JP March 18, 2011

Economic Research
March 18, 2011
Global Data Watch

Japan to contract in 2Q followed by 3% growth in 2H; limited reverberations elsewhere focused in manufacturing and EM Asia We maintain that global growth will hold above trend in 2Q and 2H11 Policy easing to support recovery in Japan; no changes elsewhere European officials unveil substantial policy package as Portugal moves closer to accessing the EFSF
Contents Economic Research note Offsetting crosscurrents for developed market consumers Keep an eye on the global inventory cycle New Fed sequence is mostly the same as the old one Euro area data point to a drift higher in core inflation Euro area delivers a good comprehensive policy package Japan to recover from the disaster, but will take time UK growth: the good, the bad, and the ugly UK: Budget for 2011 will stay the fiscal course RBNZ on hold until 2012 OCR changes more potent Global Economic Outlook Summary Global Central Bank Watch The J.P. Morgan View: Markets Selected recent research from J.P. Morgan Economics Data Watches United States Euro area Japan Canada Mexico Brazil Andeans United Kingdom Russia Turkey South Africa Australia and New Zealand China, Hong Kong, and Taiwan Korea ASEAN India Regional Data Calendars 11 13 15 17 19 21 25 27 29 4 6 7 10
The sun also rises

In the face of the unfolding tragedy in Japan, near-term global growth prospects have moderated further this week. On the heels of growth downgrades due to the oil-price shock and signs that the US and China turned into the year slower than expected, the Tohoku earthquake has prompted an 2%-pt reduction in our forecast for 1H11 Japanese GDP growth. We now project a 3.4% annualized gain in global GDP during the first half, down from a projected 4% pace that included upside risk as the year began. Recent events are a sobering reminder of the fragility of human endeavor (and forecasts) in the face of unpredictable natural and political forces. Considerable uncertainties surround the resolution of events in the MENA region and Japans impaired Fukushima nuclear facility. However, we believe that both Japan and the global economy will be resilient. For its part, the Japanese economy will likely bounce back in the second half of the year, moving on to an above-trend growth path that raises GDP above our previous forecast level by the end of next year (see Japan to recover from the disaster, but will take time in this GDW). Outside Japan, the global economy remains on track to deliver growth well above its trend pace of 2.7% per year. In part, this perspective is built on what we have learned from past shocks: If history is any guide, disruptions following natural disasters are short-lived in societies where reconstruction takes place. That was the case following the January 1995 earthquake that decimated Kobethe worlds 6th largest container port and a key hub between Japans two largest cities of Tokyo and Osaka. Although many predicted it would take a decade for Kobe return to prominence, the city was nearly fully recovered in just over one year. Moreover, GDP in Japan surged in 1995 alongside a slowing global backdrop. The cost of the current disaster is hard to predict but, assuming the nuclear situation improves, it will likely be similar to that of the Kobe earthquake at 2% of GDP. With damage to economic growth to be temporary, we expect limited reverberations to the rest of the world.
Industrial production
%3m, saar; both scales 16 Global ex Japan 36 27 8 18 9 0 Japan 0 -9 -18 2010 2011
31 39 45 49 51 53 55 57 61 63 65 67 71 75 77 81 84
Oil and equity prices

$/bbl (Brent) 120 110 100 90 80 Equities Oil Index (dev. mkt.) 1000 950 900 850
Bruce Kasman
(1-212) 834-5515 bruce.c.kasman@jpmorgan.com JPMorgan Chase Bank NA
David Hensley
(1-212) 834-5516 david.hensley@jpmorgan.com JPMorgan Chase Bank NA
Joseph Lupton
(1-212) 834-5735 joseph.p.lupton@jpmorgan.com JPMorgan Chase Bank NA
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JPMorgan Chase Bank NA, New York Bruce Kasman (1-212) 834-5515 Joseph Lupton (1-212) 834-5735 bruce.c.kasman@jpmorgan.com joseph.p.lupton@jpmorgan.com David Hensley (1-212) 834-5516 david.hensley@jpmorgan.com
Economic Research Global Data Watch March 18, 2011
Global service-sector activity

DI, sa 65 60 55 50 45 40 35 04 US services consumption Global services PMI new orders index %oya 4 3 2 1 0 -1 08 10 -2
A limited policy response

The G-7 support for yen intervention is a welcome sign that policymakers are aware of the vulnerabilities of the global recovery and can act cooperatively. Similarly, the willingness of the BoJ to leave any FX intervention unsterilized, coupled with an expansion of the central banks QE program, will provide important monetary support to the economy under the most stress. The government is expected to approve a supplementary reconstruction budget of 10 trillion or more, although a portion of this may be financed with higher taxes. Beyond these measures, however, we do not expect any additional new policy support. This should not be surprising given our view that the macroeconomic fallout will be limited. Moreover, the drift of policy is toward normalization, and the hurdle for additional easing remains very high. The Fed is firmly set to end its QEII program in June while US fiscal policy now looks to tighten earlier than we had anticipated. Fiscal policy is also tightening across Western Europe, while ECB President Trichet signaled today that recent events have not changed plans for an April hike. Running against the tide, one central bank that may be getting cold feet is the Bank of England. GDP might disappoint for a second quarter in a row and next weeks Budget Report is likely to show no letting up in fiscal tightening. Even still, however, the best this would do is delay an MPC hike to later in the year.
06
The recent jump in oil prices is squeezing purchasing power, and this will be evident in a softening of real consumer spending growth through April. However, assuming matters in the MENA stabilize, the damping effect on growth will quickly fade. This will allow continued improvements in financial and labor markets to lift demand growth to a robust pace by midyear (see Keep an eye on the global inventory cycle and Offsetting crosscurrents for developed market consumers in this GDW). In addition, our perspective on the outlook also is built on what we believe is happening now. Although official data are adding up to less growth in global GDP this quarter than we previously anticipated, there is an impressive broadening underneath the surface of the expansion that points in the direction of robust growth. Signs that service sector activity has picked up smartly are consistent with an acceleration in developed world growth and job creation in the United States. In addition, there is evidence that credit conditions are easing in the countries hardest hit by the financial crisis. And despite the fiscal turmoil in the Euro area, the disappointing performance to date in much of the region outside Germany, including France, Italy, and Spain, appears to be reversing. To be sure, there are risks that shocks will turn 2011 from being a great to a merely good year for growth. The shocks hitting the global economy will take a toll on consumer confidence and the possibility that oil prices will spike even higher is the key risk for our outlook. While overshadowed by the disaster in Japan, there was a clear intensification of turmoil in the MENA region this week, highlighting this concern. A sharp rise in oil prices that also undermined risk appetite and sent the equity markets tumbling would pose a formidable roadblock for the recovery. At the same time, the global economy is vulnerable to constraints on fiscal and monetary policy that could prompt tightening that magnifies shocks and generates a negative feedback loop with deteriorating private sector behavior.
2
Ripple effects most prominent in EM Asia

The ripple effects from developments in Japan will be felt unevenly across the world economy. Sectorally, the biggest impact will be felt by global manufacturing activity. Japan manufacturing accounts for 10% of global value-added in the sector and is a formidable player in many industries including autos and high technology. Although it is hard to quantify, the near-term disruption to Japanese production will affect the supply of materials, components, and finished goods across the globe. These disruptions will be felt the most in EM Asia, on account of its extensive trade and production linkages with Japan and the regions high manufacturing intensity. In reassessing the near-term growth outlook for EM Asia, some issues specific to EM Asias two biggest economies, China and India, also played a role. In Chinas case, some key data have fallen short of expectations in early 2011, including the PMI surveys, auto and other retail sales, and industrial production. Although the Lunar New Year holidays may account for some of this shortfall, it also appears that policy tightening is playing a role. Consequently, the 1H11 GDP forecast has been trimmed to 8.8% (from 9.3%). The forecast for 2H11 was bumped up slightly to
Customs trade with Japan

Exports to JPN % of total % of GDP 2.9 0.5 5.1 0.4 1.3 0.5 1.6 0.3 5.5 1.7 8.2 2.5 9.8 7.2 2.9 0.3 0.7 0.2 1.7 0.5 Imports from JPN % of total % of GDP 3.8 0.7 6.8 0.9 2.2 0.7 2.3 0.5 8.6 2.5 13.4 3.3 11.8 7.8 4.0 0.4 5.3 1.6 2.9 0.8
DM US Germany UK EM China ASEAN Brazil Mexico CEEMEA
port are negotiable and that they are conditional on the behavior of the debtor sovereign (as indicated by the change for Greece but not Ireland), policymakers have taken a step toward laying out a credible path to debt sustainability. Borrowing costs still remain too high (they were lowered only 100bp for Greece), but given the conditional nature of what was agreed, we think it is reasonable to expect further improvements in the terms and conditions over time. Despite a general improvement in the region as whole, events in Portugal this week highlight the challenges still ahead. Faced with increasing market pressure, the Portuguese government announced a new set of fiscal consolidation measures. Nevertheless, Moodys still downgraded the sovereign this week and concerns mounted with the risks of a fall in the minority government by April. Political developments are increasing the likelihood that the sovereign will access the EFSF despite the government's efforts to avoid this outcome.
9.0%. In India, the more downbeat prospects for near-term investment spending and the governments plans for earlier fiscal tightening point to lower near-term growth, with the 2Q GDP forecast trimmed to 8.4% from 10%. The forecast changes to Japan, China, and India means slower growth in the remainder of EM Asia, as well, where the 1H GDP growth forecast was lowered 0.5%-pts to 6.2%q/q saar. The growth backdrop in EM Asia remains solid despite these revisions. Moreover, inflation pressures continue to build, as core inflation and wage growth move higher, and the surge in commodity prices flows through to consumer food and energy prices. With the impact from Japan expected generally to be transitory, we are not making changes to our policy forecast, which calls for continued, gradual monetary tightening and modest currency appreciation. Indeed, signaling their confidence in the global and domestic growth backdrop, central banks in China and India tightened policy this week.
Latins remain focused on inflation

As in EM Asia, it appears that Latin American policymakers are still focused squarely on containing inflation pressures. Recent IP and retail sales data have been on the strong side, pointing to firm growth overall. Although year-ago inflation readings did not advance much in February, the recent deterioration of inflation expectations has not subsided and is keeping the pressure on central banks to tighten further. This week, Chiles central bank surprised the market by raising its policy rate 50bp versus a widely anticipated 25bp move. That said, we see this more aggressive move as tactical and are not changing our 6.50% policy rate call for year-end (consensus 5.75%). In turn, Colombia followed the script and hiked an expected 25bp today. Today Mexicos central bank released meeting minutes that open the door for earlier hikes if it sees signs of rising inflation expectations. The minutes included a lengthy discussion among Banxicos board members of the narrowing output gap and the deterioration in inflation expectations, which stand near the top of the inflation target range for 2011 and 2012. Given the widening gap between the international and domestic fuel prices and the likelihood that the government will be forced to accelerate the monthly increase in gasoline prices later this year, we no longer think that Banxico will be able to stand pat in 2011 and now anticipate the start of the beginning of a rate cycle with a 50bp move in 4Q11.
Editor Sandy Batten (1-212) 834-9645 sandy.batten@jpmorgan.com
EMU delivers on commitment

While uncertainties abound in the MENA region and now in Asia, considerable resolution was brought to the EMU fiscal crisis with the announced details of the regions comprehensive policy. While not addressing all concerns, the package should contain the crisis in the near term as it creates a path whereby the region can achieve debt sustainability in the medium term without debt restructuring, and it lays out a set of governance reforms to help prevent future crises. Anyone that expected the package to fully resolve the crisis was bound for disappointment, as a full resolution will not be achieved until Euro area sovereigns reach a combination of primary positions and debt levels which are deemed to be sustainable. Such an outcome can only come with time. The most important element of the package, in our view, was the decision that the cost of liquidity support can be reduced. By indicating that the terms and conditions of liquidity sup-
JPMorgan Chase Bank, New York David Hensley (1-212) 834-5516 Joseph Lupton (1-212) 834-5735 david.hensley@jpmorgan.com joseph.p.lupton@jpmorgan.com Carlton Strong (1-212) 834-5612 carlton.m.strong@jpmorgan.com
Global economic outlook summary

Real GDP
% over a year ago
Real GDP
% over previous period, saar
Consumer prices
% over a year ago
2010 The Americas United States Canada Latin America Argentina Brazil Chile Colombia Ecuador Mexico Peru Venezuela Asia/Pacific Japan Australia New Zealand Asia ex Japan China Hong Kong India Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand Africa/Middle East Israel South Africa Europe Euro area Germany France Italy Norway Sweden United Kingdom Emerging Europe Bulgaria Czech Republic Hungary Poland Romania Russia Turkey Global Developed markets Emerging markets Memo: Global PPP weighted 2.8 3.1 6.0 8.5 7.5 5.2 4.1 3.0 5.5 8.8 -1.4 4.0 2.7 1.5 9.1 10.3 6.8 8.5 6.1 6.1 7.2 7.3 14.5 10.8 7.8 4.6 2.7 1.7 3.5 1.5 1.1 2.2 5.3 1.3 4.3 0.1 2.3 1.2 3.8 -1.3 4.0 8.3 3.8 2.5 7.2 4.8
2011 2.9 3.3 4.3 5.5 4.0 6.0 4.5 3.5 4.5 7.3 1.5 0.9 2.6 1.6 7.5 9.4 4.7 8.0 6.0 4.2 5.1 5.0 5.0 4.8 4.3 4.5 3.7 2.2 3.3 2.3 1.4 2.9 4.6 1.7 4.1 3.5 3.0 2.8 4.0 2.0 4.5 4.5 3.3 2.3 6.0 4.2

2012 2.9 3.0 3.8 5.0 3.8 4.5 4.0 3.0 3.5 6.0 3.0 2.8 4.5 3.9 7.6 9.0 4.7 8.7 6.7 4.6 4.4 5.1 5.6 5.3 4.8 4.0 3.8 2.2 2.2 2.4 2.1 2.9 2.9 2.7 4.6 4.0 3.5 3.5 4.2 4.0 5.0 5.0 3.6 2.7 6.0 4.2

