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Money does not perform. People do. The economic and financial outlook in the wake of the credit turmoil Anton Brender June 2008 - Amsterdam Up to now, Emerging countries have been rather resilient and have supported world growth GDP growth Import growth (% year on year) (% year on year, in dollars) 14 60 Brazil China 12 China 40 10 Russia Russia 8 20 6 Korea 4 2 04 2 05 06 OPEC -20 Brazil 0 0 07 08 -30 00 01 02 03 04 05 06 07 Source: Thomson Datastream 08 This partly explains why some commodity prices – oil in particular – have continued to rise Commodity Index (Goldman Sachs, January 2007 = 100) 250 300 250 200 200 150 150 100 50 Jan 100 Apr Jul 2007 Oct Energy Industrial metals Precious metals Agriculture Livestock 3 Jan Apr Jul 2008 50 Jan Apr Jul 2007 Oct Jan Apr Jul 2008 Wheat Soybeans Corn Rice (not included in the index) Source: Thomson Datastream OPEC has played a role in pushing oil prices higher… World petroleum production and consumption (million barrels per day, annual change) 4 World consumption 3 2 OPEC “iso-income” curves 35 0 -1 OECD -2 -3 01 02 03 04 4 05 06 07 08 World production 3 1 0 ? -1 30 25 2007 *from January to May 2008 (annual rate) 2008* 20 $950 billion 15 $680 billion 2 Production (million barrels per day) 1 OPEC petroleum exports Consumption Non OECD Other Non OPEC OPEC 10 50 70 90 110 130 150 OPEC oil basket price ($ per barrel) -2 -3 4 01 02 03 04 05 06 07 08 Sources: IEA, Dexia-AM … but speculation also played its part Oil price and expectations 120 20 WTI oil price ($) [R.H.S.] 100 10 50 0 Spread spot price – 18-month forward price ($) -10 95 97 99 01 03 05 07 Non commercial positions (thousands of contracts) 400 Long positions 300 200 -30 20 30 120 1.60 0 20 100 1.50 80 1.40 60 Jun Aug Oct Dec Feb Apr Jun 2007 2008 1.30 40 -20 10 -40 0 -60 -80 Oct Dec 2007 Feb Apr 2008 Jun WTI oil price 95 5 97 99 01 03 05 07 1.70 140 (long minus short positions, thousands of contracts, change over 3 months) Short positions Euro/dollar exchange rate and oil price 45 40 60 Net speculative positions 100 0 0 Net speculative positions and oil price (% change over 3 months) [R.H.S.] -10 Oil price ($) Oil price (€) (indexed on the dollar oil price in June 2007) Euro/dollar exchange rate [R.H.S.] Sources: CFTC, Thomson Datastream A continuing steep rise in oil prices could end up choking world growth OPEC and Russia trade balance Trade balance* ($ billions, annual rate) OPEC 1 400 ($ billions, annual rate) 1200 WTI oil price rises at $150 1 200 Oil prices (WTI, $ per barrel) 140 400 120 $105 80 40 Exports 800 $72 $66 2006 2007 0 94 Imports 98 6 0 94 Imports 02 400 0 00 Exports 98 WTI oil price falls back to $100 06 400 200 (*) Assuming an oil price at $100 per barrel. 02 Russia 600 2008 800 02 04 06 08 If oil price increases to $150 per barrel and stay there, growth can continue only if non oil exporting countries accept and manage to reduce their surpluses or increase their deficits by more than $400 billion… 06 Sources: Thomson Datastream, Dexia-AM The more so since the financial system has turned much less “borrower friendly”... Bank lending standards (net percentage of banks tightening their standards) United States 100 80 40 Loans to firms Commercial real estate C&I loans (medium and large firms) 7 Loans