.5 -2.0 -2.0
Pub. Sect. Net Borrowing (% GDP) - - - - - - - - - - - - 10.1 7.8 5.7
Repo rate 0.50 0.50 0.50 0.50 0.50 0.50 0.75 1.00 1.25 1.50 2.00 2.50 - - -
3M GBP Libor (end quarter) 0.65 0.73 0.73 0.74 0.79 0.90 1.05 1.30 1.55 - - - - - -
10 yr (end quarter) 3.94 3.36 2.95 3.22 3.65 3.85 4.00 4.25 4.50 - - - - - -
EUR-GBP 0.89 0.82 0.87 0.86 0.88 0.89 0.88 0.87 0.85 - - - - - -
GBP-USD 1.52 1.49 1.57 1.56 1.60 1.69 1.74 1.78 1.79 - - - - - -
All data are % qoq unless otherwise specified; GDP data are wda. *Contribution to growth Source: ONS, UniCredit Research

Euro Compass
SNB – CHF up on EMU debt crisis woes, again

Alexander Koch (UniCredit Bank) The continuing strength of the Swiss currency remains a strong liability for the Swiss export
+49 89 378-13013
alexander.koch1@unicreditgroup.de sector. Manufacturers and the tourism sector have to cope with an appreciation of 17%
versus the EUR since the end of 2009. The latest exchange rate survey conducted by the
SNB confirmed that an increasing number of business contacts is reporting negative effects,
particularly on profit margins, but also on sales volumes. However, vibrant global demand
has so far more than compensated for the dampening currency impact. Real exports
delivered a strong performance at the beginning of the year. And business expectations in the
export sector remain clearly expansionary overall, also in respect to investment and
employment.
Accordingly, the upcoming growth figures for the first quarter can be expected to show the
continuation of the solid V-shaped recovery of the Swiss economy. In addition to robust
industrial demand, imported deflation for consumer goods and robust housing demand
– backed by substantial net immigration – are supporting overall domestic demand.
Although leading indicators signal softer growth dynamics throughout 2011 following the
initially very strong recovery pace, we expect annual real GDP growth in 2011 to remain
broadly unchanged compared to 2.6% last year.
Actually, the resilient economy would already require a departure from the zero-interest rate
policy of the SNB. And the recent start of interest rate normalization by the ECB should have
increased the room for maneuver for the Swiss central bank. Should have. But renewed EMU
debt crisis woes have once again pushed the Swiss currency up, leaving EUR/CHF
close to its record high. The unchanged safe-haven status of the Swiss currency together with
a still relatively relaxed inflation situation have reinforced our view that the SNB will likely
maintain its 0.25% target rate at its quarterly monetary policy meeting in June – especially as
a quick resolution of the eurozone debt crisis in the coming weeks appears rather unlikely.
In its baseline scenario, the SNB doesn't project the headline inflation rate to rise above
the 2% mark before the middle of 2013 – even under the assumption of a constantly low
target rate. Hence, this means that the SNB can take its time before raising rates. But if EMU
officials can eventually stabilize the situation in the crisis countries, a window of opportunity
for a first SNB rate hike may open up by September.
SWITZERLAND FORECASTS
1Q-10 2Q-10 3Q-10 4Q-10 1Q-11 2Q-11 3Q-11 4Q-11 1Q-12 2Q-12 3Q-12 4Q-12 2010 2011 2012
GDP (% qoq) 0.8 0.7 0.8 0.9 0.6 0.5 0.3 0.3 0.4 0.5 0.5 0.5 - - -
GDP (% yoy) 1.5 2.7 2.8 3.2 3.0 2.8 2.3 1.7 1.5 1.5 1.7 1.9 2.6 2.4 1.7
Private Consumption (% qoq) 0.8 0.0 0.4 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 1.7 1.2 1.2
Budget Balance (% GDP) - - - - - - - - - - - - 0.0 0.3 0.2
Public Debt (% GDP) - - - - - - - - - - - - 38 37 35
3M CHF Libor mid target rate 0.25 0.25 0.25 0.25 0.25 0.25 0.5 0.75 1.0 1.25 1.25 1.5 - - -
3 Months (end quarter) 0.25 0.11 0.18 0.17 0.17 0.50 0.80 1.05 1.30 - - - - - -
10 yr (end quarter) 1.88 1.48 1.40 1.58 1.86 2.10 2.30 2.50 2.60 - - - - - -
EUR-CHF 1.42 1.32 1.34 1.25 1.30 1.29 1.30 1.32 1.34 - - - - - -
USD-CHF 1.05 1.07 0.98 0.94 0.92 0.86 0.85 0.85 0.88 - - - - - -
GDP data are wda. Source: National Sources, UniCredit Research

Euro Compass
Nordics – Norges Bank catching up with Riksbank

Stephan Maier The Riksbank is expected to continue raising rates in its remaining meetings this year,
+39 02 8862 8604 bringing the repo rate to 2.75% by year-end. Norges Bank has now resumed its rate-hike
stephan.maier@unicredit.eu cycle and should hike rates twice more to reach 2.75% in 2H11.
Sweden: Riksbank should raise Economic activity in Sweden continues to be very strong and inflation is picking up too.
the key rate again by 25bp in
July Industrial production even accelerated to 4.6% qoq in 1Q11 from 1.5% growth in 4Q10, but
the manufacturing PMI is pointing to some deceleration during 2Q11. This deceleration is
already occurring in the consumer sector, where retail sales have contracted 1% qoq in 1Q11,
following a modest 0.3% expansion in 4Q10. Inflation in April accelerated to 3.3%, way above
the Riksbank’s 2% target, and underlying inflation reached 1.8%. This means that core
inflation is still in line with the Riksbank's forecasts. The spike in the headline figure has
clearly come as a surprise to the Riksbank, and implies that the 2011 figure will be at least
2.5%, clearly too high for the Riksbank, even if heavily influenced by energy prices. Therefore,
the Riksbank is expected to hike the key rate in each and every remaining meeting this
year, bringing the key rate to 2.75% at year-end.
Norway: Norges Bank should Norges Bank resumed hiking the deposit rate at the May meeting after having left it on
remain on hold in June
hold since May last year. While the pace of economic expansion continues to be moderate,
an acceleration in inflation – albeit starting from still low levels – has been one of the reasons
for the rate hike. Regarding the real economy, both retail sales and manufacturing displayed
signs of weakness during 1Q. Retail sales declined by 0.4% qoq in 1Q and manufacturing
advanced just by a meager 0.5%. Furthermore, following the easing in the PMI,
manufacturing is likely to further decelerate in 2Q. However, inflation has accelerated to 1.3%
yoy in April, from 1% in March, and underlying inflation picked up from 0.8% to 1.3%. While
inflation is still only at roughly half its target of 2.5%, Norges Bank is now worried about wage
growth and the dynamics of the housing market; wage negotiations suggest wage growth of
around 4% in 2011, as unemployment continues to fall and house prices have gained pace.
Quarterly house price readings are quite volatile, but the 5.1% qoq price rise in 1Q11 has
been the strongest increase since 2Q09 and indeed household credit growth has accelerated
to 6.3% yoy in March, from readings of around 5% in 2010. Overall, economic data still points
to quite a good pace of recovery and a further rebound in inflation should keep Norges Bank
in tightening mode. Although Norges Bank may leave the key rate unchanged at 2.25% at
the June meeting, we think that it will hike rates twice again this year to 2.75%
SWEDEN FORECASTS
1Q-10 2Q-10 3Q-10 4Q-10 1Q-11 2Q-11 3Q-11 4Q-11 1Q-12 2Q-12 3Q-12 4Q-12 2010 2011 2012
GDP (% qoq) 1.6 2.1 2.1 1.2 0.7 0.6 0.5 0.4 0.6 0.7 0.8 0.8 - - -
GDP (% yoy) 2.6 4.4 6.8 7.2 6.3 4.7 3.1 2.2 2.1 2.2 2.5 2.9 5.3 4.0 2.4
Repo rate 0.25 0.25 0.75 1.25 1.50 1.75 2.25 2.75 3.00 3.25 3.50 3.75 - - -
3 Months 0.51 0.79 1.28 1.62 2.20 2.50 2.80 3.25 3.30 - - - - - -
EUR-SEK 9.74 9.52 9.19 8.99 8.91 8.90 8.80 8.70 8.65 - - - - - -
NORWAY FORECASTS
1Q-10 2Q-10 3Q-10 4Q-10 1Q-11 2Q-11 3Q-11 4Q-11 1Q-12 2Q-12 3Q-12 4Q-12 2010 2011 2012
GDP (mainland, % qoq) 0.6 0.4 1.1 0.3 0.8 0.6 0.6 0.6 0.7 0.8 0.9 0.9 - - -
GDP (mainland, % yoy) 1.4 1.8 3.0 2.5 2.7 2.8 2.4 2.6 2.5 2.7 3.0 3.3 2.2 2.6 2.9
Depo rate 1.75 2.00 2.00 2.00 2.00 2.25 2.50 2.75 3.00 3.25 3.50 3.75 - - -
3 Months 2.34 2.79 2.60 2.55 2.61 2.75 3.00 3.25 3.35 - - - - - -
EUR-NOK 8.03 8.06 8.04 7.79 7.84 7.85 7.80 7.75 7.70 - - - - - -
NOK-SEK 1.21 1.19 1.15 1.15 1.14 1.13 1.13 1.12 1.12 - - - - - -