3Q10 2.6 1.8 2.5 1.6 1.6 8.7 0.9 6.5 3.2 7.2 0.6 3.3 0.5 -0.6 7.4 9.9 3.6 13.5 6.7 3.0 -0.6 -3.1 -16.7 3.2 -1.3 4.6 2.7 1.4 2.8 1.0 1.1 4.4 8.7 2.8 -1.0 3.6 2.2 4.9 -3.8 2.9 2.3 4.7 3.8
4Q10 2.8 3.3 3.6 2.0 3.0 3.8 6.7 3.0 5.1 8.6 -1.8 -1.3 3.0 2.1 7.9 12.7 6.1 0.9 7.5 2.2 8.9 12.7 3.9 0.0 4.8 7.7 4.4 1.1 1.5 1.4 0.2 1.3 5.1 -2.3 9.3 1.4 0.8 3.2 14.5 2.9 1.4 7.0 4.0
1Q11 2.5 4.0 3.7 6.0 3.9 5.0 6.0 3.0 2.0 6.8 2.5 1.2 -0.3 -0.6 7.6 8.7 4.1 7.9 6.0 5.0 5.2 4.9 8.7 8.2 6.5 4.5 3.6 3.0 4.5 3.5 1.5 3.3 3.5 2.8 3.2 1.5 2.5 3.5 3.5 3.4 2.5 5.8 4.2

2Q11 3.5 3.6 5.7 8.0 4.8 5.0 3.8 2.5 8.0 7.0 1.5 -1.0 4.8 2.3 7.3 8.8 4.2 8.4 5.0 4.0 5.1 3.6 7.8 5.8 5.8 4.5 3.7 2.0 2.5 2.0 1.5 3.3 3.3 2.0 3.2 3.0 3.0 4.0 3.0 3.4 2.3 6.2 4.2

3Q11 3.5 3.5 4.1 8.0 4.9 5.0 3.7 2.5 2.5 4.5 2.0 2.0 4.1 5.0 8.3 9.0 4.8 13.2 4.5 5.5 5.4 5.3 7.0 5.8 5.5 4.5 4.0 2.0 2.5 2.5 2.0 3.0 3.0 2.5 3.7 3.5 3.5 4.5 3.5 3.7 2.7 6.4 4.7

4Q11 3.0 3.3 4.3 6.0 4.6 4.5 4.2 2.0 3.6 6.7 2.5 4.0 5.2 5.0 7.3 9.0 5.0 5.8 5.0 5.8 5.0 4.5 6.6 6.0 5.5 4.5 4.1 2.5 2.5 3.0 2.5 3.0 3.0 3.0 5.0 4.0 3.5 4.5 5.5 3.8 3.0 6.1 4.5

1Q12 2.0 2.7 3.2 3.0 4.0 4.5 4.5 3.5 1.5 6.5 3.0 3.5 5.1 2.7 7.1 9.3 4.8 5.0 7.0 4.0 5.5 5.3 4.9 5.5 4.5 4.5 3.0 2.3 2.0 2.3 2.5 3.0 3.0 2.5 5.2 3.5 3.5 4.2 6.0 3.3 2.4 5.7 4.5
4Q10 1.2 2.3 6.7 10.5 5.6 2.5 2.7 3.3 4.2 2.1 27.3 0.1 2.7 4.0 4.9 4.7 2.8 9.2 6.3 3.6 2.0 2.9 4.0 1.1 2.9 2.5 3.5 2.0 1.6 1.9 2.0 2.2 1.9 3.4 6.6 2.1 4.4 2.9 7.9 8.2 7.4 2.7 1.6 5.6 3.4
2Q11 2.8 2.4 7.0 11.0 6.0 4.2 3.6 3.5 3.6 2.9 29.0 0.5 3.4 5.4 5.4 5.1 3.9 8.5 7.2 4.5 3.4 5.6 6.0 1.8 4.4 4.9 4.2 2.3 2.3 2.0 1.9 1.1 3.1 4.0 7.7 2.2 4.0 4.0 7.3 10.9 6.3

4Q11 2.5 1.9 7.6 12.0 6.1 5.5 4.0 3.8 3.7 2.8 33.8 0.4 3.6 3.8 4.4 3.3 4.2 8.5 6.3 3.2 3.7 5.1 4.8 2.9 4.3 3.8 5.9 2.3 2.3 2.1 1.9 0.9 2.9 3.8 6.9 2.9 4.2 2.9 4.8 9.7 6.5

2Q12 1.6 2.0 7.6 12.0 6.2 5.0 3.4 3.6 3.6 2.8 34.6 0.3 3.2 2.9 3.9 3.0 3.7 8.0 5.5 2.5 3.0 3.9 2.3 2.1 4.5 3.5 5.8 1.9 1.8 1.8 2.0 0.9 2.4 2.4 6.0 2.7 3.8 2.7 5.0 7.9 6.2

3.4 2.4 6.2 4.1
3.2 2.3 5.7 3.8
2.6 1.6 5.2 3.2
Note: For some emerging economies, 2010-2012 quarterly forecasts are not available and/or seasonally adjusted GDP data are estimated by J.P. Morgan. Bold denotes changes from last edition of Global Data Watch, with arrows showing the direction of changes. Underline indicates beginning of J.P. Morgan forecasts.
JPMorgan Chase Bank, New York David Hensley (1-212) 834-5516 Joseph Lupton (1-212) 834-5735 david.hensley@jpmorgan.com joseph.p.lupton@jpmorgan.com Carlton Strong (1-212) 834-5612 carlton.m.strong@jpmorgan.com
G-3 economic outlook detail

2010 United States Real GDP Private consumption Equipment investment Non-residential construction Residential construction Inventory change ($ bn saar) Government spending Exports of goods and services Imports of goods and services Domestic final sales contribution Inventories contribution Net trade contribution Consumer prices (%oya) Excluding food and energy (%oya) Federal budget balance (% of GDP, FY) Personal saving rate (%) Unemployment rate (%) Industrial production, manufacturing Euro area Real GDP Private consumption Capital investment Government consumption Exports of goods and services Imports of goods and services Domestic final sales contribution Inventories contribution Net trade contribution Consumer prices (HICP, %oya) ex unprocessed food and energy General govt. budget balance (% of GDP, FY) Unemployment rate (%) Industrial production Japan Real GDP Private consumption Business investment Residential construction Public investment Government consumption Exports of goods and services Imports of goods and services Domestic final sales contribution Inventories contribution Net trade contribution Consumer prices (%oya) General govt. net lending (% of GDP, CY) Unemployment rate (%) Industrial production Memo: Global industrial production %oya 2.8 1.8 15.1 -13.8 -3.0 60.3 1.0 11.8 12.7 1.9 1.4 -0.4 1.6 1.0 -8.8 5.8 9.6 6.0 1.7 0.7 -0.8 0.7 10.6 8.7 0.4 0.4 0.9 1.6 1.0 -6.3 10.0 7.1 4.0 1.9 2.4 -6.5 -3.3 2.3 24.2 9.8 1.5 0.3 2.2 -0.7 -7.9 5.1 16.0 9.3 2011 2.9 3.0 10.8 3.5 2.6 53.0 -0.2 10.3 8.9 3.0 -0.1 0.0 2.6 1.1 -9.8 5.0 8.8 5.7 2.2 1.2 3.3 0.1 8.3 6.8 1.3 0.1 0.7 2.3 1.3 -4.6 9.9 6.0 0.9 -0.5 1.3 6.9 -1.1 2.0 5.1 5.0 0.4 0.2 0.3 0.4 -7.8 4.7 2.0 6.3
Percent change over previous period; seasonally adjusted annual rate unless noted
2010 2012 2.9 2.7 9.6 9.6 12.5 52.3 -0.6 8.5 8.2 3.1 0.0 -0.1 1.5 1.0 -6.9 4.7 8.4 3.7 2.2 1.8 4.5 -0.3 7.0 6.8 1.8 0.1 0.3 1.6 1.6 -3.9 9.3 4.6 2.8 1.5 5.1 3.2 13.8 1.3 6.1 4.9 2.3 0.1 0.4 0.1 -7.4 4.3 8.9 6.1 4Q 2.8 4.1 5.5 4.5 2.7 7.1 -1.5 9.6 -12.4 3.1 -3.7 3.4 1.2 0.6 5.4 9.6 4.0 1.1 1.7 -2.4 0.4 7.5 4.4 0.6 -0.9 1.4 2.0 1.1 10.0 6.9 -1.3 -3.2 2.0 12.3 -20.5 1.2 -3.0 -0.5 -2.8 0.7 0.9 0.1 5.0 -6.1 5.5 7.2 1Q 2.5 1.9 8.0 2.0 2.0 64.0 -0.9 15.0 20.0 1.9 1.7 -1.1 2.1 1.1 5.2 8.9 8.4 3.0 1.0 7.0 0.0 8.0 7.0 1.9 0.5 0.6 2.3 1.1 10.0 7.0 1.2 0.2 1.0 10.0 -5.0 1.0 8.0 4.0 0.7 0.1 0.4 0.0 4.9 7.0 7.6 6.4
2011 2Q 3.5 3.5 12.0 5.0 10.0 57.7 -1.3 10.0 7.0 3.4 -0.2 0.3 2.8 1.1 5.1 8.8 5.0 2.0 1.0 4.0 -0.5 7.0 6.5 1.3 0.4 0.4 2.3 1.2 9.9 5.0 -1.0 -3.0 -5.0 5.0 10.0 5.0 2.0 4.0 -1.4 0.4 0.0 0.5 4.8 -5.0 5.6 5.4 3Q 3.5 4.0 12.0 9.0 15.0 45.3 -1.3 8.0 8.0 4.0 -0.4 -0.1 2.9 1.1 4.9 8.7 4.5 2.0 1.5 4.0 -0.5 7.0 7.0 1.5 0.3 0.2 2.4 1.4 9.8 5.0 2.0 0.5 0.0 2.0 30.0 1.2 6.0 5.0 1.5 0.3 0.2 0.7 4.6 18.0 7.8 6.6 4Q 3.0 3.0 10.0 10.0 10.0 45.1 -0.1 8.0 9.0 3.3 0.0 -0.3 2.5 1.1 4.9 8.6 3.5 2.5 1.5 5.0 -0.5 7.0 6.5 1.7 0.4 0.4 2.3 1.5 9.7 4.5 4.0 2.5 5.0 2.0 25.0 1.0 8.0 5.0 3.5 0.1 0.5 0.4 4.5 15.0 7.0 6.9 1Q 2.0 1.5 10.0 10.0 10.0 47.7 -0.4 8.0 9.0 2.3 0.1 -0.3 1.6 0.9 4.6 8.5 3.5 2.3 2.0 4.5 -0.3 7.0 7.0 2.0 0.1 0.2 1.9 1.7 9.6 4.5 3.5 2.0 8.0 4.0 20.0 1.0 6.0 5.0 3.1 0.0 0.4 0.3 4.4 15.0 6.4 6.6
2012 2Q 3.0 2.5 8.0 10.0 15.0 52.7 -0.6 9.0 8.0 2.9 0.1 0.0 1.5 0.9 4.7 8.5 3.0 2.0 2.0 4.5 -0.3 7.0 6.5 2.0 -0.4 0.4 1.6 1.7 9.4 4.5 3.2 1.8 8.0 4.0 10.0 1.0 6.0 5.0 2.7 0.0 0.5 0.1 4.3 1.0 5.0 6.5 3Q 3.5 3.0 8.0 10.0 15.0 56.2 -0.6 9.0 7.0 3.3 0.1 0.1 1.4 1.0 4.7 8.4 3.5 2.0 2.0 4.5 0.0 7.0 7.0 2.0 -0.2 0.2 1.5 1.5 9.2 4.5 2.5 1.7 6.0 3.0 -5.0 1.0 6.0 5.0 1.9 0.1 0.5 0.1 4.3 2.0 4.9 5.8
Note: More forecast details for the G-3 and other countries can be found on J.P. Morgans Morgan Markets client web site.
JPMorgan Chase Bank N.A., New York David Hensley (1-212) 834-5516 Joseph Lupton (1-212) 834-5735 joseph.p.lupton@jpmorgan.com david.hensley@jpmorgan.com Michael Mulhall (1-212) 834-9123 michael.r.mulhall@jpmorgan.com
Central Bank Watch