to individuals 100 80 80 60 Residential mortgages 40 Other consumer loans 20 0 Credit cards -40 94 98 02 06 96 00 04 Firms 40 0 0 -40 90 Euro area 08 -20 House purchase 03 Consumer credit 05 07 Sources: Thomson Datastream, ECB, Federal Reserve … even if equity capital constraints do not seem to be binding Reported credit losses versus capital raised ($ billions, as of May 22) 400 250 200 IMF estimated total losses 200 ($ billions, as of March 2008) Estimated losses on unsecuritized U.S. loans 225 Estimated mark-to-market loss on related securities 720 Total losses 945 100 0 0 World United States 120 200 of which Europe Euro area United States 80 Losses 100 40 0 8 0 Q2 Q3 Q4 Q1 Q2 2007 2008 Capital raised Banks Brokers Sources: IMF, Bloomberg Despite some improvement, liquidity on the interbank market is not back to normal… TED spread 3-month interbank rate minus OIS rate (3 months Eurodollar rate minus Tbill rate, basis points) 1-month interbank rate minus OIS rate (basis points) 120 200 80 80 100 40 40 0 0 Jan Apr Jul 2007 Oct Jan Apr 2008 Libor $ Euribor € Jun Sep 2007 Dec (basis points) 120 300 Mar Jun 2008 Libor $ Euribor € 0 Jun Sep 2007 Dec Mar Jun 2008 Starting beginning of August, central banks provided ample liquidity to ease tensions on the money markets. But market rates continued to spike upwards despite recent central banks’ initiatives. 9 Sources: Thomson Datastream, Bloomberg, Federal Reserve … and while credit spreads have recently narrowed appreciably, they still remain wider than a year ago Subprime ABX AAA Commercial CMBX AAA (07-01, basis points) 1200 (NA 3, basis points) 300 US - high yield US - Leveraged loans (Merrill Lynch, 5-year, basis points) 750 500 (LCDX NA 5-year, basis points) 400 800 200 550 400 100 350 0 Jun Sep Dec 2007 Mar Jun 2008 0 Jun Municipal bonds 120 (ML 10-year, basis points) 80 Sep Dec 2007 Mar Jun 2008 150 Jun 200 Sep 2007 Euro – Crossover Itraxx 750 (5-year, basis points) Dec Mar Jun 2008 0 Jun Sep Dec 2007 Euro – Investment grade Itraxx 200 (5-year, basis points) 650 40 0 100 450 -40 -80 -120 Jun 10 Sep Dec 2007 Mar Jun 2008 250 Jun Sep Dec 2007 Mar Jun 2008 Mar Jun 2008 0 Jun Sep Dec 2007 Mar Jun 2008 Sources: Thomson Datastream, JP Morgan, MarkIt Economic and financial outlook Contents United States: in recession… ? Euro area: weathering the storm? Annex 11 Up to now, pessimists have been wrong: the US economy has not yet contracted Unemployment rate GDP growth (% year on year) 6 Contribution to GDP growth (% year on year) Likely 4 11 2 GDP ex residential investment 2 7 Goldman Sachs IMF 0 -1 99 01 03 05 07 1 Likely 3.5 89 3 0 -1 ? -5 -2 12 -1 Residential investment [R.H.S.] 55 62 69 76 Q2 Q3 2008 01 05 Employment 83 90 97 04 -2 [R.H.S.] 40 200 0 0 -60 90 IMF* Q1 97 (year on year change, thousands) 400 Ex construction & finance -40 -1 93 80 Goldman Sachs 0 5.5 1 (% quarter on quarter, annual rate) 2 (%) 8.0 7.5 Construction & finance 94 98 -200 02 Q4 (*) Quarterly profile is our best “guess”. Sources: IMF, Goldman Sachs, Thomson Datastream, Dexia-AM 06 -300 Despite high gasoline prices and weakening consumption… Gasoline prices and consumption Consumer confidence 110 Motor vehicle sales 21 20 Consumption 200 7 150 100 90 50 70 03 04 05 06 07 08 3 150 16 100 14 50 12 0 -50 -50 1 -100 0 -150 -1 Consumer confidence - expectations 