Euro Compass
FI Strategizer
Bonds to remain bid for the time being
Luca Cazzulani US: The end of QE2 should not have a major impact on US yields given the current
+39 02 8862 0640 environment of slowing US growth. The Fed is likely to maintain its ultra-accommodative
luca.cazzulani@unicredit.eu stance, which will keep short-end yields low, and in the near term we see little pressure on the
long end from the increase in inflation or deteriorating fiscal outlook. The 2/10Y spread should
Chiara Cremonesi remain relatively steep in the near term.
(UniCredit Bank London)
+44 207 8261771
EU: Uncertainty on periphery is likely to keep top-rated debt well-bid, slowing down the rise in
chiara.cremonesi@unicredit.eu yields related to ECB rate hikes, positive growth in core countries and high inflation. The 2Y
Schatz is likely to remain at the currently expensive levels for some time yet. The 2/10Y bull
flattening may unwind in the near term before bear flattening kicks in.
UK: A weaker-than-expected recovery should keep short-maturity Gilts anchored at low
levels. We do not expect much pressure on the long end: the recent rise in inflation should be
perceived as temporary due to the sluggish growth outlook. We do not expect a significant
change in the curve shape in the near term.
Yields of AAA rated government In the last four weeks or so, yields of top-rated government bonds have declined by
bonds have fallen in the last
month: about 20bp due to renewed uncertainty surrounding the debt crisis and the weakened
growth outlooks for the US and the UK.
in the EMU due to renewed In the EMU, discussion on Greek debt restructuring has been center stage, pushing the
worries about the debt crisis
Greek curve sharply up and offering support to Bunds.
in the US due to a weakening In the US and UK, 10Y yields have also declined in the last month due to a combination of
growth outlook
weaker-than-expected macroeconomic data. EMU debt woes have offered tail wind.
The three weakest periphery were Troubles in the EMU periphery have remained center stage. GGBs have widened
under great pressure, while Spain
and Italy suffered slightly less massively, followed by PGBs and Irish bonds. Spain and Italy have widened more modestly,
although clearly investors regard Spain as relatively less safe. The potential risk coming from
the banking sector is well-known; the other issue that is going to capture investor’s attention in
the next few months is debt dynamics at regional level.
Stocks are mildly up vs. last After a boost at the end of April, stocks corrected a bit, but overall are mildly up from
month
last month. The DAX is up by 1.74%, while the S&P is up by 1.36% compared to mid-April.
Commodities prices have Commodities prices have corrected by about 10%. This has mainly been the result of profit
corrected by ca. 10%
taking as well as of worries that the recovery may not be sustainable.
YTD, USTs have delivered a Long-maturity USTs have delivered a 2.6% return (YTD, in USD) and short-dated ones
positive return, while Bunds are
in the red; ILBs have are also in positive territory (although by a much smaller 0.7%). Inflation-linked bonds are
outperformed fixed coupons on the best performers, given the increase in inflation (and inflation expectations) since the
both sides of the Atlantic
beginning of the year. YTD, Bunds are in the red by 0.7%. ILBs have outperformed fixed
coupons also in the EMU. US linkers have performed better than EU ones.
10Y UST CLOSE TO SUPPORT WEAKEST PERIPHERY COUNTRIES' BOND YIELDS ON THE RISE
6
1400
4
3.0
2.6
1200
2
1.1
Yield spread vs. Germany (bp)

0.8
0.8
0.4
0.1
0.1
1000
Total return (%)
0
-0.5
800
-2
-1.3
-4 600
-3.0
-3.3
-4.0
-4.3
-5.1
-5.2
-6 400
-8
200
Asset return Eur return
-10 PT IE GR
Core Core Perip Perip 7-10 1-3 7-10 1-3 7-10 1-3 0
7-10 1-3 7-10 1-3
May-10 Aug-10 Nov-10 Feb-11 May-11
EMU US UK JP

Euro Compass
EMU debt crisis to remain center Investor focus is likely to remain on the EMU periphery in the next month. Greek debt
stage in the near term …
restructuring should remain the key issue. Investors agree that debt is not sustainable in the
long run and some form of intervention will be needed. Several options are possible:
imposing a haircut, extending debt maturity, setting up a (permanent) transfer union.
Greek bonds maturing beyond 2014 trade at a cash price lower than 60, and this
… especially discussions on
Greece suggests that investors are placing a high probability on the haircut hypothesis.
According to our calculations, a haircut in the range of 50% is fully priced into 10Y GGBs.
More recently, the hypothesis of a re-profiling (an extension of maturity) has gained appeal
because it would be the easiest from a political perspective. We are skeptical about such an
option: it would imply a fall in GGB prices and, if not designed carefully, it risks creating a
redemption wall and it would not bring any relief in terms of debt/GDP ratio.
Scheduled events important to Scheduled events that will be important to watch are:
watch for periphery
The approval of the 5th tranche of the Greek package (by the end of May). Given the
funding shortfall of EUR 27bn and EUR 38bn respectively in the next two years, intervention
is needed. It could be a EUR 60bn extension of the bail-out package (more likely) or the
decision to re-profile the debt (which we regard as less likely). Should the first outcome
materialize, the decision to impose a haircut should come not earlier than 2013.
The elections in Portugal on 5 June are another important event. We think that whoever
the winner is, he will not be able to show less than a strong commitment to fiscal
consolidation.
The Eurogroup meeting scheduled for 24 June might discuss the case of Greece.
Indeed, the IMF and the EU will have concluded their fourth review of the program and this
would be a good window of opportunity for EU policymakers to present and discuss a plan
addressing the sustainability of the Greek debt
The results of the EBA stress test will be another important factor. At the moment the
market is putting a lot of emphasis on the restructuring of the banking sector, so we expect
the outcome of this exercise to be closely monitored. However, we doubt that this exercise
will provide a comprehensive solution for the EU banking system.
Investors are likely to continue monitoring the banking restructuring process in Spain.
All in all, uncertainty on periphery should keep safe-haven demand strong, slowing
down the rise in yields that we expect in relation to ECB rate hikes, positive EMU growth and
high inflation.
Do not expect near-term As a result, the 2Y Schatz is likely to remain at the currently expensive levels for some
cheapening of the Schatz
time yet. The chart below shows that the 2Y Schatz yield is about 30bp lower than the
average level of the first eight Euribor future contracts. This difference is related to demand
for safe assets. Note that, given that we expect the ECB refi to reach 1.75% at the end of the
year, the 2Y Schatz should trade in the 2.30/2.50% range by the end of the year.
EXPENSIVE 2Y SCHATZ THE 5Y RECOVERS VS. THE WINGS (SWAP CURVE)

140 60
Avg. 3M Euribor (first 8 contracts)-2Y Schatz - bp 2Y swap spread Actual FIT std error
120
40
100
20
80
0
60
-20
40
-40
20
0 -60
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-99 Jul-00 Jan-02 Jul-03 Jan-05 Jul-06 Jan-08 Jul-09 Jan-11

Euro Compass
The belly: still some room for The 5Y has richened up in the last month vs. the 2Y and the 10Y (this goes both for the
richening
Bunds and the swap curve). Our model that relates the belly with the fundamental variables
(ZEW) indicates that, even after its recent richening, the 5Y still has some room to go. In
absolute yield terms, the 5Y swap at 2.90% does not look very attractive, especially relative
to the 2Y. The 2/5Y spread has bull flattened about 15bp to 60bp since early April. We
expect the curve to bear flatten in response to ECB rate hikes but before this happens, we
would expect to see unwinding of the recent bull flattening.
The 10Y Bund has richened about 30bp since April 10 due to renewed risk aversion. While
the near-term outlook will remain determined by the risk on/risk off picture, in a medium-term
perspective we expect 10Y yields to rise.
10/30Y flattening: more attractive Both on the swap and the Bund curve, the 10/30-year spread has shown little volatility
with Bunds than with swaps
in the last seven months and we do not expect large changes in the near term. That
said, it would be more attractive to play flattening with Bunds than with swaps:
historical comparison with the Dec05-Jun07 tightening cycle shows that the 10/30-swap
flattened to 10bp (vs. the current 25bp) while the Bund curve flattened to 10bp (vs. the
current 50bp).
A quick glance at the US and UK

The main topic in the US: end of In the US, weaker-than-expected macroeconomic data have been the main reasons behind
QE2, debt ceiling and fiscal
consolidation the rally in Treasuries over the last few weeks. The escalation of the EMU debt crisis has
offered extra tail wind.
Over the next month the main topic for the US market should be the end of the Fed’s QE2
and the debate on fiscal consolidation.
Weak growth data and ultra-loose At present, 2Y Treasuries yields are trading in the 0.50/0.55%area, around the level
monetary policy should keep 2Y
yields low observed before Bernanke announced that the Fed would embark in QE2 last August.
The end of QE2 should not come as a surprise and in our view should not have a major
impact on US yields given the current environment of slowing US growth. Even if the Fed
does not embark on QE3, it is rather clear that it will remain in ultra-loose monetary policy
mode for some time. In this environment, a series of better-than-expected growth data are
needed to push yields up, particularly at the short end. Should growth data continue to
disappoint, 2Y yields should remain at their current ultra-low levels.
Inflation expectations and the At the long end, aside from the end of QE2, the dynamics of inflation expectations and
debt debate should be the major
drivers at the long end the debate on the fiscal outlook should be the major drivers. 10Y UST currently trade at
3.15%, the lowest level in the last five months although inflation is trending higher and the
fiscal outlook is less than brilliant.
Growth worries should keep Inflation continued to edge up in April, but this did not put much pressure on the long end.
inflation expectations subdued in
the near-term Indeed, inflation expectations as proxied by BE rates have decreased significantly following
the slide in oil prices at the beginning of May. We believe that worries about the recovery
should keep inflation expectations subdued for the time being and we see limited
pressure on the long end coming from the rise in spot inflation.
Fiscal policy should be an issue Despite S&P's revision of its US outlook from stable to negative, the market impact of the
going forward…
debt issue in the US has been so far rather negligible. Treasuries have not cheapened very
much vs. swap and Treasuries auctions have met with good demand (with a few exceptions),
as investors have focused mainly on sluggish growth in the US and on the EMU debt crisis.
…but investors may postpone it While we are convinced that in the long run the fiscal consolidation issue will have an impact
to H2
on US credit quality and Treasuries will start pricing in some risk, the precise timing of this is
hard to guess. In the next month, the focus will remain on the EMU debt crisis, so investors
might continue to put aside worries about the US fiscal outlook. However, in 2H, after the end
of QE2 and with some of the risky events in the EMU periphery behind us, Treasuries yields
should start rising, especially at the long end if the government does not embark on
serious fiscal consolidation.