Change from Official interest rate Global excluding US Developed Emerging CEEMEA EM Asia The Americas United States Canada Brazil Mexico Chile Colombia Peru Europe/Africa Euro area Sweden Norway Czech Republic Hungary Israel Poland Romania Russia South Africa Turkey Asia/Pacific Australia New Zealand Japan Hong Kong China Korea Indonesia India Malaysia Philippines Thailand Taiwan GDP-weighted average GDP-weighted average GDP-weighted average GDP-weighted average GDP-weighted average GDP-weighted average GDP-weighted average Federal funds rate Overnight funding rate SELIC overnight rate Repo rate Discount rate Repo rate Reference rate GDP-weighted average Refi rate Repo rate Deposit rate 2-week repo rate 2-week deposit rate Base rate 7-day intervention rate Base rate 1-week deposit rate Repo rate 1-week repo rate GDP-weighted average Cash rate Cash rate Overnight call rate Discount window base 1-year working capital Base rate BI rate Repo rate Overnight policy rate Reverse repo rate 1-day repo rate Official discount rate Current Aug '07 (bp) 1.91 2.61 0.62 5.48 7.85 4.08 5.18 1.38 0.125 1.00 11.75 4.50 4.00 3.50 3.75 1.49 1.00 0.50 1.50 2.00 0.75 6.00 2.50 3.75 6.25 3.00 5.50 6.25 3.27 4.75 2.50 0.05 0.50 6.06 3.00 6.75 6.75 2.75 4.00 2.50 1.625 -306 -222 -358 -162 -155 -294 -107 -444 -512.5 -325 -25 -270 -100 -550 -75 -323 -300 -500 -200 -250 -200 -175 -150 -75 -75 0 -400 -1125 -92 -150 -550 -45 -625 -51 -150 -175 -100 -75 -350 -75 -150 2 Nov 10 (+25bp) 10 Mar 11 (-50bp) 5 Oct 10 (-5bp) 17 Dec 08 (-100bp) 9 Feb 11 (+25bp) 10 Mar 11 (+25bp) 4 Feb 11 (+25bp) 17 Mar 11 (+25bp) 8 Jul 10 (+25bp) 9 Jul 09 (-25bp) 9 Mar 11 (+25bp) 30 Dec 10 (+12.5bp) 5 Apr 11 28 Apr 11 8 Apr 11 28 Apr 11 12 Apr 11 12 Apr 11 3 May 11 5 May 11 24 Mar 11 20 Apr 11 31 Mar 11 Aug 11 (+25bp) 2Q 12 (+25bp) On hold On hold 2Q 11 (+25bp) 2Q 11 (+25bp) 12 Apr 11 (+25bp) 3 May 11 (+25bp) 5 May 11 (+25bp) 24 Mar 11 (+25bp) 20 Apr 11 (+25bp) Mar 11 (+12.5bp) 7 May 09 (-25bp) 5 Mar 09 (-50bp) 15 Feb 11 (+25bp) 5 May 10 (+25bp) 6 May 10 (-25bp) 24 Jan 11 (+25bp) 21 Feb 11 (+25bp) 19 Jan 11 (+25bp) 4 May 10 (-25bp) 24 Dec 10 (+25bp) 18 Nov 10 (-50bp) 20 Jan 11 (-25bp) 7 Apr 11 7 Apr 11 20 Apr 11 12 May 11 24 Mar 11 28 Mar 11 28 Mar 11 5 Apr 11 29 Mar 11 25 Mar 11 24 Mar 11 23 Mar 11 7 Apr 11 (+25bp) May 11 (+25bp) 20 Apr 11 (+25bp) 12 May 11 (+25bp) 23 Jun 11 (+25bp) 4Q 11 (+25bp) 2Q 11 (+25bp) 5 Apr 11 (+25bp) 3Q 11 (+25bp) 25 Mar 11 (+25bp) Nov 11 (+50bp) Aug 11 (+50bp) 16 Dec 08 (-87.5bp) 8 Sep 10 (+25bp) 2 Mar 11 (+50bp) 17 Jul 09 (-25bp) 17 Mar 11 (+50bp) 18 Mar 11 (+25bp) 10 Mar 11 (+25bp) 27 Apr 11 12 Apr 11 20 Apr 11 15 Apr 11 12 Apr 11 29 Apr 11 7 Apr 11 On hold 31 May 11 (+25bp) 20 Apr 11 (+50bp) 4Q 11 12 Apr 11 (+25bp) 29 Apr 11 (+25bp) 7 Apr 11 (+25bp) Last change Next meeting Forecast next change Mar 11 Jun 11 Sep 11 Dec 11 Mar 12 1.92 2.62 0.62 5.51 7.85 4.18 5.19 1.38 0.125 1.00 11.75 4.50 4.00 3.50 3.75 1.50 1.00 0.50 1.50 2.00 0.75 6.00 2.50 3.75 6.25 3.25 5.50 6.25 3.27 4.75 2.50 0.05 0.50 6.06 3.00 6.75 6.75 2.75 4.25 2.50 1.75 2.08 2.85 0.74 5.80 8.35 4.38 5.44 1.47 0.125 1.25 12.50 4.50 5.00 4.25 4.50 1.74 1.25 0.75 1.75 2.25 1.00 6.00 3.00 4.25 6.25 3.50 5.50 6.25 3.41 4.75 2.50 0.05 0.50 6.31 3.25 7.00 7.00 3.00 4.50 3.00 1.875 2.23 3.06 0.87 6.01 8.46 4.68 5.64 1.53 0.125 1.75 12.50 4.50 6.00 5.00 4.50 2.01 1.50 1.00 2.25 2.50 1.25 6.00 3.50 4.25 6.50 3.75 5.50 7.00 3.54 5.00 2.50 0.05 0.50 6.56 3.50 7.00 7.25 3.00 4.50 3.00 2.00 2.37 3.25 1.00 6.18 8.67 5.12 5.69 1.58 0.125 2.00 12.50 5.00 6.50 5.00 4.50 2.30 1.75 1.25 2.75 2.75 1.75 6.25 4.00 4.50 6.75 4.00 6.00 8.00 3.58 5.25 2.50 0.05 0.50 6.56 3.50 7.00 7.50 3.00 4.50 3.00 2.125 2.48 3.40 1.11 6.27 8.67 5.47 5.69 1.59 0.125 2.25 12.50 5.00 6.50 5.00 4.50 2.56 2.00 1.50 3.00 3.00 2.25 6.50 4.50 4.75 7.00 4.25 6.50 8.50 3.59 5.25 2.50 0.05 0.50 6.56 3.50 7.00 7.50 3.00 4.50 3.00 2.25
Latin America GDP-weighted average
United Kingdom Bank rate
Bold denotes move since last GDW and forecast changes. Underline denotes policy meeting during upcoming week.
JPMorgan Chase Bank, London Jan Loeys (1-212) 834-5874 jan.loeys@jpmorgan.com
The J.P. Morgan View: Markets
A correction, not a reversal

Economics: the Japanese earthquake moves froth from 1H to 2H, but still pushes down our 2011 global growth projection. Asset allocation: Equities are in correction mode, but the solidity of the recovery, investor confidence, and only modest Japanese liquidation risk suggests the sell-off will be modest and temporary. We stay long equities to bonds. Fixed income: Money markets have gone too far in pricing out rate hikes. Short front end in Australia and Euro area. Equities: Cyclical sectors and Asian countries are more vulnerable following the Japanese earthquake. Credit: The damage in Japan has a negative near-term impact on Insurers, but it will increase pricing power in the long run. FX: USD/JPY should range between 80 and 82 for the next few months but still reach our year-end target of 79. Commodities: The disaster in Japan means a near-term increase in demand for fuel oil and LNG but a reduction in demand for crude oil and base metals. Riskier asset classes lurched down further and bonds spiked up this week on the escalating toll of the Japanese earthquake and the rising fear of a nuclear melt-down in the Fukushima reactor. The move pushed equities just into red territory and government bonds back to flat. Credit spreads are still tighter YTD with commodities at the top of the heap. The sell off pushed stock prices to 6% below last months cycle peak, confirming that we are in correction mode. This raises the issue of how deep and how long this correction will be, or whether this kills off the 2-year old rally. From todays vantage point, this depends on how much the twin oil and tsunami shocks depress growth and earnings; on investor positions and confidence; on how much Japan needs to liquidate assets to finance rebuilding; and on the condition of the Fukushima nuclear reactor. On the last, we have no insight and watch the news like everyone else. On growth, the Japanese earthquake, tsunami, and electricity blackouts will depress growth in 2Q, but this should be fully offset by rebuilding in 2H. We expect contagion through the Asian supply chain to be minimal. As a result, this pushes down our 2011 global GDP growth forecast by another 0.1%-pt, the third downward revision in a row, to
3.3%. Importantly, 2012 growth is raised by the same 0.1%-pt, so we are flat in terms of growth revisions. Besides direct economic contagion, the Japanese disaster could depress growth through its impact on asset prices and sentiment. Here we are greatly comforted as many investors we have met this week uniformly considered this weeks event as only a temporary setback for risky assets and thus a buying opportunity. We surmise that the same is true for global corporates. Many await nuclear reactor and Middle East news to put money to work. This is a consensus intention, and not yet a consensus position. The uniformity of positive views seems dangerous, but we see it more as confidence than complacency. One potential threat to markets from the Japanese earthquake is the risk of asset liquidation to finance the rebuilding of Japan. Our weekly Flows & Liquidity reviews the evidence and concludes that the impact is modest and concentrated on higher yielding currencies. We believe insurers will have to cover only about 1% of the estimated $190 billion in physical capital losses. The 1995 Kobe earthquake saw Japanese banks and households repatriate 7% and 10% respectively of their foreign assets, which would imply $60-$70 billion today. Some of this was offset by BoJ intervention to the tune of $27 billion at the time. During Kobe, the yen carry trade was in vogue and much of this was unwound then, putting upward pressure on the yen. In sum, we believe the downside for global equities from here is quite modest and temporary. The recent downgrading of growth projections invites comparisons with the 2Q-3Q correction last year when equities fell 15%. At the time, though, the recovery was less than 1-year old and on feeble footing. Today, we are seven quarters into the recovery and few companies and market participants think about a double dip. We stay solidly overweight riskier assets.
Fixed income
A turbulent week saw bonds rally strongly in response to the tragedy in Japan. That reflects both fears of a worsening of the nuclear accident, and concerns over the implications for global growth. Japanese government bonds participated in the rally, despite a spike higher in Japans CDS spreads. We estimate that the disaster is likely to raise Japanese government issuance by a modest 3 trillion (0.6% of GDP), too little to challenge our near-term bullish view on JPY duration. The experience of the Kobe earthquake suggests that Japanese banks and households may sell around $50 billion
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JPMorgan Chase Bank, London Nikolaos Panigirtzoglou (44-20) 7777-0386 nikolaos.panigirtzoglou@jpmorgan.com
Economic Research The J.P. Morgan View: Markets March 18, 2011
of foreign bonds over the next few months. That seems a modest headwind, particularly as it will be offset at least in part by the investment of FX intervention proceeds. See todays Flows and Liquidity for details. The downward momentum in growth forecasts is worrisome. Even so, we think that money markets have gone too far in pricing out rate hikes, especially in the stronger economies. Thus we recommend front end shorts in Korea (see Gochet and Lee, Paying 1yr KRW IRS, Mar 16) and also in Australia, where the market has started to price easing, whereas we expect the RBA to resume tightening in August. We retain money market shorts in the Euro area, with the ECB still set to hike next month. And we would look to reset shorts in 10-year US Treasuries at 3.30% or below. European peripherals outperformed as Euro area leaders came to a surprisingly early outline agreement. The deal creates a path to debt sustainability without restructuring by establishing the principle that the terms of liquidity support can be eased over time (see David Mackies research note in this GDW). That in turn bolsters the medium-term case for buying peripherals.
2011 global GDP growth forecasts: J.P. Morgan versus consensus

% 3.8 3.6 3.4 3.2 3.0 2.8 Jan 10 Consensus J.P. Morgan
Mar 10
May 10
Jul 10
Sep 10
Nov 10
Jan 11
Mar 11
liquidity cushions them during modest corrections as investors tend to sell their more liquid large caps. We remain neutral on EM vs. DM equities. Within EM we favour domestic-oriented stocks vs. exporters. We take profit on our Russia overweight given the downside we see in oil prices over the coming months.
Credit
Credit spreads widened for another week. The exception to broad weakness was Euro area HG corporates, the credit spreads of which were unchanged over the week. The Euro area policy agreement released last weekend was overshadowed by the Japanese crisis. In our view, the policy package is moving the region in the right direction and should continue to support Euro area credits including European banks. Although the details will not be finalized for another week, it is clear that Euro area policy makers are addressing the issues at heart, creating a path to debt sustainability without debt restructuring. In contrast, US and EM corporate credit spreads sold off on the week. Since mid-February, US credit spreads have given back 60% of their previous tightening for the year. US HG and HY spreads are now only 7bp and 32bp tighter YTD. We believe most US sectors will only see limited direct impact from the Japanese crisis. We are more worried about the indirect impact through weaker equity markets or further risk reduction. In the near term, the Insurance sector is likely to be under most pressure as damages and claims from the Japanese earthquake are evaluated. However, even for Japanese insurers which are likely to bear most of the losses, the estimated claims are very manageable compared to their reserves (see this weeks Flows & Liquidity). Moreover, long-term impacts of the Japanese earthquake are likely to be positive for Insurance companies as insurance premia rise.
Equities
Equities fell sharply earlier in the week, on fears of a nuclear catastrophe in Japan, but they rebounded later this week. The MSCI AC World index is now in negative territory YTD, down by 1% in local currency terms. It is true that technical and position indicators have turned more favorable following the 6% correction in equity markets. But uncertainty regarding the impact from the Japanese earthquake, the ongoing crisis in the MENA region, and a deterioration in economic surprises, suggest that the balance of risks is skewed to the downside for the near term. The US Economic Activity Surprise Index fell to negative territory for the first time since last September. An exceptional 6-month run of positive economic surprises has been a major driver of the rally that began last summer. This major driver is now a headwind for equity markets. Cyclical sectors and Asian countries are more vulnerable following the Japanese earthquake. Our economists calculate that Japanese exports make up over 13% of Chinese imports and nearly 12% of ASEAN imports. This comprises over 3% of Chinas GDP and nearly 8% of ASEAN GDP. Small caps are less vulnerable. Their lower
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JPMorgan Chase Bank, London Jan Loeys (1-212) 834-5874 jan.loeys@jpmorgan.com
Foreign exchange
This weeks all-time lows in USD/JPY and USD/CHF have brought the contrarians out in force, especially in light of the pending intervention. The G-7 are committing to prevent a USD/JPY collapse and contain volatility if repatriation flows and carry trade unwinds continue. They are not attempting to engineer a trend reversal, as with the 1987 Louvre Accord. Doing so would require one of two tactics: unlimited intervention to achieve an FX target, and/ or monetary tightening in the US and Europe to induce private investors to buy USD/JPY and EUR/JPY. For example, the Plaza Accord weakened the dollar because the Fed began easing in 1985 while the Bundesbank, and the BoJ were on hold. Likewise, the Louvre Accord lifted the dollar because the Fed began tightening as the Buba eased and the BoJ lifted rates only modestly. The most significant threat to the yen isnt the BoJ or JGB issuance. It is the possible erosion of Japans trade surplus, since quake damage will increase demand for some imports and limit exports of others. But even if the next few months could deliver some shocking trade figures, it is more likely USD/JPY will range between 80 and 82 for the next few months, and if the Fed remains on hold for another year, USD/JPY can reach our long-standing target of 79. We are selling 1-month 78 USD/JPY puts on expectation that a floor is intact. The fiscal issue too looks overstated as a yen risk. Even if the BoJ financed $100 billion of reconstruction bonds, this amount is small relative to Japanese GDP and the Feds asset purchases. This debt monetization also has no impact on the US-Japan cash rate spread which is more material to USD/ JPY than bond spreads. See G-7 coordinated interventiona much-needed breather (Sasaki) for a full discussion of the yen view post-quake and post-intervention.
Ten-year Government bond yields

Current United States Euro area United Kingdom Japan GBI-EM 3.28 3.19 3.51 1.21 7.03 Current 141 168 545 547 307 293 Mar 11 1.40 81 1.61 11Q2 105 1450 9450 7.00 Jun 11 1.43 80 1.61 11Q3 102 1475 9750 6.75 Jun 11 3.60 3.45 3.70 1.25 Sep 11 3.65 3.55 3.90 1.30 Dec 11 3.70 3.65 4.05 1.35 7.30 YTD Return 1.4% -0.1% 3.5% 2.7% 0.5% 1.5% Mar 12 3.90 3.75 4.10 1.40
Credit markets
US high grade (bp over UST) Euro high grade (bp over Euro gov) USD high yield (bp vs. UST) Euro high yield (bp over Euro gov) EMBIG (bp vs. UST) EM Corporates (bp vs. UST)
Foreign exchange
Current EUR/USD USD/JPY GBP/USD 1.42 81.0 1.62 Current Brent ($/bbl) Gold ($/oz) Copper($/m ton) Corn ($/Bu) 114 1417 9565 6.88 Sep 11 1.45 79 1.63 11Q4 102 1500 10000 6.10 Dec 11 1.48 78 1.68 12Q1 110 1500 9750 6.20
Commodities - quarterly average
Source: J.P. Morgan, Bloomberg, Datastream
Commodities
Japan has lost approximately 6% of its total power generation capacity due to the shutdown of the nuclear reactors, resulting in rolling power outages across Tokyo and the north. Although the Western part of the country is unaffected, due to limited power transfer capacity, the solution must come from power generation facilities in the East and given the damage to nuclear power plants, this means burning either LNG or fuel oil. Fortunately, there appears to be capacity to do this and enough global LNG supplies to cover the increased demand, although a side effect is likely higher gas prices elsewhere.
So what is the impact on commodity markets? The Japanese oil refineries that are currently offline account for about 1.6% of world crude oil demand though we only expect about half of this to remain offline for an extended period. The result is thus near-term bearish crude but bullish crude products, especially fuel oil and diesel which Japan will now need to import for power generation. Having said this, we continue to believe that the MENA crisis is a far more important driver of crude prices. Base metals will also likely suffer from the power outage. Japan accounts for about 5% of world base metal consumption, and we expect a reduction in manufacturing use while the power grid is repaired and brought up to full capacity. However, once efforts to rebuild the countrys infrastructure get underway, we should see demand for metals pick up sharply. Our Japanese economist expects this recovery in demand to start in 4Q11.
Selected recent research1 from J.P. Morgan Economics