03 04 05 06 07 08 Consumption (% / 3 months, annual rate) 13 18 0 -100 50 5 200 Gasoline prices Gasoline prices (% / 3 months, annual rate) [R.H.S.] (% / 3 months, annual rate) [R.H.S.] Jan 04 - July 07 average (Millions, annual rate) 04 05 06 07 08 Core retail sales 12 (% over 3 months, annual rate) 8 -150 4 0 -2 93 97 01 Source: Thomson Datastream 05 … growth has not tumbled, thanks to support from the rest of the world Exports US exports by destination* (% year on year) 20 Exports 10 15 Exports 10 5 0 0 20 10 0 -5 -10 Real effective exchange rate [R.H.S.] -15 90 94 98 02 -15 -15 06 Imports 15 -10 [R.H.S.] 6 10 4 2 0 -10 Domestic demand [R.H.S.] Imports 14 94 98 02 06 1.5 1.0 94 98 0 -2 5 20 3 0 02 06 -1 Trade balance 0.5 Canada (21%) (15%) 98 00 60 40 (contribution to real GDP growth, % year on year) +1% (% year on year) LatAm (17%) Other developed Europe (6%) -20 Euro area -30 20 02 04 0 (19%) Japan -20 -30 98 94 98 02 06 08 Asia ex Japan (5%) 00 02 04 -1.0 -1.5 90 06 Middle East (3%) 0 -0.5 (% year on year) 90 90 40 1 External demand -10 7 (*) The % in bracket is the share in US exports Source: Thomson Datastream 06 08 In the coming quarters, front loaded fiscal stimulation should provide some additional temporary support… Fiscal stimulation in two episodes How consumption might be affected (% month on month) 2001 3 Consumption 2 1 8 2008 Real disposable income 4 0 Real disposable income -1 0 -2 -2 -3 -4 In 2001, tax rebates amounted to 0.6% of disposable income ($44 billion). Three quarters of the rebates were spent (i.e. consumption was boosted by roughly 0.5%). In 2008 rebates will amount to more than 1% of disposable income. A third has been sent electronically in May. 15 (% quarter on quarter, annual rate) Q2 2008 Q3 2008 Q4 2008 Impact on consumption 1-month lag 2-month lag +2.6 +0.4 -3.0 0.0 +5.6 -5.4 Assuming only a third of the rebates is spent this time, consumption should be boosted by 0.3% for the year as a whole… with a strong rebound in Q3 if spending takes place with a 2-month lag. Sources: Thomson Datastream, Dexia-AM … while state and local governments’ revenue shortfalls should not significantly affect their spending, at least in 2008 State and local governments 10 Expenditures and the business cycle 8 States’ rainy day funds ($ billions) 1.2 80 0.8 6 4 0.4 2 0 -0.4 -2 -4 63 (% year on year) 60 40 0 73 83 Real GDP 93 03 (% year on year) State and local governments’ expenditures share in GDP (%, year on year change) [R.H.S.] 16 Contribution of state and local governments’ expenditures to GDP growth -0.8 2008 2009 Real state & local expenditures* 2.2 -0.3 -0.3 GDP weight (in %) 12 12 12 0.3 0.0 0.0 0.3 0.2 -0.2 Contributions to GDP Without using rainy day funds 20 0 79 86 93 00 During the last few years, as revenues and economic conditions have rebounded, States have built up rainy day funds. 