Euro Compass
UK: lower-than-expected growth Bonds remained well-bid in the UK over the last month, as growth data came in
data keep demand for Gilts
healthy generally weaker than expected. The latest BoE Inflation Report painted a gloomy
picture: the recovery is weaker than previously forecasted and inflation is expected to climb
to 5% this year and to remain above-target all through 2012. The April reading for inflation,
coming in at 4.5%, confirmed that price dynamics remain unfavorable to say the least.
The 2Y Gilt trades in the 1% area, Following weak growth data and the publication of the IR, investors have revised
the lower range of the last six
months down their monetary policy expectations and now expect the first rate hike by 25bp not
before year end. This has contributed to keeping demand for short-term Gilts healthy, with
2Y yields remaining in the 1% area, the lower range of the last six months. We do not see
much scope for a rise at this point, as we see an increasing risk that the BoE will only hike
rates in 4Q.
The increase in inflation Despite the increase in inflation projections in the BoE IR and inflation climbing to
projections have not had an
impact on inflation expectations 4.5% in April, inflation expectations as proxied by BE rates have not reacted
significantly, remaining rather stable across maturities. 10Y Gilts climbed temporarily above
the 3.40% threshold but they corrected afterwards, leaving the downward trend in long
maturities yields intact. Even at this maturity, yields should remain stable over the next
month.
We expect the curve to remain Overall, the curve should remain very steep at current levels (240bp) over the next month.
steep over the next month

Euro Compass
FX Strategizer
EUR-USD: shell-shocked but not definitively knocked down
Roberto Mialich (UniCredit Bank Milan) ECB Trichet signaling that the next hike of the refi rate will be probably delivered only in
+39 02 8862 0658
July sparked an exaggerated EUR-USD sell-off, which was also amplified by abruptly
roberto.mialich@unicredit.eu
escalating worries about a possible restructuring of the Greek sovereign debt amid talk
that Athens may even decide to leave the euro and return to the old drachma.
The view that the ECB refi rate will stay on hold throughout June has two clear implications
for the euro: first, it will make the EU unit more sensitive to debt restructuring fears in the
EMU periphery, as already seen in the case of Greece, while these doubts had been totally
overshadowed in recent months by prospects of widening interest rate differentials between
Europe and the US; second, it will make any potential EUR-USD recovery even more
dependent on bad news from the US economy, despite encouraging NFP data for April
(+244k, although partly offset by the unemployment rate rising to 9.0%).
Following the heavy plunge (nearly 8 big figures/more than 4% in a couple of weeks), we can
expect new volatile trading sessions ahead, but we still keep a positive view on EUR-
USD's medium-term prospects: first, Trichet only hinted at a temporarily pause to the
ECB tightening strategy, which should continue in 2H11 and next year, while Fed Bernanke
clearly indicated that the bank will not trim liquidity after QE2 ends at the end of June; second,
the commitment of EU countries to adjust the terms of Greece's aid program so that
Athens will be able to delay a return to the market to mid next year should ultimately ease
fears of a preemptive debt restructuring. On balance, while a test close to or even
below 1.40 is still quite possible before July, we still expect a firmer EUR-USD in 2H11
likely above 1.50, provided EMU debt fears ease and interest rate spreads widen again.
The EUR-USD plunge will continue to have a direct impact on EUR crosses, too: the most
critical one is EUR-JPY, as the lower EUR-USD has so far gone hand-in-hand with USD-JPY
sliding again. However, fears of intervention should prevent another USD-JPY fall down to the
previous record low at 76.25 and a firmer EUR-USD should allow a EUR-JPY recovery back
above 125 by the end of the year. EUR-GBP should stay mostly stuck in the 0.87-0.89 band,
with the BoE unlikely to hike rates before August, which would offer EUR-GBP a floor above
0.85. EUR-CHF should stay penalized by franc strength and by prospects of an SNB rate hike
in 3Q11. Lastly, the two Nordics should experience further nervous trading and their further
rise towards 8.65 for EUR-SEK and 7.70 for EUR-NOK may take some time.
EUR-USD: Still more volatile ECB President Trichet hinting at his press conference this month that the next rate hike will
sessions ahead, but long-term
picture not completely derailed not be delivered before July prompted an exaggerated EUR-USD plunge that was also
amplified by the collapse of commodity prices and even more by abruptly escalating concerns
over a possible Greek debt restructuring amid talk that Athens may even leave the euro.
EUR-USD: RATE HIKES TEMPORARILY FROZEN… … INCREASES SENSITIVITY TO EMU DEBT WOES
175 1.54 1500 1.60

Euribor vs. Usd 3M spread, Dec 11 (LS) 1400 Greece 5Yr CDS (LS) Portugal 5Yr CDS (LS)
150 1.50 Ireland 5Yr CDS (LS) Spain 5Yr CDS (LS) 1.55
EUR-USD (RS) 1300 EUR-USD (RS)
125 1.46 1200 1.50
1100
100
1.42 1000 1.45
75 900
1.38 800 1.40
50
1.34 700 1.35
25 600
1.30 500 1.30
0
400
-25 1.26 300 1.25
1.22 200 1.20

-50
100
-75 1.18 0 1.15
Jan-10 Mar-10 May-10 Jul-10 Oct-10 Dec-10 Feb-11 May-11 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Feb-11 Apr-11

Euro Compass
This EUR reaction was more surprising in magnitude rather than in direction, as the fact that
the ECB will stay pat on rates throughout June has two clear implications for the euro:
1) It will make the EU currency much more exposed to underlying EMU woes and
debt restructuring fears across the EMU periphery, as already happened in
Greece’s case, while all these worries have been totally overshadowed in recent
months by the view that interest rate differentials will move much more in favor of the
EUR, as the ECB will continue its tightening strategy with respect to a much more
reserved Fed on rates (see the two charts on the previous page).
2) It will make any potential EUR-USD recovery even more dependent on negative
news from the US economy, including the underlying debate on fiscal policy and
the debt ceiling that will continue even now that the 16 May deadline has passed.
Looking ahead, in the wake of the crash so far (nearly 8 big figures/more than 4% in nearly a
couple of weeks) we can easily imagine more nervous trading and new volatile sessions
ahead. Nonetheless, we maintain positive medium-term outlook for EUR-USD:
1) ECB Trichet only hinted at a temporarily pause in the ECB tightening strategy,
which is thus expected to continue into 2H11 and next year, as reflected in the 3M
Euribor strip even after the downward correction following Trichet’s remarks. Fed
Chairman Bernanke also indicated that the bank is in no rush to unwind ongoing
policy accommodation soon and will hold its balance sheet steady after completing
QE2, thus reinvesting maturing securities again in US Treasuries so that the amount
being held will continue to remain constant after June.
2) Even more crucial, EU countries appear to be committed to adjusting the terms
of Greece's aid program amid speculation that a new rescue plan worth nearly
EUR 60bn may be announced before the next EU leaders’ summit in Brussels on 24
June, so that Athens could delay a return to markets, originally expected by mid-
2012, easing in turn fears of a preemptive debt restructuring.
On balance, while we cannot rule out a test even below 1.40 in the near term, we still see
a firmer EUR-USD, likely above 1.50 throughout most of 2H11 and in 1Q12, provided
EMU debt fears ease and interest rate differentials widen again.
EUR-JPY: Pressured lower by a The abrupt EUR-USD plunge has had and will continue to have direct implications for the
mix of retreating EUR-USD and a
other EUR crosses, prompting a EUR retreat across the board (EUR nominal TWI fell more
dangerously weak USD-JPY
than 2% in less than a week early this month). In turn, EUR-JPY proved to be most exposed
to an abrupt sell-off, plummeting back below 115 from values above 120 previously. Clearly,
in this case the new USD-JPY drop towards 80 amplified the spillover effects of the already
tumbling EUR-USD to EUR-JPY. The USD-JPY fall still has some room before getting close
to the 76.25-77.10 area that induced intervention on 18 March, but there is risk that a quick
break below 80 may make a new BOJ or even G-7 intervention more likely.
EUR-JPY: THE WEAKER EUR-USD WON’T HELP EUR-CHF: STILL PENALIZED IN A FIRM FRANC SCENARIO
1.62 145 1.55 1.20

EUR-USD (LS)
1.58 EUR-JPY (DS) 140 1.50 1.15
1.54
1.50 135 1.45
1.10
1.46 130 1.40
1.05
1.42
125 1.35
1.38
1.00
1.34 120 1.30
1.30 0.95
115 1.25
1.26
110 1.20 EUR-CHF (LS) 0.90
1.22
USD-CHF (RS)
1.18 105 1.15 0.85
Jan-09 May-09 Oct-09 Feb-10 Jul-10 Dec-10 Apr-11 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11