Global
Developed world capex poised to accelerate once again, Mar 4, 2011 Oil prices will take some steam out of near-term growth, Feb 25, 2011 Easing G-4 bank lending standards reinforcing recovery, Feb 11, 2011 Surveys signal second wind for global recovery, Feb 4, 2011 Rising service sector will bolster DM economies, Jan 28, 2011 Return to sender: global recycling of Fed QE, Nov 26, 2010 Global IP slowdown appears to have reached bottom, Nov 5, 2010 Fault lines emerge amid global growth slowdown, Sept 10, 2010 G-4 banks begin to open the lending spigot, Aug 20, 2010 Global potential growth slows, but much slack remains, Aug 6, 2010 Euro FX depreciation widely spread but narrowly felt, Jul 9, 2010 Developed market consumer spending to keep expanding, Jul 2, 2010 DM policy stances move to extremes, Jun 25, 2010
Central Europe, Middle East, and Africa

Czech rate hikes: lagging ECB at first, but outrunning in 2012, Mar 11, 2011 Turkey: CBRTs new policy mix slow to combat loan growth, Feb 25, 2011 Taking stock of Russian inflation expectations, Feb 25, 2011 Romania is ready for a long-awaited cyclical upswing, Feb 18, 2011 MENA region: 2011 a year of political turmoil, Feb 18, 2011 South Africa: SARB faces delicate balancing act, Feb 4, 2011 Russia: stronger economy and still elevated inflation in 2011, Jan 28, 2011 Food inflation to climb higher in CIS countries in 1H11, Jan 28, 2011
Japan
Japan: core CPI deflation set to end in April, but temporarily, Mar 4, 2011 Japan: private sector spending to get boost from confidence, Feb 18, 2011 Japan: service sector capex likely to expand in 2011, Jan 21, 2011 Japan 2011 outlook: toward growth with modest deflation, Jan 7, 2011 Japan: no deficit reduction despite continued rise in debt, Dec 17, 2010 Japan: 4Q GDP contraction likely to be temporary, Nov 19, 2010
United States and Canada

US data brings hints of stronger export growth ahead, Mar 11, 2011 Commodities will give only temporary lift to core inflation, Mar 4, 2011 US GDW growth slips on oil in 1Q, Feb 25, 2011 Showdown at the not-OK Corral: battle over the US debt ceiling, Feb 25, 2011 US: one cheer for the fall in the unemployment rate, Feb 11, 2011 It doesnt take much to get a 25% rise in US housing starts, Jan 28, 2011 US: one gathers what another man spills, Jan 28, 2011 More austerity ahead for US state and local governments, Jan 21, 2011 US: turn on, tune in, drop out of the labor force, Jan 14, 2011 US: mind the gap or obey the speed limit?, Jan 7, 2011 Stronger US job growth would help clear the housing market, Jan 7, 2011 Canada: sluggish 2011 despite brighter US outlook, Jan 7, 2011 US: blame the textbook, not the TA, for money multiplier confusion, Dec 17, 2010 US tax compromise: more growth, higher deficit, less QE, Dec 10, 2010 Strong and broad US business expansion, with tepid job growth, Dec 3, 2010 A V-shaped recovery for US profits, Nov 26, 2010 US: the fiscal cost of central bank interventions, Nov 19, 2010 Looming fiscal issues include more than just Bush tax cuts, Nov 5, 2010 Impact of US QE2 on Canada, Nov 5, 2010 Equipment spending stands out in a lackluster US recovery, Oct 29, 2010
Non-Japan Asia and Pacific

Aussies online shopping: under-stating retail sales, not GDP, Mar 11, 2011 Singapore: to maintain current tightening path or go further?, Mar 11, 2011 Chinas export sector copes with rising wages, Mar 4, 2011 Figuring the drivers of Thailands inflation trajectory, Mar 4, 2011 Vietnam: navigating the monetary maze, Mar 4, 2011 Australias virtuous cycle of a rising terms of trade, Feb 25, 2011 Another earthquake in NZ puts rate hikes off agenda, Feb 25, 2011 Australias GDP/employment mix inflationary, Feb 18, 2011 Rising food prices: putting Australia in the EM Asia basket, Feb 11, 2011 China: tracking inflation in 2011, Feb 4, 2011 Australia: household incomes stretched as living costs rise, Feb 4, 2011 Severe floods depress Aussie GDP growth, lift inflation, Jan 7, 2011 Aussie 2011 outlook: making room for the mining boom, Dec 30, 2010 Return to trend growth in NZ slowed by deleveraging, Dec 30, 2010
Latin America
Fiscal policy back in the spotlight in Brazil, Mar 4, 2011 Latin America: policymakers in need of tightening will innovate, Jan 28, 2011 Chile: unpleasant CPI math, Jan 21, 2011 Brazil: BRL cyclically strong despite pricey valuation, Oct 1, 2010
Western Europe
The role of the time horizon in Euro area debt sustainabilitly, Mar 11, 2011 ECB about to begin a rate normalization cycle, Mar 4, 2011 The Euro areas journey to a comprehensive policy package, Feb 25, 2011 The not-so-small role of the output gap at the ECB, Feb 25, 2011 UK: quantifying MPC credibility, Feb 25, 2011 Euro area: more growth, more inflation, and higher rates, Feb 11, 2011 Uncertainty to persist beyond Euro area policy changes, Feb 4, 2011 Euro area: closing fiscal books on 2010 and opening for 2011, Feb 4, 2011 UK: a hawkish shift at the MPC, Feb 4, 2011 Agricultural commodity prices to push up Euro area inflation, Jan 21, 2011 Another busy year for Euro area policymakers, Jan 7, 2011 The three-speed Euro area recovery to continue in 2011, Dec 30, 2010
Special Reports and Global Issues

UK: why inflation is so high, and why it will come back down, Feb 11, 2011 Strong global growth ahead: eleven themes for 2011, Jan 7, 2011 US 2011 economic outlook: strength, breadth, jobs, and a rising fiscal deficit, Dec 30, 2010 A way out of the EMU fiscal crisis, Dec 16, 2010 Jobs vs. income smoothing: a comparison of US and German labor markets, Nov 15, 2010 Stuck in a low inflation rut, Oct 27, 2010
1. Research notes listed have been published in GDW; Special Reports and Global Issues are stand-alone features, but may also have appeared in some form in GDW.
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JPMorgan Chase Bank, New York Joseph Lupton (1-212) 834-5735 joseph.p.lupton@jpmorgan.com David Hensley (1-212) 834-5516 david.hensley@jpmorgan.com
Economic Research Note
Oil price and developed market retail sales volume

%3m/3m -30 -15 0 15 30 45 60 00 02 Retail sales 04 06 08 10 Brent oil (inverted) %3m/3m, saar 6.0 4.5 3.0 1.5 0.0 -1.5 -3.0
Offsetting crosscurrents for developed market consumers

Spending damped by oil price jump but supported by past equity gains and improving labor markets Major concern is a further jump in oil prices that is amplified by a decline in equity prices 2Q11 spending growth forecast of 2.4% annualized with risk distribution ranging from 1.1% to 3.9% After slowing in mid-2010 against a backdrop of rising uncertainties, consumer spending in the developed markets accelerated into year-end. However, personal outlays are once again being buffeted by a number of powerful crosscurrents that is clouding the outlook. The foremost concern is the 20% year-to-date jump in oil prices (the 2H10 rise is less of a concern as it is associated with improved growth perceptions).1 As noted in recent research, the direct impact of this move is damping global GDP growth by about 1/2%-point annualized spread over 1H11. While less visible, the rise in oil prices is being countered by strong prior gains in equity markets and improving labor markets. At present, the net effect is likely damping growth somewhat. As inflation pressures subside, however, we expect some acceleration in developed market goods spending growth even as the lift from equity gains moderates some. Coupled with a projected pickup in services spending, we expect total developed market personal outlays to accelerate into midyear. Gauging the impact of the Japan earthquake is difficult at this point as spending is both damped by the initial shock but hoarding behavior could ultimately end up spurring outlays. Short of a nuclear meltdown, we maintain the impact will be temporary in Japan and limited globally. Consequently, the key risk is that oil prices move up materially from their current highs and that the macro impact is amplified by a more damaging deterioration in confidence and financial markets. Such a dual adverse shock would more than double the direct impact of the move up in the price of oil alone. By contrast, a significant improvement in MENA conditions would generate a powerful positive feedback loop. Our outlook is for developed market goods spending growth of 2.4%(ar) in 2Q11, with a risk distribution of +/-1.5%pt. Arguably, a similar distribution applies to GDP. There are two caveats to this analysis. While the household spending response to a purchasing power hit from inflation is mechanical and quickly propogated to spending behav1. The even more impressive surge in agriculture prices is more of a concern for the EM outlook and less so for developed market spending, where passthrough to consumer food prices is limited and the share of food in the consumer basket is also smaller.
Consumer spending fundamentals, developed markets

%3m/3m, saar (fcst Mar 11 to Jun 11) 6 3 0 -3 -6 CPI Equity prices %3m/3m 20 10 0 -10 -20
2007
2008
2009
2010
2011
ior, the response to moves in equity prices tends to be more gradual. While beyond the scope of our analysis,wealthier households may be more inclined to smooth through wealth effects if they are viewed as temporary even as more liquidity-constrained households react to fuel prices. A second caveat is that, for lack of data, we use changes in the unemployment rate as a proxy for labor income. While adequate at lower frequencies, monthly unemployment rate moves are affected by the supply of as well as the demand for labor. Thus, a sticky unemployment rate against improving labor markets may understate income growth.
Fundamentals support modest gains in 2Q

To gauge the fundamental support to consumer spending, we estimate a model of retail sales volumes. The model accounts for CPI inflation (to capture the purchasing power of labor income), changes in the unemployment rate (to proxy growth in labor income), and equity and house prices (to account for the wealth effect). The model explains retail spending well, predicting almost two-thirds of the variation. The fit deteriorated significantly in 2H08 (the model is estimated from 1998m1 through 2008m8 to avoid overfitting during the global financial crisis). However, while some have viewed this error as a break in behavior that will persist in the recovery, we maintain the error reflects a collapse in consumer confidence and a breakdown in credit markets, both of which are absent from the model. Consistent with our view, spending rebounded smartly in the recovery and has tracked the model forecast well.
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JPMorgan Chase Bank, New York Joseph Lupton (1-212) 834-5735 joseph.p.lupton@jpmorgan.com David Hensley (1-212) 834-5516 david.hensley@jpmorgan.com
Economic Research Offsetting crosscurrents for developed market consumers March 18, 2011
In general, a 1%-pt (annualized) rise in inflation damps spending growth by 0.5%-pt annualized, while a 0.5%-pt move down in the unemployment rate generates enough income to lift spending growth by about 2%-pt. A 10% rise in equity prices in a given quarter (40% annualized) boosts annualized goods spending growth by 1.2%-pt. Movements in house prices have a considerably larger impact on spending behavior, according to the model estimates. Based on the model estimates, spending growth is currently being buffeted by offsetting fundamentals. The sharp jump in oil prices that is pushing up consumer price inflation is slowing spending growth by about 3/4%-pt relative to its historical mean. A slide in house prices over the past year (primarily in the US) is subtracting a similar amount. However, these drags are offset by a strong prior gains in equity prices and improvements in labor markets. It is unclear whether the improvement in the unemployment rate in the US is reflecting increased labor income rather than an improving participation rate. This clearly poses a downside risk to the model outlook, as the change in the unemployment rate is currently the largest support for spending growth according to the model estimate. At the same time, the model is missing the support to disposable income from the US tax cut. These two errors are thus potentially offsetting. Looking forward, spending growth should continue to post solid gains through in 2Q11. A stabilization in oil prices will generate a sharp swing in inflation from being a large drag to a large support. This will be offset by more modest gains in equity prices. On net, the fundamentals point to solid spending gains through to midyear. Our official J.P. Morgan forecast generally tracks this, although with somewhat more initial drag from energy prices and a somewhat larger acceleration from improvements in labor income not adquately captured in the model.
Regression of retail sales volume (%3m/3m,saar); Sample 1999m1 to 2008m8 Coefficient t-statistic Constant 3.36 7.82 CPI (3m/3m,saar) -0.50 -3.76 Unemployment rate (3m chg, 3mav) -3.96 -2.88 Equity prices (3m/3m,saar) 0.03 3.42 Home prices (3m/3m,saar) 0.11 3.73 Spending (3m/3m,saar; 3m lag) -0.18 -2.16 0.62 Adj. R-squared
Model of developed market consumer goods spending
Retail sales volume, developed market

%3m/3m, saar (fcst begins Feb 2011) 6.0 4.5 3.0 1.5 0.0 -1.5 -3.0 01 03 05 07 09 11 Model fit Actual & J.P. Morgan fcst
Contributions to retal sales volume growth, developed markets

%-pt contrib. to %3m/3m chg, dev. from mean; fcst begins Feb 2011 1.5 1.0 0.5 0.0 -0.5 -1.0 2010 House prices 2011
Apr 11 May 11 2.0 -9.0 5.0 3.0 3.4 2.6 2.0 2.7 2.1 3.0 2.0 -1.0 4.0 2.0 2.8 1.2 2.8 2.4 1.3 3.2 Jun 11 2.0 0.0 3.0 1.2 2.3 0.1 3.3 2.8 1.1 3.9
Unemp rate Equities CPI
Alternative simulations, developed markets

Equity prices (%m/m) Brent holds at $115/bbl (baseline) Brent jumps to $135/bbl Brent falls to $95/bbl CPI (%3m/3m,saar) Brent holds at $115/bbl (baseline) Brent jumps to $135/bbl Brent falls to $95/bbl Retail sales volume (%3m/3m,saar) J.P. Morgan forecast Model: Brent holds $115/bbl (baseline) Model: Brent jumps $135/bbl Model: Brent falls to $95/bbl Mar 11 -2.4 3.5 1.8
Gauging the risks