07 Using $35 billions of rainy day funds 2007 (*) Rate of growth of expenditures maintaining the same net borrowing requirement as in 2007 (-1.1% of GDP). Sources: Thomson Datastream, National Association of State Budget Officers Still, there is no sign of bottoming in the housing sector… Home sales 6500 12 11 Existing Existing home prices By metropolitan area National 30 20 10 S&P/CS -10 10 OFHEO -20 (% year on year) -10 Futures S&P/CS -20 (% quarter on quarter, annual rate) -30 88 92 96 00 04 08 4500 7 (% change over 3 months, annual rate) 0 (% year on year) 0 9 -30 -40 -50 5 2500 85 1400 1300 Sept. 07 Mar. 08 89 93 97 01 3 05 12 11 New 1100 9 900 7 700 5 500 95 97 99 01 03 05 07 Home sales (thousands, annual rate) Houses for sale to houses sold (months supply) [R.H.S] 17 Sources: Thomson Datastream, S&P, Bloomberg 3 … partly because the financial turmoil prevented mortgage rates from falling with Treasury rates CDS and mortgage spreads Home sales and mortgage rates 250 Home sales Mortgage rates (change over 3 months) (as given by Bankrate, %) 0.8 Mortgage rates 200 160 0.4 100 8 80 Freddie Mac CDS 7 0 6 0 0.0 5 -100 -0.4 Home sales -200 -250 03 04 05 06 07 110 30-year fixed rate 70 4 -0.8 08 07 08 290 30-year mortgage rate minus 10-year Treasury 250 [R.H.S.] 170 08 -10 18 07 30 3 06 06 Freddie Mac CDS US 10-year treasury rate (thousands, monthly rate) Banks CDS (US libor sample) 30-year jumbo rate (-2M, change over 4M) [R.H.S.] (basis points) 200 06 07 Sources: Thomson Datastream, Bloomberg 08 90 The Fed and the Administration are trying to make credit available to borrowers Fed’s balance sheet and offbalance sheet selected items 450 400 The Fed is helping financial institutions to carry their debt load… 200 Primary Dealer Credit Facility (PDCF) and discount (billions of dollars, change over 1 quarter at annual rate) 800 GSE backed pools Repurchase agreements 900 800 700 600 500 19 Financing of home mortgages Term Securities Lending facility (TSLF) Term auction facility (TAF) 0 … without increasing global liquidity (billions of dollars) 400 2007 2008 400 Reserve Bank credit 300 Treasury securities held outright Repurchase agreements [R.H.S.] 200 TAF [R.H.S.] Other loans [R.H.S.] 2007 2008 0 Commercial banks and Saving & Loans -400 94 96 98 00 ABS issuers 02 04 06 100 0 Sources: Thomson Datastream, Federal Reserve 08 However the risk of a deep and long lasting correction in home prices has significantly increased OFHEO home prices (log level) 7.0 7.0 California Reference Level* 6.5 12 8 OFHEO prices and home transactions 5.5 Real OFHEO (% year on year) 4 -8 76 7.5 5.0 6.5 4.5 83 5.5 0 -4 4.5 Home sales (per year and hundreds of households) [R.H.S.] 86 96 53% 6.0 06 3.5 2.5 30Q 29 quarters 95 Home prices Reference level* 4.5 -16% 89 New York State 5.5 Home prices 25% 6.5 01 07 3.5 75 13 83 91 99 United States 6.1 Home prices 5.8 -1% per year 24% 5.5 -11% per year 5.2 Reference level* 4.9 (*) The reference level is derived, state by state, by regressing local home prices on the national disposable income per household. 4.6 83 20 07 89 95 01 07 13 Sources: Thomson Datastream, OFHEO, Dexia-AM In the coming years, negative wealth effects could be a serious headwind for the economy Household wealth Mortgage equity withdrawal (% of annual disposable income) (% of disposable income) Financial wealth 350 Tangible wealth 50 60 70 80 90 00 20 97 01 05 Cash out Turnover related Home equity borrowing MEW 21 Acquisition of assets 40 2 0 -1 93 Home improvements 60 4 150 Repayment of non-mortgage debt 80 6 250 (%) 100 9 8 450 Utilization of MEW 0 91 Personal consumption 95 99 03 07 A 10% fall in home prices diminishes consumption by 1.2% after two years Sources: Thomson Datastream, Federal Reserve Even if the credit squeeze recedes quickly, growth