Euro Compass
However, we remain confident that a progressive deflation of resumed risk aversion that
spurred some carry-trade unwinding should push USD-JPY back to the 80-85 area, amid
evidence that the Japanese economy has been seriously hit by the recent earthquake. This
likely USD-JPY pullback together with a recovering EUR-USD should help EUR-JPY rally
back above 120 and maybe even above 125 on a 9/12M time frame
EUR-CHF: Still a firm franc for As suspected, the Swiss franc has again proved the catalyst of current market uncertainty
now
after the burst of the commodity price and the resurfacing of EMU debt restructuring woes. In
this scenario, it is not a surprise that – also due to the tumbling EUR-USD – EUR-CHF fell
further below 1.25, i.e. not too far away from its all-time low of 1.2395 in late December
last year. USD-CHF remaining below 0.90 despite the greenback’s recovery attempts worked
as a further drag on EUR-CHF. Looking ahead, we doubt the underlying strength of the
franc will be seriously challenged. The ECB resuming rate hikes in July may help EUR-
CHF as the SNB is also unlikely to start an aggressive tightening cycle before 3Q11, as Swiss
CPI backpedaled to 0.3% yoy in April after the 1% jump in March. However, this EUR cross
rate will remain capped again ahead of 1.35 in a 12M time frame, also taking into account
that USD-CHF should stay further locked in the 0.85-0.90 band in the meantime.
EUR-GBP: Attempts to break The EUR-USD retreat has also deflated EUR-GBP rallying attempts above 0.90, confirming
above 0.90 to remain frustrated that this EUR cross proves capped at around this threshold unless a mix of positive news for
the euro and bad news for the pound materializes. Admittedly, the latter has become evident:
deterioration emerged in the most recent PMI Surveys in Britain and was confirmed by
the BoE’s decision to revise downwards (although not slashing) UK GDP growth in its
latest Inflation Report last week. In turn, this picture will clearly heighten the bank’s policy
dilemma between sluggish growth and stubbornly high inflation, which accelerated further in
April to 4.5% yoy with the core rate even jumping to 3.7% yoy, much above the BoE’s 2.0%
target. The main implication of these opposite forces for sterling is that the BoE is unlikely to
start a tightening cycle before 3Q11 and August, in particular. On balance, the lack of an
immediate rate hike from both the ECB and the BoE in the near term will make EUR-GBP
more exposed to ordinary market swings in the very near term and relative moves
between EUR-USD and cable. In turn, this should probably lock EUR-GBP mostly between
0.87 and 0.89 for now, with limited margin for a break below the 0.85 base.
Nordics: Large swings likely in a As feared, the two Nordics have become more exposed to huge swings in a less bullish
less bullish overall picture
picture, mostly due to higher global volatility, falling commodity prices and more risk aversion.
In turn, uncertainty at home may discourage fresh aggressive tightening, despite evidence of
higher inflation, especially in Norway. At the end of the day, we confirm our medium-term
target for EUR-SEK and EUR-NOK at 8.65 and 7.70, respectively, by 1Q12, as both the
Riksbank and the Norges Bank should hike rates further to 2.75%. In both cases a less risk-
adverse market scenario should help, but we warn that the decline will be gradual and
characterized by frequent assaults and retreats in-between.
EUR-GBP: WEAK EUR-USD TO LIMIT GAINS NORDICS: STILL A SLOW APPRECIATION AHEAD
1.55 1.00 10.45 8.35

EUR-USD (LS) EUR-SEK (LS)
1.50 EUR-GBP (DS) 0.98 10.25 EUR-NOK (RS) 8.25
1.45 0.96 10.05
8.15
0.94
1.40 9.85
8.05
0.92
1.35 9.65
0.90 7.95
1.30 9.45
0.88 7.85
1.25 9.25
0.86
7.75
1.20 0.84 9.05
1.15 0.82 8.85 7.65
1.10 0.80 8.65 7.55

Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Apr-11

Euro Compass
FX Monitor: G-10 Monthly Change

Charts below show weekly changes among the G-10 currencies. In particular, positive percentage changes indicate a gain of
the currency indicated in the title against the others, while negative percentage changes indicate a loss.
USD MONTHLY PERFORMANCE EUR MONTHLY PERFORMANCE
5% 5%
Monthly spot gains / losses of the USD vs. the other G-10 units Monthly spot gains / losses of the EUR vs. the other G-10 units
4% 4%
3% 2.56% 3%
1.93%
2% 1.58% 2%
1.32%
0.97% 0.99%
1% 0.61% 1% 0.68%
0.36% 0.34%
0% 0%
-0.39% -0.26%
-1% -1% -0.62%
-1.15% -1.00%
-2% -1.65% -2% -1.76%
-2.24%
-3% -3%
-4% -4%
-5% -5%
EUR JPY CHF GBP AUD NZD CAD SEK NOK USD JPY CHF GBP AUD NZD CAD SEK NOK
JPY MONTHLY PERFORMANCE CHF MONTHLY PERFORMANCE
5% 5%
Monthly spot gains / losses of the JPY vs. the other G-10 units 4.26%
Monthly spot gains / losses of the CHF vs. the other G-10 units
4% 4% 3.77%
3.27%2.95% 2.77%
3% 2.62% 3%
2.46%
2.27% 2.12%
2.02%
2% 1.65% 2% 1.80%
1.53%
1.24% 1.17%
1% 1% 0.77%
0.47%
0% 0%
-1% -1% -0.49%
-2% -2%
-3% -3%
-4% -4%
-5% -5%
USD EUR CHF GBP AUD NZD CAD SEK NOK USD EUR JPY GBP AUD NZD CAD SEK NOK
GBP MONTHLY PERFORMANCE NORDICS MONTHLY PERFORMANCE
5% 5%
Monthly spot gains / losses of the GBP vs. the others G.10 units Monthly spot gains / losses of the NOK vs. the other G-10 units
4% 4%
Monthly spot gains / losses of the SEK vs. the other G-10 units
3% 3%
2.21%
2% 2% 1.6%
1.25%
0.93%
1% 0.60% 1% 0.6%
0.25% 0.3%
0% 0%
-0.37% -0.3%
-1% -0.75% -1% -0.6%
-1.0% -1.0%
-1.3% -1.2%
-2% -1.52% -2% -1.6%
-1.99% -1.9%
-2.1% -2.1%
-2.5% -2.6%
-3% -3%
-2.9%
-4% -4% -3.6%

-4.1%
-5% -5%
USD EUR JPY CHF AUD NZD CAD SEK NOK USD EUR JPY CHF GBP AUD NZD CAD SEK
Update: May 18, h.10.00 CET Source: Bloomberg, UniCredit Research (all charts in this page)

Euro Compass
FX Monitor: G-10 Implied Volatility Curves

Charts below show the term structure of implied volatility for FX majors at different maturities (at present and last month).
EUR-USD USD-JPY
20 20
Now Last month Now Last month
18 18
15 13.51 15 13.86
12.83 13.21 12.77
12.64
13 13 11.75
10.99 12.76
12.63
11.97 11.66
10 11.26 10
10.39 10.75
10.19
8 8
5 5
1M 3M 6M 12M 1M 3M 6M 12M
USD-CHF GBP-USD
20 20
18 18
15 15
12.57 12.90
11.86 12.13
13 13
10.92
11.94 10.22
11.56 9.65
10 11.21 10 9.20 10.98
10.55
10.07
9.24
8 8 8.46
5 5
1M 3M 6M 12M 1M 3M 6M 12M
EUR-JPY EUR-GBP
20 20
18 16.45 18
16.00
15.50 15.60
15 15.83 15
14.97 15.25
14.59
13 13
10.02 10.37
9.54 9.77
10 10
10.05
9.58
8.92
8 8 8.33
5 5
1M 3M 6M 12M 1M 3M 6M 12M
Update: May 18, 2011 h. 10.00 CET Source: Bloomberg, UniCredit Research (all charts in this page)

Euro Compass
Country Outlook
Germany – Already back to pre-crisis high
Alexander Koch (UniCredit Bank)
+49 89 378-13013
■ The German economy staged an impressive early spring recovery in the first quarter. The
alexander.koch1@unicreditgroup.de GDP flash estimate showed a very strong quarterly increase of 1.5%. The eighth
consecutive rise lifted the level of real GDP back above its pre-crisis high. According to the
Federal Statistical Office, domestic demand was the main driver of growth at the beginning
of the year. Especially construction investment showed a very strong rebound after
weather-related weakness in the preceding quarter. But other investment and private
consumption also continued to expand. Moreover, although not having been the major
contributor, net exports were also reported to have added to growth in 1Q11.
■ Looking ahead, the temporary push in construction activity won't be repeated in the current
quarter. Moreover, the latest two marked declines in the Ifo business expectations index
point to a gradual softening in economic dynamics. Accordingly, quarterly GDP growth
should be substantially lower for the remainder of the year. Nevertheless, the prerequisites
for an ongoing solid and broad-based upswing remain intact so far. New order inflow for
the important manufacturing sector remained quite strong in the first quarter. Firms across
all sectors are reporting very high order backlog levels, boding well for vibrant production
and export growth in the coming months. In addition, record high investment plans in the
corporate sector accompanied by a healthy labor market development indicates further
impulses from domestic demand. We expect 2011 growth to repeat the +3.5% from 2010.
■ The rally in commodity prices triggered a strong acceleration in consumer prices across the
eurozone, above all for energy products. Combined with the excellent domestic situation
this is adding additional inflationary pressure in Germany. Comparing the assessment of
input prices by purchasing managers in manufacturing in Europe, German firms report a
disproportionately high level. Consequently, selling price expectations in the retail sector
signal significant indirect commodity price effects in the course of the year. Concerning
wage dynamics, already agreed on pay rises are not ringing any alarm bells. Wage
increases from collective bargaining agreements will average around 2% in 2011. We
expect consumer price inflation to average 2.2% this year, double the 2010 rate.
■ The V-shaped recovery helped to offset a considerable deterioration in public finances last
year, despite continuing extensive fiscal support measures. And with the start of budget
consolidation efforts this year – in order to comply with the constitutional debt brake – the
general government deficit can be expected to fall below the Maastricht threshold again
this year, with a further improvement planned for the coming years. The very strong
rebound in tax revenues might even leave scope for moderate income tax reductions
without violating the requirement to reduce the structural deficit.
GERMANY FORECASTS
1Q-10 2Q-10 3Q-10 4Q-10 1Q-11 2Q-11 3Q-11 4Q-11 1Q-12 2Q-12 3Q-12 4Q-12 2010 2011 2012
GDP 0.5 2.1 0.8 0.4 1.5 0.6 0.5 0.4 0.4 0.4 0.4 0.4 - - -
GDP (% yoy) 2.3 3.9 3.9 3.8 4.8 3.2 2.9 2.9 1.9 1.7 1.7 1.7 3.5 3.5 1.7
Gross Fixed Capital Formation 1.4 5.5 1.5 -1.1 3.4 1.2 1.2 0.7 0.4 0.4 0.4 0.4 5.7 6.4 2.5
Domestic Final Expenditures 1.8 2.1 0.1 -0.4 1.0 0.5 0.4 0.3 0.2 0.2 0.2 0.2 2.4 1.9 1.1
Exports 2.2 7.6 2.7 2.5 2.0 2.0 1.2 1.0 1.0 1.0 1.0 1.0 13.8 9.6 4.4
Imports 5.5 7.9 1.4 0.9 1.0 2.1 1.3 0.8 0.7 0.7 0.7 0.7 12.4 6.8 3.6
Current Account (% GDP) - - - - - - - - - - - - 5.2 4.4 4.1
Public Debt (% GDP) - - - - - - - - - - - - 83 81 80
All data are % qoq unless otherwise specified; GDP data are wda. *Contribution to growth Source: National sources, UniCredit Research