Our baseline assumes that oil prices stabilize near their current levels of $115/bbl (Brent), equity prices recovery this years high by June (a 6% rise), and inflation slows sharply to 1.2%(3m/3m saar). The risks around this outlook are two sided. On the downside, we consider the impact of a jump in oil prices to $135/bbl. However, rather than consider only the independent purchasing power hit from this scenario, we also consider the dual impact of a hit to risk appetites that result in a 10% decline in equities. In this case, spending growth is damped to a tepid 1.1% annualized gain in 2Q11, on par with the slowest gains seen in the 2001 recession. Alternatively, we consider the upside scenario whereby oil prices decline to $95/bbl. We complement this with a 12% rise in equity prices by midyear. In this case,
goods spending growth jumps to 3.9% annualized in 2Q11, near the boomy gains seen late last year. Our risk analysis implies developed market goods spending in 2Q11 could range from 1.1% to 3.9% annualized, with a baseline of 2.5%. This roughly -/+1.5%-pt band also provides a reasonable guide for the risk distribution around developed market GDP growth.
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JPMorgan Chase Bank NA, New York David Hensley (1-212) 834-5516 david.hensley@jpmorgan.com Joseph Lupton (1-212) 834-5735 joseph.p.lupton@jpmorgan.com
Global final goods expenditures (J.P. Morgan proxy) vs. IP

%3m, saar 16 12 8 4 0 Jan 10 Final goods sales IP
Keep an eye on the global inventory cycle

Recovery in business inventory growth will boost global growth for a few more months Inventories will not be a problem unless final demand growth turns weak Despite the unprecedented array of shocks buffeting the global economy, we are maintaining our forecast for above-trend global growth over the remainder of the year. This assessment is based on two premises. The first is that the shocks hitting the economy will prove to be both limited and temporary, and that the foundations of the expansion are solid. The second is that the underlying trajectory of growth was quite strong as these events unfolded. This strong global growth trajectory owes partly to a solid advance in the final demand for goods and services as the purchasing power squeeze from higher commodity prices is being cushioned by a strengthening labor market, prior large gains in equity prices, and a sizable tax cut in the US (see Offsetting crosscurrents for developed market consumers, in this GDW). At the same time, global growth is getting a powerful additional lift from an increase in global stockbuilding. Indeed, global factory output has surged at an annualized 10% pace in the 3-months through January, well above the pace of final goods sales. This additional growth impetus from the inventory cycle is expected to help offset some near-term softening in final demand, principally from the oil shock, keeping growth above trend. The restocking phase is not expected to last beyond the next few months, however. If final demand growth rebounds into midyear as expected, then any slowing in IP growth will be limited and GDP growth will remain above trend, in line with our forecast. On the other hand, if growth in final goods demand weakens significantly, this will likely prompt a production adjustment that will weigh on global growth in 2H11. These global growth dynamics appear to apply to a broad range of countries, including the United States. The key exception is Japan, where the natural disaster will impart a sharply different pattern to nearterm output and demand. More on this below.
Apr 10
Jul 10
Oct 10
Jan 11
Producers' inventories
%3m/3m, saar; US is total M&T 30 20 10 0 -10 2009 Korea Taiwan Japan
US 2010
Japan
Developed economiesinventory contribution to GDP growth

%-pt contribution to q/q, saar growth rate 3 2 1 0 -1 -2 2007 2008 2009 2010 2011
Ratio of inventories to shipments

Index, Jan 07=100; Asia is mfg, US is total M&T 140
120
Japan US Taiwan 2007 2008 2009 2010 Korea 2011
100
80
Inventory boost will wane by midyear

The inventory cycle has played a starring role in the economic recovery, and it is destined to remain an important player in the months to come. The inventory cycle made a major contribution to economic growth up through the
middle of last year, as companies shifted stance from liquidating stocks to accumulating them in line with the growth of sales. Companies then slammed the brake on inventory growth in the latter half of 2010, perhaps due to the uncertainty caused by the European debt crisis. Having overre-
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JPMorgan Chase Bank NA, New York David Hensley (1-212) 834-5516 david.hensley@jpmorgan.com Joseph Lupton (1-212) 834-5735 joseph.p.lupton@jpmorgan.com
Economic Research Keep an eye on the global inventory cycle March 18, 2011
acted at that time, companies are now scrambling to realign the growth of stocks with sales once again. It is not possible to observe directly the global inventory cycle in a timely way. Only the United States and a handful of Asian countries report monthly data on inventories. But we can infer the contour of global inventory growth more broadly from the variations in growth in global IP and our final goods sales proxy, which combines retail sales and capital goods shipments. As seen in the first exhibit on the previous page, global IP growth nearly halted in 3Q10 but since then has returned to a robust pace. The growth of final goods sales has been more moderate and steadier. Putting these observations together, the implication is that inventory growth slowed sharply in the second half of last year and then quickened once again as firms moved to realign the growth of stocks with sales. This impression of the global inventory cycle is borne out in monthly data for the US and Asia, and in the NIPA-based measures of inventory contributions to GDP growth in the developed economies (second and third charts, previous page). Based on available data, we are reasonably confident that the level of inventories is lean in relation to sales (fourth chart, previous page). Nonetheless, the current pace of global IP growth cannot be maintained for long or else the rate of inventory growth will become excessive. As noted above, with the restocking cycle boosting both IP and GDP growth, this can compensate for some near-term softening in final demand growth in response to the oil shock and the uncertainty generated by the natural disaster in Japan. What is critical is that this softening in demand does not become excessive. Our modeling shows that the fundamental supports for consumption growth are solid, based in the improving labor market and the impressive gain in equity prices over the past seven months. A similar picture holds for corporate spending on capex. As the purchasing power squeeze from higher inflation dissipates into midyear (based on an assumption of stable to falling oil prices), final demand growthfor both goods and servicesshould strengthen. The pickup in final goods spending will cushion IP growth as the restocking phase is completed. This development, along with faster growth in services, will keep GDP growth on an above-trend pace. On the other hand, should final demand growth weaken meaningfully, not only would 2Q growth disappoint, but the prospects for second-half growth would shift downward as well. This likely would lead to some overshooting in the rate of inventory growth, necessitating a production adjustment that would spill over into the third quarter.
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Global PMI finished goods inventory index (excludes US)

DI, sa 51 50 49 48 47 46 45 98 00 02 04 06 08 10 2004-07 avg
Retail sales volume, developed market

%3m/3m, saar (fcst begins Feb 2011) 6.0 4.5 3.0 1.5 0.0 -1.5 -3.0 01 03 05 07 09 11 Model fit Actual & J.P. Morgan fcst
%3m, saar; both scales 16 Global ex Japan 36 27 18 9 0 Japan 0 -9 2010 2011 -18
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Japan will diverge from the global pattern

The natural disaster means that Japan is set to diverge from this global path. Industrial output is set to fall sharply this month, in all likelihood by more than the 3%m/m drop that occurred during the month of the January 1995 Kobe earthquake. The level of output should then begin to recover as manufacturers in unaffected areas boost output and firms in the affected region gradually restart idled production lines. The swings are likely to be quite large, which will distort our global IP numbers. Thus, it will be important to track these data separately so as not to lose sight of the underlying dynamics in the majority of the world economy.
JPMorgan Chase Bank, New York Michael Feroli (1-212) 834-5523 michael.e.feroli@jpmorgan.com
Fed UST holdings as % of outstanding

%, assuming QE2 completed Forecast 25 20 15 10 5 Passive run-off 52 57 62 67 72 77 82 87 92 97 02 07 12 No run-off
New Fed sequence is mostly the same as the old one

Asset sales still likely to come only after the first hike in the overnight policy rate Halting reinvestment of maturing assets could become the first step in the long road to the exit Eventual assets sales still on the agenda The minutes to the April 2010 FOMC meeting laid out a sequence for the Fed to exit from extraordinary monetary policy accommodation. That sequence called for the Fed to sell securities only after it had begun raising overnight interest rates. Shortly after that meeting, economic growth slowed materially and discussion of exit strategies was put on the back burner. Subsequently, the Fed changed policy in two ways: first, in August it began reinvesting the proceeds of prepaying MBS back into Treasury securities, and second, in November it put itself on course to buy another $600 billion of Treasury securities, on top of the amount bought from reinvesting MBS proceeds. We dont believe these two actions will change the likely exit sequence whereby asset sales occur only after the first hike in overnight interest rates. The principle concern that had led the majority of the committee to its conclusion last spring was that asset sales could potentially be disruptive. While the whole point of tightening policy is, in some sense, to be disruptive, policymakers were wary that the degree of financial tightening caused by asset sales could not be well-calibrated, and for that reason, tightening should be done primarily through the more familiar tool of raising the overnight interest rate. The actions taken last summer and fall result in the Fed having a larger balance sheet than was anticipated when the committee mostly agreed on an exit sequence last spring. This means the process of reducing the size of the Feds balance sheet will take longer and so, one could argue, should begin sooner. However, the concern expressed about the disruptive effects of asset sales still seems to hold. If anything, the larger portfolio the Fed now holds implies that any step to sell securities could be even more disruptive and harder to calibrate than was the case last spring. For this reason, we believe the rate hike-asset sale sequence laid out last spring remains the preferred path. The August-November policy actions of 2010 do, however, add another step to the exit process: halting the reinvest-
ment of maturing assets. If the US economy gets past current economic worries and returns to above-trend growth, we think this step could occur as soon as the second half of this year. It will likely involve two smaller steps: first, halting reinvestment of prepaying MBS, and second, halting reinvestment of maturing Treasuries. The first step would be consistent with the long-term objective of returning to an allTreasuries balance sheet, whereas the second step would be consistent with the long-term objective of reducing the Feds balance sheet over time to a more normal size (i.e., around the amount of currency demanded by the public).
LSAP-adjusted Taylor rules?

Arguably one other effect of the decision to purchase more assets last November was to bring forward the timetable by which the Fed finally raises overnight interest rates. This certainly seems like a reasonable conclusion: LSAP2 eased financial conditions and probably hastened the eventual return to full employment and of core inflation closer to 2%. Of course, other things have happened since last spring as well: business has exhibited ongoing caution regarding hiring, and more recently consumers have been hit by higher gasoline prices. So all else equal, LSAPs do pull forward eventual tightening, but unfortunately all else is not equal. For this reason we think Fed asset purchases are not divorced from the timing of rate hikes, but this interdependence is complex. We would be quite cautious about approaches such as adjusting Taylor rules for LSAPs and presuming that this would give a prescription for when overnight rates should be increased. Translating the tightening or easing from asset sales or purchases into an equivalent degree of short rate tightening or easing is an appealing approach for combining balance sheet policy with conventional monetary policy. Indeed, some Fed policymakers have spoken about asset purchases in a similar manner. For example, Bernanke noted that $600 billion of purchases has eased financial conditions equivalent to about a 75bp fed
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JPMorgan Chase Bank, New York Michael Feroli (1-212) 834-5523 michael.e.feroli@jpmorgan.com
Economic Research New Fed sequence is mostly the same as the old one March 18, 2011
funds rate cut, though by Bernankes own admission, that was a very rough estimate. The original Taylor rule was descriptive and meant to match how Fed policy was set in the 1987-1992 period. Subsequently, some researchers found that variants of Taylor rules were optimal in certain economic models, and so could also be prescriptive. However, those classes of models were usually quite restrictive, such as assuming policy was not at the zero bound, or that the central bank only tried to influence the short end of the curve. (In fact, very few optimal policy models even incorporate multi-period interest rates.) When those restrictive assumptions dont hold, Taylor rules no longer necessarily represent optimal policy. As such, its not clear what an LSAP-adjusted Taylor rule tells us.
Fed securities holdings and currency outstanding

$ bn 2500 2000 1500 1000 500 0 90 95 00 05 10 Currency Securities
Asset sales
It probably remains the case that the Fed will sell assets after beginning to raise the overnight interest rate. But we do not see this need to sell assets as being motivated by a desire to remove excess stimulus from the economy. Rather, there appears to be a desire to return to a system in which the price of reserves is set in the market (i.e., reserves are scarce, and the Feds balance sheet is about the size of currency in the hands of the public). To see why the size of the balance sheet may not represent excessive long-term stimulus, it is useful to recall that the way the Fed thinks about the impact of asset purchases on long-term interest rates is through the so-called portfolio balance effect. In this view, when the Fed buys longer duration Treasury securities and removes that supply from the market, the price of those securities goes up and the yield goes down (even though there is not necessarily any change in the expected path of short rates). In this framework, the overall size of the market clearly matters. For example, the $600 billion to be purchased under LSAP2 should not necessarily be seen as a more meaningful amount than the 200 billion purchased by the Bank of England under their Asset Purchase Facility, as the Feds $600 billion of intended purchases amounts to less than 7% of marketable US Treasury securities outstanding, whereas the 200 billion purchased by the BoE amounted to nearly a quarter of the outstanding stock of gilts. (Related, and not surprisingly, the per dollar impact of Fed asset purchases is generally estimated to be less than the dollar equivalent per pound impact of BoE asset purchases.) Looking at how much Treasury securities the Fed balance sheet has removed from the market, even after the end of the current $600 billion purchase plan, the share of the
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overall market held by the Fed will be well below its historical highs and basically just back to where it was before the crisis began.1 This is so for two reasons: first, the Fed sold some of its Treasuries during the early phase of the credit crisis in order to make room on its balance sheet for liquidity support programs, and second and more importantly, the amount of Treasury securities outstanding has soared in the past few years. If the Fed balance sheet has only removed a normal share of duration from the market, this might suggest that asset purchases have not exerted much of a portfolio balance effect, and hence have not had much impact on lowering long rates. However, one should keep in mind Chairman Bernankes qualifier that asset purchases should have lowered long rates relative to where they otherwise would have been. The massive issuance of Treasury securities has required the market to absorb significant duration risk, which could have otherwise put upward pressure on long rates. Arguably, the Fed has partially averted that outcome. Even though the portfolio balance effect does not indicate that the Fed balance sheet is providing excessive stimulus, there is still a consensus on the FOMC that reducing the balance sheet over time is appropriate. It is important to note that this does not reflect a concernat least for most committee membersthat large amounts of excess reserves are inherently inflationary. Rather, it appears the committee would prefer to move toward a market for reserves that looks more like the corridor systemas in the Euro arearather than a floor systemas in New Zealand. (For more on the distinction, see The Feds road home, Mar 2, 2010.) Reducing Fed assets and reserve liabilities appears to be the preferred long-term route for moving to a corridor system.
1. The Fed has also bought over a trillion dollars of mortgage-backed securities, which arguably should be added to the tally of how much interest rate risk the Fed has removed from the market. Unlike government debt, when a mortgage is issued, the mortgage buyer takes on interest rate risk, while the mortgaged homeowner sheds interest rate risk. For this reason, measuring the degree to which private credit adds interest rate risk to the private sector is problematic.
JPMorgan Chase Bank, London Raphael Brun-Aguerre (44-20) 7777-0282 raphael.x.brun-aguerre@jpmorgan.com
Euro area HICP inflation