should stay below potential both this year and next GDP growth GDP growth in the United States Q/Q annual rate (%) Q2 07 Q3 07 Q4 07 Q1 08 2005 2006 2007 2008 2009 Consumption 1.4 2.8 2.3 1.0 3.2 3.1 2.9 1.7 1.6 Investment 3.0 0.1 -3.2 -6.8 7.3 2.8 -2.5 -4.5 0.2 - Residential -11.8 -20.5 -25.2 -25.5 6.6 -4.6 -17.0 -22.3 1.4 - Equipment 4.7 6.2 3.1 -0.9 9.6 5.9 1.3 2.1 2.3 - Structures 26.2 16.4 12.4 1.1 0.5 8.4 12.9 -0.1 -8.8 Inventory changes ($ billions) 5.8 30.6 -18.3 -14.4 33.3 40.3 4.6 7.7 16.2 Government 4.1 3.8 1.9 2.0 0.7 1.8 2.0 2.2 1.6 External balance ($ billions) -574 -533 -503 -480 -618 -624 -556 -448 -365 - Exports 1380 1441 1464 1474 1203 1304 1410 1507 1623 - Imports 1953 1974 1967 1954 1821 1929 1965 1956 1988 3.8 4.9 0.6 0.9 3.1 2.9 2.2 1.7 2.1 GDP 22 (% year on year) 6 4 2 0 95 99 03 07 Unemployment rate (%) 6.5 5.5 4.5 3.5 95 99 03 Source: Dexia-AM 07 But the combination of ever-increasing gasoline prices and a protracted credit crunch... Gasoline prices and inflation perception Consumer prices (% year on year) 5 Total 7 Auto loans delinquency rates 400 Retail gasoline 2.0 5 Core 98 02 06 Nominal wages 8 03 05 07 Consumer confidence (% year on year) 10 Inflation in 12 months (%) 4 Wages 6 (through dealers) 300 3 1 Indirect loans 3.0 (cents per gallon) [R.H.S.] 6 (% of loans) 3.5 (Conference board, expectations) 130 100 200 130 1.0 Direct loans 90 95 00 05 Mortgage delinquency rates (% of loans) 18 16 Subprime Prime [R.H.S.] 4 0 PCE deflator -2 98 23 02 Real wages 06 40 2.5 12 70 2 69 75 81 87 93 99 05 8 3.5 98 02 06 Sources: Thomson Datastream, ABA 1.5 … would lead to a “L-shaped” slowdown Housing starts 2300 OFHEO home prices (thousands units, annual rate) 15 (% year on year) Structures (% year on year) 20 5 0 0 1500 -5 -20 700 93 97 01 05 09 -15 01 03 05 07 09 -30 95 99 03 07 Consumption GDP growth Unemployment rate (% year on year) (% year on year) (%) 6 6 8 7 4 4 2 2 V-SHAPED 5 L-SHAPED 0 95 99 03 07 0 95 99 Reasonably optimistic 24 03 07 3 95 99 03 07 Protracted slowdown Source: Dexia-AM To sum up After lowering its policy rate by 225 basis points since January, the Fed will stay accommodative for many months and will continue to try to alleviate credit markets’ strains. Long term interest rates should stay below 4% as long as the housing market does not give clear signs of stabilization. If the economic and financial outlook deteriorates significantly, the Fed will act aggressively again and the Congress will vote a new stimulus package to try to avoid a protracted stagnation of the economy. Long term rates would then fall close to 3%. Against such a backdrop, the stock market perspectives for end of 2008 remain uncertain: 1500 for the SP500 in our reasonably optimistic scenario, but 1250 in a “L-shaped” one! 25 Economic and financial outlook Contents United States: in recession… ? Euro area: weathering the storm? Annex 26 Monthly surveys point to a clear slowdown in activity in the coming months PMI indices Manufacturing Eurozone PMI and GDP Services 70 70 5 62 4 60 60 57 50 50 40 40 99 01 03 05 07 2 52 99 01 03 05 07 0 99 47 01 03 05 GDP (% year on year) France 27 Germany Italy Spain PMI [R.H.S.] Sources: Thomson Datastream, Reuters 07 As in the United States, European households are facing strong inflation Wholesale gasoline prices 180 United