Euro Compass
France – Recovery keeps strengthening

Tullia Bucco
■ On May 13 the INSEE released a preliminary estimate of 1Q GDP switching the reporting
+39 02 8862-2079 of the GDP series to a “2005-base”, which caused some significant revisions to past GDP
tullia.bucco@unicredit.eu figures. In 1Q11, GDP surprised on the upside accelerating 1.0% qoq/2.2% yoy (vs.
0.3%/1.8%), the highest pace since 2Q06. The stronger-than-expected outcome was
explained by a firmer pick-up in gross fixed investment (up 1.1% qoq vs. 0.5%), also lifted
by a surge in public works (1.0% qoq vs. -1.4%), and a larger contribution from inventories,
mainly transport materials, adding 0.7pp to GDP. Stocking fully offset a negative
contribution to GDP from net exports (-0.4pp), as imports largely outpaced exports.
■ Business surveys continue to show very solid momentum at the beginning of the second
quarter. In April (the latest available data), the manufacturing PMI rose from 55.4 to 57.5,
whereas its services counterpart surged from 60.4 to 62.9, the highest level since
September 2000. The composite PMI climbed to 61.2, consistent with a 0.8% qoq pace of
growth. When looking at the details, momentum in manufacturing activity reflects an
improvement in the output (up to 61.1 vs. 56.3) and employment sub-component (to 53.9
vs. 52.2). In the services sector, the improvement was particularly notable in new business
(up to 63.3 vs. 62.1) and employment conditions (to 53.7 vs. 51.5). The EC survey
suggests that economic activity in the construction sector remains favorable (confidence
improved to -11.3 vs. -14.8), although financial constraints continue to persist. Overall, we
expect that growth momentum will hold up throughout the quarter, with GDP expanding by
about 0.5% in 2Q11.
■ Consumer inflation accelerated 0.1pp to 2.1% in April, due to a further acceleration in

transport costs (to 5.5% yoy vs. 4.9% previously) and a 4.4% mom hike in gas prizes. The
harmonized reading moved sideways to 2.2%. Our baseline scenario now foresees
inflation accelerating only gradually until the autumn, before entering an easing trend.
■ The 2010 general government deficit as percentage of GDP came in better than expected,
settling at 7.0% (EUR 137bn), 0.7pp below the estimate in the 2011 Draft Budget Law
published in September. In March, the budget balanced settled at EUR 33.6bn vs. EUR
28.9bn last year, mostly due to a deterioration in special accounts which is chiefly related
to money disbursements to Greece and money advances to local authorities as part of the
recent reform of the business tax. In fact, central government expenditure declined by
4.5% whereas revenues improved by 5.9% compared to March last year.
FRANCE FORECASTS
1Q-10 2Q-10 3Q-10 4Q-10 1Q-11 2Q-11 3Q-11 4Q-11 1Q-12 2Q-12 3Q-12 4Q-12 2010 2011 2012
GDP 0.2 0.5 0.4 0.3 1.0 0.5 0.4 0.4 0.4 0.5 0.5 0.5 - - -
GDP (% yoy) 1.0 1.5 1.7 1.4 2.2 2.2 2.2 2.3 1.8 1.7 1.9 2.0 1.4 2.3 1.8
Government Consumption 0.0 0.3 0.3 0.2 0.3 0.0 0.0 0.2 0.2 0.2 0.2 0.2 1.4 0.7 0.7
Gross Fixed Capital Formation -1.2 1.1 0.9 0.5 1.1 0.6 0.7 0.7 0.8 0.9 0.9 1.0 -1.4 3.2 3.2
Domestic Final Expenditure -0.2 0.3 0.6 0.4 0.6 0.3 0.3 0.4 0.4 0.4 0.5 0.5 0.9 1.8 1.6
Inventories* -0.4 0.3 0.5 -0.3 0.7 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.5 0.9 0.0
Exports 4.7 3.1 2.0 0.4 1.4 1.2 1.2 1.2 1.2 1.3 1.3 1.3 9.4 5.3 5.0
Imports 1.8 3.4 4.1 -0.7 2.7 0.7 0.8 0.9 1.0 1.1 1.1 1.1 8.3 6.3 4.0
Net Exports* 0.7 -0.1 -0.6 0.3 -0.4 0.1 0.1 0.1 0.0 0.0 0.0 0.0 0.1 -0.4 0.2
Public Debt (% GDP) - - - - - - - - - - - - 81.7 86.5 88.0
All data are % qoq unless otherwise specified; GDP data are wda. *Contribution to growth Source: INSEE, UniCredit Research

Euro Compass
Italy – Still lagging behind

Chiara Corsa
■ Against the backdrop of stronger-than-expected EMU GDP in the first quarter, Italy’s
+39 02 8862 2209 meager economic growth (0.1% qoq) was particularly disappointing. ISTAT reported that
chiara.corsa@unicredit.eu both services and industry activity remained broadly flat, implying that construction
probably accelerated only marginally, while industry output ex-construction was slightly
down. Early indications for the second quarter are not very encouraging. The
manufacturing PMI eased to 55.5 from the previous 56.2 and the manufacturing confidence
index fell to 103 from the previous 103.5: while remaining at a relatively healthy level by
historical standards, these two surveys do not point to a firm acceleration in factory activity
after the weak performance recorded in the last two quarters. Moreover, the services PMI
points to slowing momentum, with the index easing to 52.2 from 53.3.
■ The labor market keeps sending mixed signals. In March the unemployment rate rose
slightly to 8.3% from 8.2% in February. While the number of unemployed rose by 40k vs.
February (+2% mom), employment was up by 111k (+0.5% mom), but for the quarter as a
whole new hiring was up by a meager 0.1% qoq. Encouragingly, the number of inactive
people fell by 114k (-0.8% mom), recording the second decline in a row. However, should
this trend continue over the coming months without a pick-up in employment numbers, the
unemployment rate may rise further.
■ CPI inflation accelerated further in April, to 2.6% from 2.5% in March. Upward contributions
came from core prices, up by 1.8% yoy (vs. 1.7% in March), and energy costs (up by
10.7% yoy vs. 10.3%). While the latter was mostly due to a 3.9% mom increase in
electricity tariffs, the pick-up in the core was driven by a large increase in transport costs,
probably due to the late Easter. We expect CPI inflation to stabilize throughout the summer
and accelerate towards the end of the year, before entering a downward trend early in
2012. We see CPI inflation averaging 2.6% in 2011 and 2.0% next year.
■ In the first four months of this year, the state-sector borrowing requirement (SSBR)
amounted to EUR 40.1bn, a 5% reduction vs. the same period the previous year, when the
SSBR amounted to EUR 42.0bn. Still, it is worth noting that the 2011 data include the
disbursement of two tranches of the loan to Greece (one in January and one in March).
Overall, the fiscal consolidation effort seems to be on track.
■ The local elections held on 15-16 May were a crucial test for the PM’s center-right coalition.
The PDL (Berlusconi's party) and the Northern League recorded sweeping losses,
including a very poor showing in the city of Milan, one of Berlusconi’s most important
strongholds. Run-off elections have to be held in two-week time in some of the largest
cities, notably Naples and Milan, but it’s clear that the center-right coalition was hit hard by
this round of local election. While this should not have the potential to lead to early general
elections, the wake-up call for the ruling coalition was loud and clear.
ITALY FORECASTS
1Q-10 2Q-10 3Q-10 4Q-10 1Q-11 2Q-11 3Q-11 4Q-11 1Q-12 2Q-12 3Q-12 4Q-12 2010 2011 2012
GDP 0.5 0.5 0.3 0.1 0.1 0.4 0.2 0.3 0.3 0.3 0.4 0.5 - - -
GDP (% yoy) 0.6 1.5 1.4 1.5 1.1 0.9 0.8 1.0 1.2 1.1 1.3 1.5 1.2 1.1 1.2
Government Consumption -0.7 0.5 -0.3 -0.6 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.2 -0.6 -0.5 0.0
Gross Fixed Capital Formation 1.2 1.4 0.8 -0.7 0.5 1.0 0.8 1.0 1.1 1.1 1.2 1.3 2.3 2.1 4.3
Domestic Final Expenditure 0.2 0.4 0.3 -0.1 0.2 0.3 0.3 0.4 0.4 0.4 0.4 0.5 0.9 0.9 1.5
Inventories* 0.3 -0.5 0.6 1.1 -0.3 0.0 0.0 0.0 0.0 -0.2 0.0 0.0 0.8 0.8 -0.1
Exports 4.2 2.6 2.6 0.5 3.0 1.5 1.2 1.0 0.8 0.8 0.9 0.9 8.9 7.4 3.8
Imports 4.0 0.4 4.9 3.4 2.0 1.2 1.3 1.3 0.9 0.7 0.8 1.0 10.3 9.2 4.0
Net Exports* 0.0 0.5 -0.7 -0.9 0.2 0.0 -0.1 -0.1 -0.1 0.0 0.0 -0.1 -0.5 -0.7 -0.2
Public Debt (% GDP) - - - - - - - - - - - - 119.0 120.1 119.6
All data are % qoq unless otherwise specified. *Contribution to growth Source: ISTAT, UniCredit Research