%oya 5 4 3 2 1 0 -1 2005 2006 2007 2008 2009 2010 2011 Headline Core (ex. food, alcohol, tobacco, energy, and admin. prices)
Euro area data point to a drift higher in core inflation

Direct measures of slack point to gradual rise in core inflation... ... as do survey measures of pricing intentions Core inflation to reach 1.4%oya by year-end Euro area core inflationwhich excludes food, alcohol, tobacco, energy, and administered pricestroughed at 0.7%oya at the start of last year and drifted up to 1.0% last summer. Since then, it has remained steady around this level. However, this stability is unlikely to last. Direct measures of slack have tightened to such an extent that our models point to a gradual rise in core inflation in the second half of the year. Moreover, survey measures of pricing intentions point in the same direction. It now looks like core inflation will rise modestly to 1.4%oya by year-end, and that this upward trend will continue in 2012.
Phillips Curve core inflation forecasts

%oy a, min-max band and av erage forecast 2.5 1.5 0.5 -0.5 -1.5 05 06 07 07 Actual 05 06 08 08 09 09 10 10 11 11 Average forecast
The message from slack

We believe that the most important driver of core inflation is the amount of slack in the economy. Unfortunately, it is hard to measure how much there is. Broadly speaking, there are two ways to measure slack. First, output and unemployment rate gap measures can be estimated, where the current state of the economy (as measured by production or the labor market) is compared to some equilibrium level. Using a simple Hodrick-Prescott filter, our analysis suggests the current output gap is limited, while the amount of slack coming from the labor market is still significant. Second, direct measures of resource use from the surveys can be used to gauge how far the economy is from an equilibrium. The European Commission survey provides such measures for the manufacturing sector, which suggest that slack is quite limited: capacity utilization is now close to its long run pre-recession average; equipment shortages are close to their previous cyclical peak; and labor shortages are now above their long run pre-recession average. A key point is that the amount slack extracted from these measures, gap measures and surveys, can differ widely. We have a suite of simple Phillips Curve models which use direct and indirect measures of slack to predict core inflation. In these models, the four quarter change in core inflation is predicted using one of the slack variables (lagged two quarters) and an exchange rate term (lagged three quar-
Phillips Curve core inflation predictions for 3Q11

Capu Change in core infl. (%oya) from 3Q10 Contributions: Slack, t-2 NEER, t-3 Core infl. 3Q11 (%oya) -0.52 0.07 0.53 0.64 0.19 1.83 0.05 0.11 1.18 -0.01 0.11 1.07 -0.26 0.19 0.94 -0.48 Eq. short. 0.82 Lab. short 0.18 GDP gap UR gap 0.07 -0.07
The contributions might not add up exactly to the 4-quarter change in core inflation because the constant is not included.
PMI ouput price

Diffusion index, sa 65 60 55 50 45 40 35 00 02 04 06 08 10 Services Manufacturing
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JPMorgan Chase Bank, London Raphael Brun-Aguerre (44-20) 7777-0282 raphael.x.brun-aguerre@jpmorgan.com
Economic Research Euro area data point to higher core inflation March 18, 2011
ters). These models point to a gradual increase in core inflation. However, there is a larger than normal degree of uncertainty around these forecasts, for two reasons. First, the wide dispersion of slack across measures gives very different core inflation predictions (see table on the preceding page). And second, core inflation has actually been running ahead of almost all of these models over the past year or so, which suggests a greater degree of pricing power than the measures of slack would indicate.
EC survey pricing intentions

%balance, sa 30 20 10 0 -10 -20 04 05 06 07 08 09 10 Services Retail Industry
The message from price surveys

Given the heightened uncertainty around the forecasts generated by our slack models, it is worth looking at other evidence to see whether the prediction of the gradual rise in core inflation is corroborated. Thus, to complement our Phillips Curve analysis, we have looked at the pricing components of the PMI and European Commission surveys. These surveys have received considerable attention recently, as the surge in oil and agricultural commodity prices has been reflected not only in the input price components but also in the output price components. Output prices in manufacturing are close to the highest level seen since 1985, and output prices in services are close to the previous cyclical peak. Our analysis finds these surveys to be good predictors of core inflation three quarters ahead. We use these surveys in simple univariate models to forecast core inflation over the coming quarters. These models suggest that by the third quarter of this year core inflation will be in a range between 1.4%oya and 1.6%oya, which corroborates the message from the slack models. However, in contrast to the slack models, actual core inflation has recently been running slightly below where the pricing intentions models predicted it would be.
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PMI composite output price (lagged 3 quarters) and core inflation

Diffusion index, sa 65 60 55 50 45 40 35 00 02 04 06 08 10 Composite PMI Core inflation ex. admin. prices
% oya 2.3 1.8 1.3 0.8 0.3
% balance, sa 30 20 10 0 -10
Retail pricing intentions (lagged 3 quarters) and core inflation

Core inflation ex. admin. prices
% oya 2.5 2.0 1.5
EC survey
1.0 0.5
Core inflation to rise, but only modestly

Both measures of slack and surveys of pricing intentions are sending a similar message: core inflation is set to rise in the coming quarters. The average forecast coming from the slack analysis suggests that core inflation will reach 1.1%oya in the third quarter. However, given recent errors, the outcome is likely to be higher than this. Meanwhile, the average forecast coming from the price survey analysis suggests that core inflation will reach 1.5%oya in the third quarter. However, given recent errors, the outcome is likely to be lower. We assume the middle of this range by the end of the third quarter. Looking beyond that point, we expect the uptrend to continue, to 1.4%oya at year-end, and then higher still in 2012.
-20 00 02 04 06 08 10
Core inflation models and predictions using surveys

PMI manuf. Coefficient t-stat R-square Predictions: 2Q11 3Q11 0.04 (10.4) 0.55 1.51 1.57 PMI serv. 0.07 (13.9) 0.67 1.39 1.41 PMI EC Ind. comp. 0.06 (13.0) 0.66 1.42 1.46 0.03 (10.0) 0.51 1.52 1.59 EC serv. 0.03 (11.1) 0.59 1.36 1.41 EC retail. 0.02 (10.9) 0.56 1.40 1.46 Average 1.43 1.48
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JPMorgan Chase Bank, London David Mackie (44-20) 7325-5040 david.mackie@jpmorgan.com
Gross debt under alternative interest rate subsidies

% of GDP 2015 Scen 1 Esp Grc Ire Prt 84 161 135 95 Scen 2 83 151 129 95 Scen 3 79 142 121 89 Scen 1 89 184 155 95 2020 Scen 2 87 153 136 95 Scen 3 78 125 113 80
Euro area delivers a good comprehensive policy package

Terms and conditions of liquidity support now made conditional on behavior of debtor sovereign Creating a path to debt sustainability without debt restructuring Exit journey still long and uncertain Although the comprehensive policy package will not be finalized until March 24-25, enough has now been agreed to understand what policymakers are seeking to achieve. In our view, the package is about as good as could have reasonably been expected. By making it clear that the terms and conditions of liquidity support are open to negotiation, policymakers have created a path down which the region can travel to exit the current sovereign crisis without disruptive debt restructurings. We have argued that the exit plan that was put on the table last yearwhich we would describe as huge amounts of fiscal consolidation around the periphery and liquidity support at a borrowing rate of 350bp over that in Germany didnt really help to exit the crisis. It simply enabled the peripheral sovereigns to stabilize their debt-to-GDP ratios at close to the peaks. If this exit plan had remained unchanged, then debt restructurings would have been inevitable at some point. We have also argued that although the region does want to establish debt restructuring as the ultimate fiscal end gamethis is clear in the way the ESM is being structuredpolicymakers only want to use this as a last resort. Given the political, financial, and macroeconomic disruptions caused by sovereign debt restructuring, the region would like to exit the current crisis in some other way. This is only possible if fiscal consolidation around the periphery is combined with very low-cost liquidity support, and possibly other measures such as liability management and asset sales. By indicating that the terms and conditions of liquidity support are negotiable, and are conditional on the behavior of the debtor sovereign (as indicated by the change for Greece but not Ireland), policymakers have provided an incentive to the debtor sovereigns to continue with fiscal consolidation and have created a mechanism that makes it possible that these consolidations can actually help sovereigns re-
Note: Scenario 1 assumes borrowing rates are capped at 6% through 2012 but then move to market rates thereafter. Scenario 2 assumes market rates are capped at 350bp above the German borrowing cost from now through 2020. Scenario 3 assumes market rates are capped at 100bp above the German borrowing cost from now through 2020. See "A way out of the EMU fiscal crisis," Global Issues, December 16, 2010.
turn to debt sustainability without debt restructuring. Borrowing costs still remain too high, but given the conditional nature of what was agreed last weekend, we think it is reasonable to expect further improvements in the terms and conditions of liquidity support over time. A journey back to debt sustainability without debt restructuring may ultimately be unsuccessful, either because the debtor sovereigns do not put in a good faith effort in terms of fiscal consolidation, or because nominal economic growth turns out to be too weak for too long, or because the rest of the region fails to give sufficiently concessional borrowing costs on the liquidity support. But, the path exists now in a way that it didnt exist a week ago.
The context for the policy package

In order to gauge whether the comprehensive policy package is reasonable, we need a proper understanding of the nature of the sovereign crisis. Peripheral sovereigns in the Euro area have both an income problem (large primary deficits) and a balance sheet problem (large amounts of outstanding debt). A sovereign income problem can only be resolved in one of three ways: fiscal consolidation to close the primary deficit, an ongoing permanent fiscal transfer from a rich neighbor, or a permanent increase in money supply growth which eventually generates an inflation tax. Given that the latter two are extremely unlikely, there is really no alternative to significant fiscal austerity around the periphery. It is important to stress that default and debt restructuring do not help to resolve an income problem. What can be done to help is that generous liquidity support can be provided so that the fiscal consolidations take place over a reasonable horizon which limits the macroeconomic consequences. Meanwhile, a sovereign balance sheet problem can be resolved in one of four ways: fiscal consolidation to generate a primary surplus, a debt restructuring, a one-off lump-sum
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JPMorgan Chase Bank, London David Mackie (44-20) 7325-5040 david.mackie@jpmorgan.com
Economic Research Euro area delivers a good comprehensive policy package March 18, 2011
fiscal transfer from a rich neighbor, or a one-off increase in the money supply and the price level. As far as the Euro area is concerned, the latter two are not in the cards, which leaves the resolution of the balance sheet problems lying between further fiscal consolidation and debt restructuring. In this context, it was unreasonable to expect the comprehensive policy package to fully resolve the sovereign crisis. Given the size of the primary deficits and the reluctance to engage in debt restructuring, it will take time to exit the current crisis. The best that could have been expected from the policy package was a set of measures which contained the crisis in the near term, created a path whereby the region could exit the current crisis in the medium term without debt restructuring, and laid out a set of governance reforms to help prevent future crises. In our view, this is what policymakers have delivered.
agreement of Euro area member states. Operational decisions can be changed at any point in time. Thus, the terms and conditions of liquidity support can be changed further; low-cost loans could be made to enable liability management exercises to be conducted; and the authority to purchase secondary market debt could be given. At the Ecofin meeting on Tuesday, finance ministers agreed on the package of reforms to the Stability and Growth Pact and the new macroeconomic surveillance framework, which essentially implements the recommendation of the European Council Task Force (for details of the governance framework see The Euro areas journey to a comprehensive policy package, GDW, Feb 25, 2011). Euro area leaders agreed on the broad contours of the competitiveness pact (it is now called the pact for the euro). This is essentially about boosting growth potential in the region, motivated by the idea that competitiveness is essential to help the EU grow faster and more sustainably in the medium and long term, to produce higher levels of income for citizens, and to preserve our social models. It covers four areas: improving competitiveness (through inter alia a better alignment of wages and productivity, and through higher productivity); boosting employment (through increased flexibility and tax reforms); improving the medium-term sustainability of public finances (through inter alia aligning retirement ages with demographics); and reinforcing financial stability (through legislation on banking resolution and regular bank stress tests).
The content of the policy package

The comprehensive policy package was meant to contain five elements: an increase in the size and a broadening of the scope of the EFSF (which will provide liquidity support out to mid-2013); more details on the operation of the ESM (which will provide liquidity support beyond mid-2013); a reformed Stability and Growth Pact (which will guide fiscal policy across the region); a new macroeconomic surveillance framework (which will guide macro prudential and structural policies to limit intraregional imbalances); and a competitiveness pact (which will guide all policies toward lifting growth potential in the region). Regarding the EFSF, Euro area leaders agreed that its lending capacity will be increased to 440 billion, although they did not specify how this would be achieved. In terms of additional functionality, only one thing was agreed: allowing the EFSF to intervene in the primary debt markets. This is an alternative to providing liquidity loans and a way of helping to ease sovereigns back into the capital markets after a spell in the liquidity hospital. The responsibility of secondary market purchases remains with the ECB. Regarding the ESM, it was confirmed that it will have an effective lending capacity of 500 billion and that this will be ensured by a mix between paid-in capital, callable capital, and guarantees. It will also have the power to purchase debt in primary markets, but not in secondary markets. An important point to stress is that the functionality of both the EFSF and the ESM are not set in stone by this policy announcement. The functionality of these two liquidity providing vehicles is determined by an intergovernmental
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Conclusions and implications for the ECB

There should be no doubt that Euro area leaders are committed to ensuring the survival of the monetary union. On the question of whether sovereign debt restructuring is going to occur, the comprehensive policy package was never going to be able to fully resolve that issue. Whether or not any of the peripheral sovereigns ends up restructuring their debt depends on both the extent of the fiscal effort it is willing to engage in and the extent to which the rest of the region is willing to subsidize the liquidity support. Each of these is still unclear, but the region has now sent a powerful signal that if the debtor sovereign puts in a good faith effort, then debt restructuring could well be avoided In our view, the fiscal authorities are now doing enough to enable the ECB to set monetary policy on the basis of macro conditions in the region as a whole. On the Securities Markets Program, the ECB will continue with its current policy: stepping in when absolutely necessary but not otherwise, and limiting the purchases as much as possible.
JPMorgan Securities Japan Co., Ltd. Masaaki Kanno (81-3) 6736-1166 masaaki.kanno@jpmorgan.com Masamichi Adachi (81-3) 6736-1172 masamichi.x.adachi@jpmorgan.com Miwako Nakamura (81-3) 6736-1167 miwako.nakamura@jpmorgan.com
Northeast Japan and Tokyo metropolitan area