States France Germany 120 170 2007 2008 Retail gasoline prices 2 Germany France Italy 28 (Jan. 2007 = 100) 2007 2008 (% year on year) 01 03 3 (in dollars) 90 0 05 07 Milk, cheese & eggs Meat 1 Food 30 20 % Bread & cereals Fruits 10 0 0 -1 99 (% year on year) 01 03 05 Motor fuel Shares in the Euro CPI-food Contribution to the Euro CPI-food United States 130 5 0 -1 99 United States Euro % 2 Italy Shares in the total CPI 10 United States 4 (Jan. 2007 = 100) 80 15 Euro area 6 (in euros) 160 CPI-food 7 07 Sources: Thomson Datastream, Eurostat But except in Spain and Ireland, employment growth has kept its momentum… Employment by country (% year on year) Employment in the Euro area and the United States (% year on year) 3 Spain 4 2 Euro area 2 4 0 -2 1 Germany 99 03 05 2 07 United States 99 01 03 05 Belgium 1 0 -1 6 -1 Germany -2 99 Spain Netherlands 01 03 4 07 2 0 29 01 France 3 8 0 -2 7 6 Ireland 99 01 03 05 07 Source: Thomson Datastream 05 07 … and a progressive improvement in German consumption is to be expected Employment and wages (2003=100) 105 Employment 108 France Real wages per employee 106 Real consumption and income in Germany France 103 102 101 99 03 Germany 05 Euro area 5 4 98 94 03 07 Germany 05 07 3 1 (% year on year) 0 France 4 -1 -2 2 Disposable income 2 Real disposable income 5 (% year on year) Consumption 93 96 99 02 05 0 -2 93 30 Germany 99 05 Sources: Thomson Datastream, Dexia-AM 08 Moreover, equipment investment in many Euro countries – in Germany in particular – seems to keep on growing Credit to non financial corporations by country Equipment investment in the Euro area and the United States (% year on year) 35 Spain 30 (% year on year, nominal) 20 15 Euro area 10 Germany 10 -5 0 USA 10 04 05 06 07 08 40 -5 Ireland 30 -10 99 01 03 05 07 5 0 Germany -5 -10 Spain -15 Netherlands Belgium Italy France 15 0 5 04 05 06 20 10 31 20 04 05 06 07 08 Source: Thomson Datastream 07 08 The sources of Euro domestic demand growth should hence progressively become more balanced… Domestic demand growth Contributions to euro area domestic demand growth Domestic demand growth (% year on year) (% year on year) 8 5 (%, annual average rate) 2007 4 1.5 2008 2 6 1.0 4 0.5 0 2 0.0 0 -4 96 Others 21% 98 00 02 04 06 08 -1.0 96 98 Euro area Germany Italy Spain France 32 Spain Euro area Shares in Euro domestic demand -0.5 -2 Germany 00 02 04 06 08 Germany 26% Spain 13% Italy 18% Sources: Thomson Datastream, Dexia-AM France 22% … while, despite the appreciation of the euro, exports should not totally falter Extra Euro area exports Recent exchange rate movements 1.7 1.6 Euro / $ 1.4 Euro effective exchange rate 1.2 125 By country of destination (%) Other 2% Africa 5% United States 12% Middle East 6% Western Hemisphere 4% United Kingdom 15% Developing +3% since Asia 12% Other developed January 08 Europe 13% (indexed on the euro $ in 01/07) J FMAM J J ASOND J FMAM J J 2007 2008 Pound 115 CEE & CIS 25% Other advanced 6% By exporting country (%) Austria 4% Finland 3% 100 Czech Koruna 85 33 Zloty J F MA M J J A SO N D J F M A M 2007 2008 Germany 40% Netherlands 11% (ULC based, 2007 = 100) 110 Italy Belgium Netherlands Spain France Germany 105 100 95 United Kingdom 90 Belgium 8% Yen Real effective exchange rate United States 85 2007 Spain 5% Italy 14% France 15% Source: Thomson Datastream 