Euro Compass
Spain – The recovery remains an export story

Tullia Bucco (UniCredit Bank Milan)
+39 02 8862 2079
■ The Spanish economy slightly accelerated in the first quarter, printing at 0.3% qoq vs.
tullia.bucco@unicredit.eu expectations for a 0.2% qoq reading. The expenditure breakdown was in line with earlier
indication from the INE showing that net export was, once again, the main growth engine:
net export added approximately 0.2pp to 1Q GDP as an acceleration in exports firmly
outpaced that in imports. Final domestic demand (excluding inventories) made no
contribution to GDP, something that can be seen as a favorable development compared to
the previous quarters, when final domestic demand was a drag on GDP. Still, the outcome
is mostly explained by a rebound in government expenditure (up 1.4% qoq vs. -0.7%)
whereas private consumption growth was muted (0.0% qoq vs. 0.3%) reflecting the
ongoing process of deleveraging of the household sector. Inventories added 0.1pp to GDP.
■ The April manufacturing PMI – the latest available figure – suggests that momentum in
factory activity lost steam quite abruptly at the beginning of the second quarter, although
the current level of 50.57 remains consistent with positive economic activity. Its services
counterpart in April moved back above the 50-threshold, after a short-lived decline in
March. What is less encouraging is the fact that to date the (mild) improvement in business
expectations has failed to translate into higher new businesses (actually down to 47 after
49.9 in March) and there is no evidence of a recovery in employment prospects.
Information from the EC survey hardly challenges this weak picture for the services sector.
We expect that 2Q GDP will expand at 0.2% qoq pace.
■ The rate of unemployment (based on the survey of the labor force) surged from 20.3% to
21.3% in the first quarter, the highest level in 15 years. The increase in the unemployment
rate was largely explained by a further mild increase in the labor force (up 0.2% yoy vs.
0.6% in 4Q), with Spaniards re-entering the labor pool having a hard time finding a job (the
number of unemployed was still up 6.4% yoy). The number of payrolls continued to shrink
(by 1.3% yoy) despite the fact that job shedding came to a halt in the services sector
(where payrolls were up 0.3% yoy).
■ The general government deficit for 2010 came in marginally lower than expected at 9.2%
of GDP vs. 11.1% in 2009, lifting the debt-to-GDP to 60% vs. 53.2% in 2009. The central
government deficit improved to 5.0%, compared to a government estimate of 5.9%. The
government aims to reduce the general government deficit to 6.0% in 2011, mostly through
a sharp cut in the central government deficit (estimated at 2.3%) and a positive contribution
from the social security account (which is expected to post a 0.4% surplus). The recently
released multi-annual Stability Program foresees a 3% target for the fiscal deficit in 2013.
SPAIN FORECASTS
1Q-10 2Q-10 3Q-10 4Q-10 1Q-11 2Q-11 3Q-11 4Q-11 1Q-12 2Q-12 3Q-12 4Q-12 2010 2011 2012
GDP 0.1 0.3 0.0 0.2 0.3 0.2 0.2 0.3 0.3 0.4 0.5 0.5 - - -
GDP (% yoy) -1.4 0.0 0.2 0.6 0.8 0.7 0.9 1.0 1.0 1.2 1.6 1.8 -0.1 0.8 1.4
Private Consumption 0.9 1.4 -1.0 0.3 0.0 0.1 0.1 0.2 0.2 0.2 0.3 0.3 1.2 0.2 0.8
Government Consumption -0.5 1.1 -0.7 -0.7 1.4 -0.4 -0.3 -0.1 -0.1 -0.1 -0.1 0.1 -0.7 0.2 -0.5
Gross Fixed Capital Formation -1.8 -0.3 -2.8 -1.5 -1.4 -0.6 -0.4 0.3 0.5 0.5 0.7 0.6 -7.6 -4.5 1.3
Domestic Final Expenditure 0.0 1.0 -1.3 -0.3 0.0 -0.2 -0.1 0.2 0.2 0.2 0.3 0.3 -1.2 -0.8 0.6
Inventories* 0.2 0.3 -0.3 -0.1 0.1 0.1 0.0 0.0 -0.1 0.0 0.0 0.0 0.1 0.0 0.0
Exports 4.4 1.4 0.5 3.9 5.0 1.5 1.5 1.2 1.2 1.4 1.4 1.4 10.3 11.1 5.4
Imports 4.0 4.2 -4.3 1.6 3.9 0.6 0.6 0.7 0.7 0.8 0.8 0.8 5.4 4.9 2.9
Net Exports* -0.1 -1.0 1.7 0.6 0.2 0.3 0.3 0.2 0.2 0.2 0.2 0.2 1.0 1.7 0.8
Public Debt (% GDP) - - - - - - - - - - - - 60.0 67.5 70.0
All data are % qoq unless otherwise specified; GDP data are working-day adjusted; *Contribution to growth Source: INE, UniCredit Research

Euro Compass
Austria – Economic growth in 2011 expected to exceed 3%

Stefan Bruckbauer (Bank Austria)
+43 (0) 50505 41951
■ In the first quarter of 2011, economic growth accelerated to 1.0% qoq (Q4 2010: +0.9%),
stefan.bruckbauer@unicreditgroup.at largely supported by a stronger momentum in foreign trade, the most important growth
driver in 2010. Exports were up 3.4% qoq, but the domestic economy also made an
Walter Pudschedl (Bank Austria)
+43 (0) 50505 41957 important contribution to growth. Higher capacity utilisation levels and a further increase in
walter.pudschedl@unicreditgroup.at the backlog of orders have supported investment activity (gross fixed capital formation:
+0.9% qoq), and the stable growth trend in private consumption, at 0.2% qoq, remained on
track. Year-on-year, economic growth reached 4.2% in Q1 2011.
■ The momentum of new orders received by industry is softening, the backlog of orders is
rising more slowly, the Bank Austria Purchasing Managers’ Index has declined and the
mood in Europe’s industrial sector is less positive. Our business indicator shows a clear
slowdown in economic growth in April, especially as confidence of domestic consumers
slipped somewhat in the face of growing uncertainty. Consumers are nonetheless entering
the forthcoming summer months in a very optimistic mood. As from the second quarter, the
growth momentum of the Austrian economy is likely to be barely half as strong as that
seen in the winter. But with qoq growth of 0.3-0.4% until the end of 2011, the economy will
continue its buoyant and stable upward trend. Notwithstanding the anticipated slowdown,
economic growth in 2011 will be much stronger than in the previous year. As the first
quarter was more dynamic than expected, we are revising our growth forecast for 2011
upwards from 2.8 to 3.1%.
■ April saw a further rise in inflation to 3.3% yoy. Driven primarily by the rise in commodity
prices, inflation averaged 2.9% in the first four months of 2011. While the correction in
commodity prices that has taken place in the meantime may ease inflationary pressure, the
inflation rate is likely to remain above 3% in the next few months. It will only fall noticeably
at the turn of the year.
■ The government’s financial plan for the period until 2015, published at the end of April,
does not seem very ambitious. At 3.9% of GDP in 2011, the budget deficit will not fall
below 3% until 2013, and will still amount to 2% in 2015. In light of the favourable
economic trend, which supports tax revenues, we expect that strong GDP growth will
enable the government to reach its target sooner than planned.
AUSTRIA FORECASTS
1Q-10 2Q-10 3Q-10 4Q-10 1Q-11 2Q-11 3Q-11 4Q-11 1Q-12 2Q-12 3Q-12 4Q-12 2010 2011 2012
GDP 0.2 1.0 1.1 0.9 1.0 0.4 0.3 0.3 0.5 0.5 0.5 0.4 - - -
GDP (% yoy) 0.2 2.5 2.5 3.0 4.2 3.5 2.7 2.1 1.6 1.7 1.9 2.0 2.0 3.1 1.8
Government Consumption -0.5 0.1 -0.1 -0.1 0.0 0.2 0.1 0.2 0.3 0.2 0.2 0.2 -2.4 0.4 0.9
Gross Fixed Capital Formation -1.2 0.4 1.5 1.2 0.9 0.8 0.6 0.6 0.9 0.9 0.7 0.5 -1.3 4.2 3.0
Domestic Final Expenditure -0.3 0.7 1.0 1.1 0.4 0.3 0.3 0.3 0.4 0.3 0.3 0.2 0.7 1.5 1.2
Inventories* 0.0 0.5 0.5 0.7 0.1 -0.1 -0.1 0.0 0.0 0.0 0.0 0.0 0.7 0.1 -0.1
Exports 2.4 4.2 3.3 2.0 3.4 1.7 0.9 0.9 1.6 1.5 1.3 1.0 10.8 9.5 5.3
Imports 2.4 3.9 3.2 2.1 2.4 1.7 0.9 1.0 1.5 1.3 1.1 0.8 9.3 7.7 5.0
Net Exports* 0.5 0.3 0.1 -0.2 0.6 0.1 0.0 0.0 0.1 0.2 0.2 0.2 1.3 1.5 0.6
Current Account (% GDP) - - - - - - - - - - - - 2.7 3.0 3.2
Public Debt (% GDP) - - - - - - - - - - - - 72.3 71.9 72.3
All data are % qoq unless otherwise specified. *Contribution to growth; Source: Statistik Austria, UniCredit Research
UniCredit Research page 35