Iwate
Japan to recover from the disaster, but will take time

2Q GDP to contract from hit to production, but economy to recover in 2H on public works as in the past More than 10tn supplementary budged expected, financed by tax hike, spending cut, and JGB issuance BoJ started QE2 with bank reserves to rise to historical high; coordinated intervention unsterilized Remaining concern is problems at Fukushima nuclear power plant, still facing risk of reactor core meltdown Japan had four unprecedentedly large disasters in a week: an earthquake, tsunami, partial power outage (in eastern part of Japan), and the nuclear power plant accident, which is the most serious problem at the moment. A massive earthquake struck Japans northeast coast on Friday, March 11. It was not only the largest in the modern history, but the unprecedentedly large tsunami has significantly exacerbated the damage. The last weeks 9.0 magnitude earthquake is said to have 300 times more energy than the 1995 Kobe earthquake, or more than 100 times more than the 2008 Sichuan quake in China. The casualties from last weeks earthquake, which are still increasing day by day, are expected to rise to far above ten thousand, mostly caused by the tsunami, rather than the earthquake itself. While the damage from the earthquake on the capital stock remains to be seen, we estimate that it should be at least 15 trillion (approximately 3% of GDP), 50% larger than that associated with the Kobe earthquakes 9.9 trillion, as the quake struck a much broader area, ranging from Hokkaido to the Tokyo metropolitan area, although the main damage was concentrated in three prefectures, Iwate, Miyagi, and Fukushima. Manufacturing output in these three prefectures is approximately 4% of the nations while output of their agriculture/forestry/fishing industries is about 6%. To be sure, the loss in capital and peoples lives will reduce demand and production in the damaged areas in the short run. But history shows that the loss of output tends to be more than offset by the subsequent additional spending on public works. In all, we revised down 1Q GDP modestly and now look for a contraction of GDP in 2Q, but the economy is expected to recover in 3Q and jump in 4Q due to a large public works spending. As a result, our 2011 GDP forecast was revised down to 0.9%oya from 1.7%, but 2012 was revised up to 2.8% from 1.8%.
Miyagi the main shock Nuclear Power Plant Fukushim a 94km 227km Tokyo
Hypocenter of
Real GDP produced in earthquake-impacted prefectures

FY 2008 yen trillion for GDP, thousands for population Iwate Miyagi Fuku -shima Overall 4.9 9.0 9.0 Agriculture, forestry 0.2 0.1 0.2 & fishing Mining 1.0 1.4 2.8 & manufacturing Private services 2.8 6.0 4.9 Other 1.1 1.7 1.3 Population 1352 2340 2052
Note: Nation is the aggregate of the prefectures.
Total 22.9 0.6 5.2 13.7 4.1 5744
Nation 554.1 9.0 130.6 339.5 91.2 127692
GDP forecast
%q/q, saar, oya for CY2011 1Q New 1.2 Previous 2.2 2Q -1.0 2.2 3Q 2.0 2.5 4Q 4.0 2.0 CY2011 0.9 1.7
Composite index and IP

Index 2005=100 sa, for both scales 90 88 86 84 82 80 1994 1995 IP Composite index 98 96 94 92 90 88 86
Lessons from Kobe earthquake

The experience of the Kobe earthquake in January 1995, which took 6,433 lives and destroyed 104,906 houses, offers some guide for anticipating the impact of the recent earthquake on economic activity in coming months. As ex21
Economic Research Japan to recover from the disaster, but will take time March 18, 2011
pected, there was a negative impact in the short term, but it did not last long: The coincident economic indicator, IP, and real exports fell noticeably in January 1995, but rebounded in February and the following months. Real private consumption also plunged in January, but recovered somewhat in following months. Firms sentiment did not deteriorate even with the earthquake, according to the January Shoko Chukin survey, but fell in the ensuing months, on the heels of yen strength. Indeed, USD/JPY fell from 99 in January 1995 to below 80 in April. The yens appreciation was likely reflected in changes in foreign capital flows: net Japanese foreign security purchases, which started to slow even before the earthquake, slowed further after the quake, and were negative (which means that the funds came back to Japan) in March, before recovering in April. However, it is worth noting that yen appreciation largely reflected the growing pressure from the US government over a trade dispute between the two countries. Indeed, despite the Kobe earthquake, GDP continued to grow above 3%ar for three consecutive quarters until 3Q 1995. Indeed, one of the main drivers of the rapid growth was an increase in public works, which rose 19.9% on average for four quarters to 1Q96. The government passed three supplementary budgets, totaling 3 trillion, or 0.6% of GDP. In addition, especially after USD/JPY hit bottom in 2Q, stronger private consumption boosted GDP.
Cabinet Office real private consumption index

Index 2000=100 sa 98 96 94 92 90
1994
1995
Nikkei equity prices and yen FX rate

Yen 22000 20000 18000 16000 14000 Nikkei 225 Yen/dollar 120 110 100 90 80
JPY/USD 1994 1995
Net Japanese purchases of foreign securities

Yen bn 2400 1600 800 0 -800 -1600 1994 1995
New constraint from power outages

However, last weeks earthquake appears to weigh on the economy more significantly and will likely linger for a more extended period than the Kobe earthquake, due to the secondary effect of the disaster. The massive damage to the nuclear power plant in Fukushima, operated by Tokyo Electric Power Company (TEPCO), resulted in power outages in the Tokyo metropolitan area, which produces 40% of Japans GDP. As the shortage of power supply is expected to last until this summer, when demand increases seasonally, and with the outage also affecting train service, it will weigh on economic activity not only in northeastern Japan, but also in the Tokyo metropolitan area. We have usually assumed that the damage of an earthquake would be limited in duration as a shortage of goods caused by an earthquake could easily filled by an increase in production in other regions, which are not affected by the earthquake. Indeed, economic activity, including electricity production, in the western part of Japan has been about normal. In theory, the
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transfer of the power from the west to the east would solve, or at least ease, the problem. But, because of a technical issue, electricity cannot be transferred, as the frequency in the east (50 Hz) differs from that in the west (60 Hz). The disruption to domestic production from insufficient power may generate a supply chain problem especially in Asia. Japanese manufacturers have been increasing overseas production to avoid the risk of yen appreciation and also to take advantage of the high economic growth rates in the EMs, especially in Asian EMs. But Japanese overseas affiliates depend relatively heavily on the import of the parts and machines from Japan. So, any decline in the sup-
ply of materials and parts from Japan will likely restrain operating rates of foreign affiliates (see tables, next page). On the financial front, we have seen repatriation of assets, which drove USD/JPY to below 80, breaking the previous post WWII high marked in April 1995. Domestic investors waning risk appetite would likely put upward pressure on the yen, delivering an additional blow to exporters.
Electricity generation by source in Japan

As of FY2009 Coal 24.7% Hydroelectric 8.1% Nuclear 29.2% LNG 29.4%
New power, etc. 1.1%
Petroleum 7.6%
Nuclear power plant problem

Nuclear power provides 30% of Japans electricity, and that ratio is thought to be rising. The tsunami following the earthquake destroyed TEPCOs fuel tank for its diesel generators at the Fukushima nuclear power plant, which power the cooling systems when the main system fails. As a result, the cooling system failed, and the temperature inside the nuclear reactor rose substantially, as the water level in the reactors fell, exposing fuel rods. Should the fuel rods in the reactor remain exposed, the temperature inside the reactor would soar, and, the fuel rods could melt down. To cope with this very dangerous situations, TEPCO flooded the reactor with sea water to cool it down. However, according to the government and the TEPCO, despite the desperate effort, the temperature has not yet fallen significantly. On Tuesday, March 15, leakage of radioactive materials was first reported even in Tokyo, located 227 kilometers away from the troubled nuclear power plant, in the aftermath of a hydrogen explosion, which apparently caused some small cracks in the reactor. The Fukushima situation may be comparable with the Three Mile Island episode in the US but is far different from Chernobyl. The government urged the local residents living within 20-30 kilometers to stay inside their houses. Actual amounts of radiation in Tokyo were very low0.0008 milli Sievert (mSv)far below the critical level1 and much lower than the amount of radiation to which one is exposed flying in an airplane from Tokyo to NY (0.2 mSv).
BOJ's current deposit

Yn tn 40 30 20 10 0
00
02
04
06
08
10
However, how the supplementary budget will be financed remains to be seen. There is no consensus at the moment on how much should be financed by a new reconstruction tax and how much by issuing JGBs. If the consumption tax rate is hiked 1%-pt for a year, tax revenue will rise 2.5 trillion (0.5% of GDP) per year. The BoJ injected 15 trillion this week into the banking system, and is expected to increase current account deposits (about the same as bank reserves) to above 40 trillion next Monday, which will exceed the BoJs liquidity injection under QE1 that it conducted from 2001 to 2006. The size of the coordinated purchase of USD that the BoJ conducted today with the other G-7 countries to prevent the yen from strengthening further is estimated to be close to 2 trillion and appears to have been unsterilized.
Supplementary budget likely to exceed 2% of GDP with the BoJ starting QE2
Given the size of the damage from the disaster, the budget for reviving the damaged area should exceed the one passed in the aftermath of the Kobe earthquake (3 trillion). While it is premature to estimate the size of the budget, it should be at least 10 trillion (2% of GDP). With the public works multiplier of 1.1, this will push up GDP, first offsetting the expected fall in private demand in 2Q 2011, and accelerating the GDP growth to close to 4% by 4Q.
1. 100 mSv per day is estimated to be the critical level. A normal x-ray is 0.6 mSv.
New risks abound

We still believe that the economy will start to recover in 2H11, assuming that the nuclear power plant problem does not worsen further. However, we attach a 10% probability to a scenario in which there is a massive leakage of radiation, which in turn contaminates a meaningful portion of the food supply.
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Economic Research Japan to recover from the disaster, but will take time March 18, 2011
Obviously, this would have tremendous negative impacts on the economy. Agriculture in the northeast of Japan would be devastated. Distribution channels would be disrupted. On the international trade front, Japans food imports would surge. With industrial production and exports falling, the trade balance could easily fall into deficit, and even the current account could be in deficit, if the trade deficit exceeds the income account surplus. On the fiscal front, the government would increase spending to compensate for the decline in private demand and to help rebuild destroyed infrastructure. With a fall in tax revenue, the fiscal deficit would expand with debt rising to far above 200% of GDP, unless consumption tax rate is hiked significantly. The net impact of the disaster on Japans debt dynamics is that the time for the current account surplus to disappear will be sooner. In addition, if investors risk appetite wanes markedly, and if investors exhibit a strong preference to hold cash, even bonds could sell-off. In an extreme case in which overseas portfolio investments are liquidated to repatriate funds, the sharp change in the direction of capital flows could severely limit the liquidity in EM asset markets. Meanwhile, even though we assume that Japans current account surplus will persist for some time, the loss of confidence in government policies and a surge in liquidity preference could reduce demand for JGBs, especially long dated JGBs. To avoid a rise in JGB yields, the government would have to cut expenditures and hike the consumption tax rate. This painful prescription would restrain economic growth, perhaps significantly. Under these scenarios, the BoJs policy options would be limited, as conventional measures of the monetary policy have already been overextended. The BoJ could purchase equities as well as the bonds, by expanding the size and the scope of the Asset Purchase Program. If this option were chosen, the BoJ would monetize both the fiscal deficit and real assets held by the private sector. Indeed, the BoJs aggressive policies would ease deflation, and may create inflation, if they are combined with an increase in public spending. This may seem like a favorable outcome. However, creating inflation through debt monetization policy is fraught with risks. The important question would be whether the government could cut the spending or increase taxes to reduce the need for debt monetization as inflation nears the target. In other words, a workable debt monetization plan ultimately would require fiscal discipline.
Major partners in Japan's international trade

Exports from Japan % of total Japanese nominal exports 1 2 3 4 5 6 7 8 China United States Korea Taiwan Hong Kong Thailand Singapore Gernamy Rest Aggregate Asia ASEAN NIES 2000 6.3 29.7 6.4 7.5 5.7 2.8 4.3 4.2 33.0 41.1 14.3 23.9 2005 13.5 22.5 7.8 7.3 6.0 3.8 3.1 3.1 32.8 48.4 12.7 24.3 2009 18.9 16.1 8.1 6.3 5.5 3.8 3.6 2.9 34.8 54.2 13.8 23.5 2010 19.4 15.4 8.1 6.8 5.5 4.4 3.3 2.7 34.4 56.1 14.7 23.7
Imports of Japan
% of total Japanese nominal imports 1 2 3 4 5 6 7 8 China United States Saudi Arabia UAE Korea Indonesia Taiwan Malaysia Rest Aggregate Asia ASEAN NIES 2000 14.5 19.0 3.7 3.9 5.4 4.3 4.7 3.8 40.6 41.7 15.7 12.2 2005 21.0 12.4 5.6 4.9 4.7 4.0 3.5 2.8 41.0 44.4 14.1 9.8 2009 22.3 10.7 5.3 4.1 4.0 3.9 3.3 3.0 43.3 44.7 14.1 8.6 2010 22.1 9.7 5.2 4.2 4.1 3.3 3.3 3.0 44.9 45.3 14.5 8.9
Major traded goods in Japan's international trade (2010) Exports from Japan
% of total Japanese nominal exports 1 2 3 4 5 6 7 8 Transport machinery Indusrial machinery Electric machinery Manufactured goods Chemicals Mineral fuels Raw materials Food Rest 22.6 19.8 18.8 13.0 10.3 1.6 1.4 0.6 11.9
Imports of Japan
% of total Japanese nominal imports 1 Mineral fuels 2 Electric machinery 3 Chemicals 4 Manufactured goods 5 Food 6 Indusrial machinery 7 Raw materials 8 Transport machinery Rest 28.6 13.3 8.9 8.9 8.6 7.9 7.8 2.8 13.2
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JPMorgan Chase Bank, London Malcolm Barr (44-20) 7777-1080 malcolm.barr@jpmorgan.com Allan Monks (44-20) 7777-1188 allan.j.monks@jpmorgan.com
Composite output PMI versus real GDP growth

Standard deviations from average since 2000 2 1 0 -1 -2 -3 -4 00 02 04 06 08 10 GDP PMI
UK growth: the good, the bad, and the ugly