2008 If the US avoids a protracted slowdown, Euro growth could stay close to potential GDP growth GDP growth in the Euro area (% Q/Q annual rate) Q107 Q207 2004 2005 2006 2007 2008 2009 Consumption 0.2 2.6 2.1 -0.3 1.5 1.6 1.8 1.5 1.3 1.6 Investment 5.3 -0.1 4.4 3.4 2.0 3.1 5.3 4.1 3.3 2.8 - Construction 2.0 2.0 4.6 1.7 1.9 0.9 - Equipment 2.8 4.2 6.5 6.0 4.7 4.5 - Other -0.5 2.5 2.9 4.4 2.4 1.6 Unemployment rate (%) Change in inventories (contribution, % GDP) Government 1.9 -1.5 0.9 -0.5 0.2 0.0 0.2 0.0 0.1 -0.4 4.1 0.9 2.6 -0.4 1.4 1.4 2.0 2.2 1.6 2.0 External balance (contribution, % GDP) -0.8 1.0 -0.6 -0.6 0.1 -0.3 0.2 0.4 -0.1 0.4 - Exports 3.3 3.6 8.4 2.3 6.7 4.9 8.1 6.0 4.3 4.8 - Imports 5.3 1.3 10.2 -1.2 6.5 5.7 7.8 5.1 4.6 4.2 2.7 1.3 2.9 1.5 1.9 1.7 2.9 2.5 1.8 1.9 GDP 34 Q307 Q407 (% year on year) 5 4 2 0 95 99 11 03 07 10 8 6 95 99 Source: Dexia-AM 03 07 Still risk factors have accumulated, with fiscal policy having only a limited capacity to respond Change in cyclically adjusted primary balances Bank lending survey Factors affecting demand for loans to Euro area enterprises Debt restructuring 20 Stimulation -20 -40 -60 03 M&A -0.5 -1.5 05 06 07 08 Budgetary leeway* Demand for loans to enterprises -40 -60 -80 03 Euro area Germany 04 05 06 07 08 (% of GDP, 2008) -20 Public deficit 0 Greece 60 Italy 40 6 40 20 (basis points) 80 -1.0 Fixed investment 04 Governments’ spread vs German 10-year Bund 0.0 Inventories 0 Restriction (%, 2008) 0.5 SP IR GE SL Euro AU FN BG IT LX FR PT NL GR 40 1.0 4 2 0 -2 -3 -4 0 20 FN LX 0 NL SP GE SL BG GR AU PT IR 40 60 Spain France J F MAM J J A SO ND J FMAM 2007 IT FR 20 Belgium 80 Public debt 100 120 (*) Bubble size proportional to weight in euro area GDP (% of GDP, 2008) 35 Sources: Thomson Datastream, European Commission, Dexia-AM 2008 The ECB has tried its best to keep the interbank market liquid but has not changed its policy rate 300 Frontloading the distribution of liquidity Policy rate and monetary pillar 14 (€ billions) 250 Reserves 200 (% year on year) 10 Reserves requirement 3 Repo rate M3 100 Jan Mar May Jul Sep Nov Jan Mar May Jul 2007 2008 Lengthening the average maturity of operations 2 99 01 0 Longer-term refi. operations (€ billions) Main refinancing operations Fine-tuning operations -200 Jan Mar May Jul Sep Nov Jan Mar May Jul 2007 2008 36 03 05 Consumer prices 2 07 Cumulated deviation from the ECB inflation target (% year on year) 5 104 Oil=$150 (index, 1999=100) 103 Headline CPI Total net refinancing operations 200 (%) [R.H.S.] (% year on year) 4 400 4 6 150 600 5 Credit to the private sector 102 Oil=$125 2 101 100 99 99 Core CPI 03 07 0 97 99 01 03 05 07 09 Sources: Thomson Datastream, ECB, Dexia-AM Up to now, the euro / dollar exchange rate has remained driven by expectations on monetary policies Memo: December 2007 5.5 5.0 Expected Sept. 08 US short term rates (%) Exchange rates and short term interest rates differentials 6 Expected June 09 US ST rates (%) 4.0 June 09 short term rate differential (%, Euro-US) [R.H.S.] 5 Expected Sept. 08 Euro short term rates (%) 3.0 Oct Jan Apr Jul Oct 2006 2007 1.53 Sept. 08 short term 1.50 1.68 1.0 1.53 0.4 4 0.7 rate differential 3 (%, Euro-US) [R.H.S.] $ against the euro Expected June 09 Euro short term rates (%) -0.2 1.38 -0.8 0 1.40 2 Oct 1.30 $ against the euro 1.23 O D