Euro Compass
UniCredit Forecasts
EUROZONE FORECASTS
1Q-10 2Q-10 3Q-10 4Q-10 1Q-11 2Q-11 3Q-11 4Q-11 1Q-12 2Q-12 3Q-12 4Q-12 2010 2011 2012
GDP 0.4 1.0 0.4 0.3 0.8 0.5 0.3 0.4 0.4 0.5 0.5 0.5 - - -
GDP (% yoy) 0.8 2.0 2.0 2.0 2.5 1.9 1.9 2.0 1.6 1.5 1.7 1.9 1.7 2.1 1.7
Government Consumption -0.1 0.2 0.4 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.7 0.4 0.3
Total Consumption 0.2 0.2 0.2 0.3 0.3 0.2 0.2 0.2 0.2 0.3 0.3 0.3 0.8 1.0 1.0
Gross Fixed Capital Formation -0.2 2.1 -0.2 -0.5 1.0 0.5 0.5 0.6 0.7 0.8 0.9 1.0 -1.0 1.8 2.9
Domestic Final Expenditure 0.1 0.6 0.1 0.2 0.4 0.2 0.2 0.3 0.3 0.4 0.4 0.5 0.4 1.2 1.3
Change in Inventories* 0.4 0.3 -0.1 -0.1 -0.1 0.0 0.0 0.0 0.0 0.0 0.1 0.1 0.5 -0.1 0.1
Domestic Total Expenditure 0.1 0.6 0.1 0.2 0.4 0.2 0.2 0.3 0.3 0.4 0.4 0.5 0.9 1.1 1.5
Exports 3.1 4.5 2.1 1.6 3.0 2.0 1.3 1.4 1.4 1.5 1.6 1.7 11.0 9.1 6.0
Imports 3.6 4.2 1.5 1.0 2.1 1.6 1.3 1.3 1.4 1.5 1.7 1.9 9.1 7.0 6.1
Net Exports* -0.2 0.1 0.3 0.3 0.5 0.2 0.0 0.0 0.0 0.0 0.0 -0.1 0.8 1.0 0.1
Core HICP Inflation (% yoy) 0.9 0.9 1.0 1.1 1.1 1.5 1.4 1.5 1.5 1.6 1.7 1.8 1.0 1.4 1.7
Unit Labour Costs (% yoy) -0.5 -0.6 -0.6 -0.2 -0.5 0.2 0.5 0.4 0.9 0.9 0.9 0.9 -0.5 0.1 0.9
Employment growth -0.0 0.1 -0.0 0.2 0.3 0.3 0.2 0.2 0.3 0.3 0.3 0.3 -0.4 0.8 1.1
Current Account (% GDP) - - - - - - - - - - - - -0.1 0.1 0.2
ECB Refi rate 1.00 1.00 1.00 1.00 1.00 1.25 1.50 1.75 2.00 2.25 2.50 2.75 - - -
All data are % qoq unless otherwise specified; GDP data are working-day adjusted; interest rates are end of period; *Contribution to growth;
GLOBAL FORECASTS
GROSS DOMESTIC PRODUCT
% yoy ACTUAL UniCredit CONSENSUS (May-11)
2007 2008 2009 2010 2011 2012 2010 2011 2012
UNITED STATES 1.9 0.0 -2.6 2.9 2.5 2.7 2.9 2.7 3.2
JAPAN 2.3 -1.2 -6.3 4.0 1.0 2.5 3.9 0.0 2.8
EURO ZONE 2.8 0.3 -4.1 1.7 2.1 1.7 1.7 1.7 1.7
GERMANY 2.8 0.7 -4.7 3.5 3.5 1.7 3.6 2.8 1.9
ITALY 1.4 -1.3 -5.2 1.2 1.1 1.2 1.1 1.0 1.1
FRANCE 2.2 -0.2 -2.6 1.4 2.3 1.8 1.5 1.6 1.7
SPAIN 3.6 0.9 -3.7 -0.1 0.8 1.4 -0.1 0.7 1.3
AUSTRIA 3.5 2.0 -3.9 2.0 3.1 1.8 2.0 2.2 1.9
SWEDEN 3.4 -0.8 -5.3 5.3 4.0 2.4 5.3 4.3 2.9
NORWAY (mainland) 5.4 1.6 -1.1 2.2 2.6 2.9 2.2 3.1 3.3
UNITED KINGDOM 2.7 -0.1 -4.9 1.3 1.5 2.0 1.4 1.6 2.2
SWITZERLAND 3.6 1.9 -1.9 2.6 2.4 1.7 2.6 2.4 2.0
CONSUMER PRICE INDEX

% yoy ACTUAL UniCredit CONSENSUS (May-11)
2007 2008 2009 2010 2011 2012 2010 2011 2012
UNITED STATES 2.9 3.8 -0.3 1.6 3.2 2.7 1.6 3.0 2.1
UNITED STATES (Core CPI) 2.3 2.3 1.7 1.0 1.4 1.9 -- -- -
JAPAN 0.0 1.4 -1.4 -0.7 -0.3 0.4 -0.7 0.4 0.2
EURO ZONE 2.1 3.3 0.3 1.6 2.7 2.0 1.6 2.5 1.9
GERMANY 2.3 2.6 0.4 1.1 2.2 1.7 1.1 2.3 2.0
ITALY 1.8 3.4 0.8 1.5 2.6 2.0 2.0 2.5 2.1
FRANCE 1.5 2.8 0.1 1.5 2.1 1.7 1.5 2.0 1.7
SPAIN 2.8 4.1 -0.3 1.8 3.5 2.5 1.8 3.0 1.8
AUSTRIA 2.2 3.2 0.5 1.9 3.2 2.2 1.9 2.5 2.1
SWEDEN 2.2 3.5 -0.3 1.3 2.5 1.5 1.3 2.9 2.4
NORWAY 0.7 3.8 2.2 2.4 1.7 2.4 2.4 1.6 1.9
UNITED KINGDOM 2.3 3.6 2.1 3.3 4.1 2.5 3.3 4.1 2.3
SWITZERLAND 0.7 2.4 -0.5 0.7 0.7 1.1 0.7 1.0 1.4
Source: Consensus Forecast, UniCredit Research

Euro Compass
INTEREST AND EXCHANGE RATE FORECASTS

EU US
Current Jun-11 Sep-11 Dec-11 Mar-12 Current Jun-11 Sep-11 Dec-11 Mar-12
Key rate 1.25 1.25 1.50 1.75 2.00 Key rate 0.25 0.25 0.25 0.25 0.25
3M 1.43 1.50 1.75 2.10 2.30 3M 0.26 0.35 0.35 0.45 0.55
2Y 1.79 2.10 2.25 2.50 2.80 2Y 0.53 0.90 1.05 1.25 1.55
5Y 2.45 2.83 2.95 3.10 3.25 5Y 1.79 2.45 2.60 2.78 2.95
10Y 3.09 3.45 3.55 3.65 3.70 10Y 3.12 3.65 3.80 4.00 4.15
30Y 3.61 3.85 3.90 3.95 3.90 30Y 4.24 4.70 4.80 4.90 5.00
2/10 130 135 130 115 90 2/10 260 275 275 275 260
2/5/10 1 5 5 2 0 2/5/10 -3 17 17 15 10
10/30 51 40 35 30 20 10/30 112 105 100 90 85
2Y SwSp 49 60 55 40 35 2Y SwSp 19 15 10 10 10
10Y SwSp 33 25 20 10 10 10Y SwSp 7 5 0 0 0
UK SZ
Key rate 0.50 0.50 0.75 1.00 1.25 Key rate 0.25 0.25 0.50 0.75 1.00
3M 0.82 0.90 1.05 1.30 1.55 3M 0.18 0.50 0.80 1.05 1.30
2Y 0.99 1.60 1.80 2.05 2.35 2Y 0.56 0.75 1.10 1.35 1.60
5Y 2.04 2.73 2.95 3.20 3.48 5Y 1.19 1.43 1.70 1.93 2.10
10Y 3.37 3.85 4.00 4.25 4.50 10Y 1.87 2.10 2.30 2.50 2.60
30Y 4.21 4.55 4.65 4.85 5.05 30Y 2.20 2.25 2.40 2.60 2.70
2/10 238 225 220 220 215 2/10 131 135 120 115 100
2/5/10 -14 0 5 5 5 2/5/10 -3 0 0 0 0
10/30 84 70 65 60 55 10/30 33 15 10 10 10
10Y SwSp 15 20 30 30 40 10Y SwSp 36 40 40 40 40
JN CA
Key rate 0.10 0.10 0.10 0.10 0.10 Key rate 1.00 1.25 1.50 1.50 1.75
3M 0.20 0.20 0.25 0.25 0.25 3M 1.20 1.50 1.75 1.75 2.00
NO SW
Key rate 2.25 2.25 2.50 2.75 3.00 Key rate 1.75 1.75 2.25 2.75 3.00
3M 2.68 2.75 3.00 3.25 3.35 3M 2.46 2.50 2.80 3.25 3.30
AU NZ
Key rate 4.75 5.00 5.25 5.25 5.50 Key rate 2.50 2.50 2.50 2.50 2.75
3M 4.96 5.40 5.75 5.75 5.85 3M 2.65 2.75 2.85 3.00 3.05
FX FORECASTS
vs. EUR Current Jun-11 Sep-11 Dec-11 Mar-12 vs. USD Current Jun-11 Sep-11 Dec-11 Mar-12
EUR-USD 1.42 1.50 1.53 1.55 1.52 EUR-USD 1.42 1.50 1.53 1.55 1.52
EUR-JPY 115 122 125 129 128 USD-JPY 81 81 82 83 84
EUR-GBP 0.87 0.89 0.88 0.87 0.85 GBP-USD 1.62 1.69 1.74 1.78 1.79
EUR-SEK 9.00 8.90 8.80 8.70 8.65 USD-SEK 6.35 5.93 5.75 5.61 5.69
EUR-NOK 7.93 7.85 7.80 7.75 7.70 USD-NOK 5.59 5.23 5.10 5.00 5.07
EUR-CHF 1.25 1.29 1.30 1.32 1.34 USD-CHF 0.88 0.86 0.85 0.85 0.88
EUR-AUD 1.34 1.36 1.35 1.41 1.41 AUD-USD 1.06 1.10 1.13 1.10 1.08
EUR-NZD 1.82 1.88 1.84 1.94 1.97 NZD-USD 0.78 0.80 0.83 0.80 0.77
EUR-CAD 1.38 1.46 1.45 1.49 1.49 USD-CAD 0.98 0.97 0.95 0.96 0.98