F A J A O D F A J 2007 2006 37 1.6 -1 Jan Apr 2006 Jul 2007 Oct Jan Apr 2008 1.23 Oct Jan Apr 2006 Jul Oct Jan Apr 2007 -1.4 Sources: Thomson Datastream, Dexia-AM 2008 -1.4 To sum up With high inflation and an economy staying close to potential, the ECB is likely to stay pat this year. Long term 10-year interest rates should stay around 4% until the end of 2008. If financial distress increases, the ECB might contribute to global stabilization by adjusting its policy rates. As in the US, the stock market perspectives for end of 2008 remain uncertain: the MSCI EMU should be close to 250 if growth tracks our reasonably optimistic scenario, but at 190 with a deeper slowdown. 38 Economic and financial Outlook Contents United States: walking on a tight rope… Euro area: how resilient? Annex 39 Delinquency rates for US commercial banks COMMERCIAL BANKS DELINQUENCY AND CHARGE-OFF RATES (% of loans) Delinquency rates 8.0 8.0 8.0 Total C&I loans Real Estate Consumer loans 7.0 6.0 5.0 7.0 Total 7.0 6.0 Residential 6.0 Commercial 5.0 4.0 4.0 3.0 3.0 3.0 2.0 2.0 2.0 1.0 1.0 1.0 0.0 97 02 07 87 Charge-off rates 4.0 3.0 Other 92 97 02 07 87 3.0 Total Residential Commercial 2.5 2.0 2.5 2.0 1.5 7.0 6.0 1.5 5.0 1.0 4.0 0.0 1.0 -0.5 0.0 40 95 00 05 07 3.0 0.5 90 02 Total Credit cards Other 8.0 0.5 85 97 9.0 1.0 0.0 92 Consumer loans charge-off rates Real estate charge-off rates Total C&I loans Real Estate Consumer loans 3.5 Credit cards 0.0 0.0 92 Total 5.0 4.0 87 Consumer loans delinquency rates Real estate delinquency rates 2.0 85 90 95 00 05 85 90 95 00 05 Sources: Thomson Datastream, Federal Reserve Mortgage delinquency rates in the United States MORTGAGE DELINQUENCY RATES (% of loans) Prime residential loans seriously delinquent 4.4 Prime residential loans foreclosure started 1.2 Prime Fixed rate Adjustable rate 3.9 3.4 Prime Fixed rate Adjustable rate Adjustable mortgage delinquency rates and projected ARM resets 0.8 2.9 2.4 1.9 Subprime - adjustable rate Prime - adjustable rate 0.4 1.4 4 0.9 0.4 0.0 98 99 00 01 02 03 04 05 06 07 08 98 99 00 01 02 03 04 05 06 07 08 12 10 3 8 2 Subprime residential loans seriously delinquent 25 Subprime Fixed rate Adjustable rate 20 Subprime residential loans foreclosure started 6.0 5.0 4.0 15 Subprime Fixed rate Adjustable rate 6 4 1 2 0 989900 01020304 05060708 30d 0 60d 9899000102030405060708 > 90d 3.0 10 2.0 5 1.0 0 98 99 00 01 02 03 04 05 06 07 08 41 0.0 98 99 00 01 02 03 04 05 06 07 08 Source: Thomson Datastream Selected indicators for Spain Credit institutions’ balance sheet Housing prices (% year on year) 20 Spain 15 (year on year change, euro billions) 500 France Assets 400 0 0 -5 97 00 03 Loans 100 United States 0.4 0.0 00 Securities other than shares -100 00 06 (% of total loans) 0.8 200 5 1.6 1.2 Total assets 300 10 Ratio of doubtful loans 02 04 06 08 02 04 40 (% year on year) 250 Construction and real estate activities 150 30 100 20 10 0 97 42 Liabilities 200 Domestic deposits Securities other than shares 50 Households Other business 00 03 06 09 0 -50 00 RoW deposits 02 04 06 08 Default rate curve by vintage Credit to the private sector 50 06 08 Sources: Thomson Datastream, Central bank of Spain, Dexia-AM Money does not perform. People do. The economic and financial outlook in the wake of the credit turmoil Anton Brender June 2008 - Amsterdam