Euro Compass
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Euro Compass
ADDITIONAL REQUIRED DISCLOSURES UNDER THE LAWS AND REGULATIONS OF JURISDICTIONS INDICATED
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Euro Compass
UniCredit Research*
Thorsten Weinelt, CFA Dr. Ingo Heimig
Global Head of Research & Chief Strategist Head of Research Operations
+49 89 378-15110 +49 89 378-13952
thorsten.weinelt@unicreditgroup.de ingo.heimig@unicreditgroup.de
Economics & FI/FX Research
Economics & Commodity Research EEMEA Economics & FI/FX Strategy

European Economics Gillian Edgeworth, Chief EEMEA Economist
+44 0207 826 1772, gillian.edgeworth@unicredit.eu
Marco Valli, Chief Eurozone Economist
+39 02 8862-8688 Gyula Toth, Head of EEMEA FI/FX Strategy
marco.valli@unicredit.eu +43 50505 823-62, gyula.toth@unicreditgroup.at
Andreas Rees, Chief German Economist Güldem Atabay, Economist, Turkey
+49 89 378-12576 +90 212 385 9551, guldem.atabay@unicreditgroup.com.tr
andreas.rees@unicreditgroup.de
Dmitry Gourov, Economist, EEMEA
Stefan Bruckbauer, Chief Austrian Economist +43 50505 823-64, dmitry.gourov@unicreditgroup.at
+43 50505 41951
stefan.bruckbauer@unicreditgroup.at Hans Holzhacker, Chief Economist, Kazakhstan
+7 727 244-1463, h.holzhacker@atfbank.kz
Tullia Bucco
+39 02 8862-2079 Marcin Mrowiec, Chief Economist, Poland
tullia.bucco@unicredit.eu +48 22 656-0678, marcin.mrowiec@pekao.com.pl
Chiara Corsa Vladimir Osakovsky, Ph.D., Head of Strategy and Research, Russia
+39 02 8862-2209 +7 495 258-7258 ext.7558, vladimir.osakovskiy@unicreditgroup.ru
chiara.corsa@unicredit.eu Rozália Pál, Ph.D., Chief Economist, Romania
Dr. Loredana Federico +40 21 203-2376, rozalia.pal@unicredit.ro
+39 02 8862-3180 Kristofor Pavlov, Chief Economist, Bulgaria
loredana.federico@unicredit.eu +359 2 9269-390, kristofor.pavlov@unicreditgroup.bg
Mauro Giorgio Marrano Goran Šaravanja, Chief Economist, Croatia
+39 02 8862-8222 +385 1 6006-678, goran.saravanja@unicreditgroup.zaba.hr
mauro.giorgiomarrano@unicredit.eu
Pavel Sobisek, Chief Economist, Czech Republic
Alexander Koch, CFA +420 2 211-12504, pavel.sobisek@unicreditgroup.cz
+49 89 378-13013
alexander.koch1@unicreditgroup.de Dmitry Veselov, Ph.D., Economist, EEMEA
+44 207 826 1808, dmitry.veselov@unicredit.eu
Chiara Silvestre
chiara.silvestre@unicredit.eu Vladimír Zlacký, Chief Economist, Slovakia
+421 2 4950-2267, vladimir.zlacky@unicreditgroup.sk
US Economics Global FI/FX Strategy

Dr. Harm Bandholz, CFA, Chief US Economist Michael Rottmann, Head
+1 212 672 5957 +49 89 378-15121, michael.rottmann1@unicreditgroup.de
harm.bandholz@unicredit.eu
Dr. Luca Cazzulani, Deputy Head, FI Strategy
+39 02 8862-0640, luca.cazzulani@unicredit.eu
Commodity Research
Chiara Cremonesi, FI Strategy
Jochen Hitzfeld +44 20 7826-1771, chiara.cremonesi@unicredit.eu
+49 89 378-18709
jochen.hitzfeld@unicreditgroup.de Elia Lattuga, FI Strategy
+39 02 8862-2027, elia.lattuga@unicredit.eu
Nikolaus Keis
+49 89 378-12560 Dr. Stephan Maier, FX Strategy
nikolaus.keis@unicreditgroup.de +39 02 8862-8604, stephan.maier@unicredit.eu
Armin Mekelburg, FX Strategy
+49 89 378-14307, armin.mekelburg@unicreditgroup.de
Roberto Mialich, FX Strategy
+39 02 8862-0658, roberto.mialich@unicredit.eu
Kornelius Purps, FI Strategy
+49 89 378-12753, kornelius.purps@unicreditgroup.de
Herbert Stocker, Technical Analysis
+49 89 378-14305, herbert.stocker@unicreditgroup.de
Publication Address
UniCredit Research
Corporate & Investment Banking Bloomberg
UniCredit Bank AG Milan Branch UCGR
Economics & FI/FX Research
Via Tommaso Grossi, 10 - 20121 Milan Internet
Tel +39 02 8862.2019 - Fax +39 02 8862.2585 www.research.unicreditgroup.eu
*UniCredit Research is the joint research department of UniCredit Bank AG (UniCredit Bank), UniCredit CAIB Group (UniCredit CAIB), UniCredit Securities (UniCredit Securities),
UniCredit Menkul Değerler A.Ş. (UniCredit Menkul), UniCredit Bulbank, Zagrebačka banka, UniCredit Bank, Bank Pekao, Yapi Kredi, UniCredit Tiriac Bank and ATFBank.

2011-05-04 Unicredit Euro Compass - How Long Before The Next Cyclical Downturn

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2011-05-04 Unicredit Euro Compass - How Long Before The Next Cyclical Downturn

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May 2011 Economics & FI/FX Research

How long before the next cyclical downturn?

■ When the ECB meets on 9 June, we expect a switch to “(strong)

UniCredit Research page 1 See last pages for disclaimer.

UniCredit Research page 2 See last pages for disclaimer.

Key Eurozone Forecasts

UniCredit Research page 3 See last pages for disclaimer.

UniCredit Research page 4 See last pages for disclaimer.

The European Economist

BUSINESS SURYES REMAIN IN GOOD SHAPE DATING EUROZONE CYCLICAL RECOVERIES

EC Economic Confidence Output gap (In % of potential GDP)

Source: Markit, OECD, UniCredit Research

UniCredit Research page 5 See last pages for disclaimer.

FINANCING GAP TRACKS THE BUSINESS CYCLE ULC S REMAIN DEPRESSED

3.0 Output Gap - LS 7.0

Source: Eurostat, OECD, UniCredit Research

UniCredit Research page 6 See last pages for disclaimer.

- A V-shaped recovery in emerging markets, which pushed up strongly demand for

A LOOK AT PAST CREDIT CYCLES THIS INFLATION CYCLE MAY BE DIFFERENT

Source: ECB, OECD, Eurostat, UniCredit Research

UniCredit Research page 7 See last pages for disclaimer.

Can monetary policy affect the length of this recovery?

Another couple of years of healthy growth. What could go wrong?

5.0 Financial Market Index

Source: Markit, ECB, Datastream, UniCredit Research

UniCredit Research page 8 See last pages for disclaimer.

UniCredit Research page 9 See last pages for disclaimer.

Core CPI (in %, yoy) FAO Food Price Index (in %)

0.5 -14 -40

Source: Eurostat, FAO, UniCredit Research

UniCredit Research page 10 See last pages for disclaimer.

UniCredit Inflation Forecasts

2010 1.6 1.5 1.0 1.5 1.6

Source: Eurostat, INSEE, ISTAT, UniCredit Research

UniCredit Research page 11 See last pages for disclaimer.

The ECB Watcher

2.60 March ECB Projections

1.60 UniCredit assessment of the June ECB Projections

1.20 GDP CPI

Source: Bloomberg, ECB, UniCredit Research

UniCredit Research page 12 See last pages for disclaimer.

UniCredit Research page 13 See last pages for disclaimer.

ECB Most Watched

ECB Forecasts ECB Key exogenous variables

UniCredit Composite PMI & GDP Growth Inflation

1.0 58 4.0 Core (in %, yoy)

M3 Dynamics Credit Dynamics

Source: Datastream, ECB, Eurostat, Markit, UniCredit Research

UniCredit Research page 14 See last pages for disclaimer.

The Eurozone Economist’s Toolbox

Source: Markit, Eurostat, UniCredit Research

UniCredit GDP Tracker

Source: European Commission, Eurostat, ECB, National Sources, UniCredit Research

UniCredit Research page 15 See last pages for disclaimer.

-2.0 UniCredit Employment Indicator

Source: European Commission, Eurostat, UniCredit Research

Source: ECB, UniCredit Research

UniCredit Research page 16 See last pages for disclaimer.

UNDERLYING INFLATION UP FURTHER

Source: Eurostat, UniCredit Research

UniCredit Persistence-Weighted (PW) Inflation Index

PW INFLATION STABILIZED IN APRIL