Good: business survey and labor market data suggest growth is holding up Bad: consumer indicators warn of weak spending Ugly: plunge in construction output runs into January 2011, threatening another fall in GDP in 1Q11 As Chancellor George Osborne prepares his March budget, and the MPC deliberates a hike in rate motivated by inflation concerns, the UK data are more difficult to read than usual. After a surprise decline in GDP in 4Q, partly reflecting the impact of December snowstorms, a bounce in 1Q has been widely anticipated. The data in hand are creating significant doubt as to whether that will occur. Business survey data suggest at least a tepid underlying pace of growth and the possibility of something close to trend. The labor market as a whole is broadly stable despite job cuts in the public sector. But indicators of household spending have weakened of late, warning that consumption may be contracting anew amid ongoing weakness in real incomes. And official data on construction output suggest that, having boosted growth through the middle quarters of 2010, the sector may act as a large drag on output in 1Q; output has fallen further after Decembers sharp decline. Our forecast has been for growth to gradually pick up as 2011 progressed, and that remains the case. But uncertainty on the current momentum in growth is unusually high, with risks still skewed to the downside after 4Qs surprising weakness. Releases in late March and early April will provide further color on how 1Q has fared, but are likely to leave the picture uncertain ahead of the April 27 release of the preliminary estimate of GDP growth. Although the MPC will take all of the available data into account, that release will be an important input into its appraisal of the outlook in May. The bar for the a majority to vote to raise rates is low (the February inflation report had forecast growth averaging near 1.5% q/q saar over 4Q10 to 2Q11) but the data are keeping that debate going.
Claimant count unemployment versus real GDP growth

000s sa, chg over 3 months -100 0 100 GDP 200 300 Claimant count % q/q sa 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5
04
05
06
07
08
09
10
11
Industrial production versus business investment

%3m/3m, saar for IP, %q/q, saar for business investment 20 10 0 -10 -20 -30 2005 0 Business investment 2006 2007 2008 2009 2010 2011 -20 -40 IP capital goods 40 20
fore Decembers snowstorms hit, while business surveys point to ongoing growth. Where the official data and the surveys are not in conflict is in the manufacturing sector, where output and exports are growing strongly. It would be complacent to rely solely on the business surveys as a signal that the official data are underreporting output growth, as the linkages (even in the mature data) are not always very close. But we are inclined to put weight on them for three reasons beyond their tracking record. First, the composite output PMI has retained its linkage with the global measure through recent releases, which makes the apparent strength explicable. Second, the data on employment have held in better than we would expect if the service sector were contracting. Having hoarded labor through the downturn, we would expect to see a quick turn to labor shedding if output growth were to falter again. But such
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The good: business surveys hold in

As GDP fell in 4Q, many pointed out that after allowing for the impact of Decembers snow, the underlying weakness in output growth was not consistent with business survey data. More specifically, the official data report that private service sector output had begun to contract again even be-
JPMorgan Chase Bank, London Allan Monks (44-20) 7777-1188 allan.j.monks@jpmorgan.com Malcolm Barr (44-20) 7777-1080 malcolm.barr@jpmorgan.com
Economic Research UK growth: the good, the bad, and the ugly March 18, 2011
weakness in the labor market data has not been forthcoming, and some of the business survey readings on the labor market have been strengthening of late. Third, production of capital goods is leading the gains in manufacturing production, which hints that investment spending in the UK is also firming.
Household spending versus tracking indicator using monthly data

%q/2q, defined as real HH consumption plus investment spending 6 4 2 0 -2 -4 -6 -8 Actual overall HH spending Tracker using monthly data 2008 2009 2010 2011
The bad: households take the hit

Should UK growth disappoint, it is clear where it would be concentrated on the expenditure side: consumer spending faces a litany of headwinds. Weekly nominal pay growth per employee is running below 3%, while employment is running near flat. Increases in consumer prices have meant that pre-tax labor income has been falling in real terms for over a year. The recent hike in VAT has generated another step down in real incomes in early 2011, while ongoing gains in food and energy prices threaten further downward pressure on real incomes. Public service provision is set to be cut, while the near 25% of the workforce who work in the public sector face job uncertainty, alongside weaker pay and pensions even if they keep their jobs. Meanwhile, the housing market remains weak, the ability to borrow against housing is constrained, and unsecured credit is relatively expensive. Consumer confidence began to sag in the wake of last years election and that fall has accelerated in early 2011. Sustaining even modest gains in real consumption over 1H11 will likely require households to reduce their saving rate. After the sharp retrenchment seen during 2008-9, 2010 saw the saving rate move down from its peak, supporting sluggish gains in consumption. A bounce in investment spending by households, which is comprised mainly of additions and repairs to the housing stock, also suggested some stabilization in household behavior through to 3Q10. Tracking spending is not easy, but our indicator has suggested the data are consistent with near flat household spending for a while.
2007
Real labor income proxy versus real private consumption

%oya, income proxy=avg earnings plus employ. growth minus RPI inflation 4 2 0 -2 -4 -6 Income proxy 2005 2006 2007 2008 2009 2010 Consumption
Construction output
bn at 2005 prices, nsa, quarterly data prior to 2010 9.5 9.0 8.5 8.0 7.5 7.0 6.5 2009 2010 2011
The ugly: construction fails to bounce

An outsized bounce in construction output added significantly to GDP growth through mid-2010, and the potential for a correction has been clear. After an almost 17% m/m nsa decline in construction output in the snow-impacted December, the January data were expected to rebound. But the monthly data show a further near 8% m/m nsa fall. The official monthly data on construction output have only 13 months of history, are volatile, and not seasonally adjusted. But with Januarys level of output down some 18% on the 4Q average, even strong monthly gains over February and March will likely leave the sector acting as big drag on GDP growth in 1Q. The next update of the monthly data is
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due on April 8. As the data stand, we need to see strong (10% m/m) gains over both February and March to bring the quarterly change in construction output up to the bottom of the historical range at around an 8% q/q sa decline. Such an outcome would reduce the (not annualized) quarterly growth rate of GDP by 0.5%-pt. After the 4Q downside surprise, we had penciled in a 0.7% q/q gain in GDP for 1Q. The release of official data on services output for January (due March 30) will be important as a window on the magnitude of the bounce after Decembers sharp decline. But the drag from the construction sector threatens to dominate the 1Q data, leaving us tracking a near flat outcome with the data in hand. A further contraction in output in the quarter cannot be ruled out if the move up in services output proves underwhelming.
Changes in the current budget deficit and investment spending

Change from prior year, bn 12 10 8 6 4 2 0 -2 -4 -6 Current budget deficit Deterioration
UK: Budget for 2011 will stay the fiscal course

The Chancellor is under pressure to slow the pace of fiscal consolidation following better news on tax receipts But next weeks Budget will stick to the austerity program outlined last year Osborne will instead announce small supply-side measures aimed at supporting growth The government continues to face criticism about the speed and scale of the austerity program being pushed through, while economic growth has yet to show a sustained recovery. Recent positive surprises from tax receipts appear set to deliver a 10-15 billion undershoot in borrowing for the 2010-11 fiscal year. This creates some pressure for the Chancellor to slow the pace of planned consolidation in next weeks 2011 Budget, which is also likely to see the OBR downgrade its growth forecasts. But Osborne will likely stick to his guns. New tax increases are scheduled to begin from April. And spending cuts will intensify during the 2011-12 fiscal year, resulting in a larger drop in the primary structural deficit worth 2.3%-pts of GDP. The Chancellor will divert attention from this reality by arguing that the plans are part of a broader strategy aimed at kick-starting growth. The Budget will therefore center attention on a host of micro level reforms aimed at encouraging businesses to expand and create jobs. These reformswhich will include identifying enterprise zones most in need of support, targeted tax breaks, and simpler planning ruleswill be aimed at facilitating a rebalancing toward private sectorled growth. Consumers appear likely to be offered some relief from rising oil prices in the form of a reduction in fuel dutywhich may involve a mechanism to stabilize petrol prices. But these measures will cost little in the aggregate, and will not meaningfully alter the near-term growth outlook. New measures are more than likely to be covered by the better news on tax receipts, allowing for some modest downward revisions to the 2011-12 forecast for borrowing.
Net investment
Improvement 2006/07 2007/08 2008/09 2009/10 2010/11
Central government revenue and expenditure

%oya 15 10 5 0 -5 -10 -15 2007 Revenue 2008 2009 2010 Expenditure
OBR public finance projections

% of GDP, unless stated 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 OBR 2011 projections (expected): Overall deficit (bn) 139 113 93 62 37 20 Overall deficit (% GDP) 9.3 7.4 5.7 3.6 2.0 1.0 GDP, %oya 1.7 1.8 2.7 2.9 2.7 2.6 OBR November 2010 report: Overall deficit (bn) Overall deficit (% GDP) Current deficit (cyc. adj.) Net debt (PSND ex) Revenue Total expenditure Investment spending Paybill (%oya) GDP, %oya Potential GDP, %oya Output gap 149 10.0 4.7 62.8 6.9 4.2 2.9 2.5 1.7 -3.3 117 7.6 3.3 67.2 6.7 0.8 2.0 -0.7 2.0 2.1 -3.4 92 5.6 1.8 69.8 5.8 1.1 1.7 -0.6 2.7 2.3 -3.0 62 3.6 0.5 70.3 6.1 1.1 1.4 -1.5 2.9 2.2 -2.3 37 2.0 -0.5 69.4 5.9 1.9 1.3 -3.2 2.8 2.1 -1.6 20 1.0 -1.0 67.4 5.3 2.7 1.3 -1.5 2.7 2.0 -0.9
Rising receipts give Osborne some leeway

A resurgence in tax revenues and headway in cutting public investment spending helped to generate better monthly budgetary outturns toward the end of last year. With the current fiscal year (which ends in March) drawing to a close, borrowing looks likely to undershoot the 148.5 billion projection made by the OBR in November, by around
10-15 billion (almost 1% of GDP). The improvement in the structural deficit may be less than this if the OBR concludes that potential growth was weaker than thought which appears likely given recent data on activity. Moreover, the OBR will be forced to revise down 2010-11 GDP growth following recent weak outturns, and may shave its estimate for 2011-12 as well. Allowing for a package worth 2-3 billion (0.2% of GDP) aimed at delivering reforms to support growth, the reduction in the OBRs 2011-12 borrowing projection is therefore likely to be small. We anticipate a 4 billion revision, leaving the forecast for the com27
Economic Research UK: Budget for 2011 will stay the fiscal course March 18, 2011
ing fiscal year at 113 billion. The cyclically adjusted current budget will be shown returning to balance in 201415in line with the fiscal objectives.
Government net investment

bn -8 -6 -4 -2 0 10/11 target 2009/10 2010/11
Fiscal pain to increase from 2Q

The OBR estimated that the primary structural deficit for the current fiscal year would fall by 1.9% of GDP. For the fiscal year that begins in April 2011, the drag is expected to increase to 2.3%which is estimated to be the single largest year of adjustment in the five year consolidation process. But offering a more specific quarterly time line for the planned measures is not easy, given the information available. A step up in the intensity of the current consolidation process will occur from 2Q and last for the next four quarters, concentrated mostly in spending cutbacks: A host of tax and benefit measures will come into effect from Aprilbut are relatively small. In the aggregate these changesall planned to take effect from early April to coincide with the new fiscal yearare equivalent to a net fiscal drag of 5.4 billion (0.3% of GDP) according to the Institute of Fiscal Studies. This is relatively small and measures the impact over the fiscal year as a whole. The largest takeaway is the 1%-pt rise in national insurance. But some offset will come in the form of a higher personal income tax allowance and an increase in the threshold of employer national insurance contributions. VAT was also increased at the beginning of this year, which is providing an additional fiscal drag compared to last year. Nominal spending growth will slow dramatically in 2011-12accounting for the lions share of the consolidation. Departmental spending limits are set for the fiscal year as a whole, which makes it tough to identify a quarterly profile for the spending cuts. But nominal growth is expected to slow from 4.2%oya to 0.8% in the fiscal year beginning in April. This works out to be worth around 1.7% of GDP according to the Budget and accounts for around 80% of the planned tightening for the year. We will be able to track the pace of slowdown in spending using the monthly public finances data. Since current spending slowed less than projected in 2010-11, this may imply that a larger drag is to come from this source from April. Public sector pay freeze to broaden from April, with ongoing job cuts. A two-year public sector pay freeze will take effect in 2011-12, and will save the government 3.3 billion a year (0.2% of GDP)a small part of the measures described above. But there are signs that this adjustment is already at work, which may suggest a smaller incre28
Apr
Jul
Oct
Jan
Public spending projections

%oya 8 6 4 2 0 -2 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 Real Nominal
Public job cuts happening more quickly

OBR projections suggested the change in public sector employment in the year to March 2011 would be negligible with most of the expected 330,000 loss of jobs over the current parliament concentrated from 2013-2016. The latest ONS data, however, report a decline in public sector jobs of 45,000 in 4Q alone, and of 132,000 drop (2.1%) over the past year. This raises questions about whether the OBRs approach, which involves a model of the aggregate public sector paybill, is the more reliable guide to the timing of employment decisions within the public sector.
Public versus private sector employment
Mn sa, survey of public institutions 6.4 6.3 6.2 6.1 6.0 5.9 2007 2008 2009 2010 Public sector Private sector 23.4 23.1 22.8 22.5 Mn sa, LFS household survey adjusted by estimate of public employment
mental impact from April. Some civil servants who were awaiting legally binding pay deals in 2010-11 will have had their two-year pay freeze already. And public employment has started falling much earlier than planned (box).
J.P. Morgan Australia Limited, Sydney Helen Kevans (61-2) 9220-3250 helen.e.kevans@jpmorgan.com
Floating rate home loans now more popular

% of loans 80 70 60 50 40 30 20 05 07 09 Floating 11
RBNZ on hold until 2012 OCR changes more potent

The RBNZ cut the official cash rate (OCR) 50bp last week as an insurance measure Preference for floating rate mortgages means the OCR cut will benefit households faster than before RBNZ to leave policy settings unchanged until earthquake rebuilding phase begins The Reserve Bank of New Zealand (RBNZ) slashed the official cash rate (OCR) 50bp last week in a preemptive move to mitigate against broader economic damage from the recent earthquake. The quake on February 22 was the second within six months to rock the city of Christchurch and surrounding areas, which account for 15% of national GDP. The near-term economic damage is significant. Most rebuilding will be delayed until 2012 given the severity of the land damage, which will need to be repaired before rebuilding can begin. The RBNZ now will remain on the policy sidelines for an extended period. Our forecast calls for the next OCR hike to be delivered in 2Q12. RBNZ Governor Alan Bollard returned the OCR to the record low 2.5% last seen during the most recent recession in a move he labeled an insurance measure. While we had believed that a rate cut was not strictly needed and that targeted fiscal policy was a more appropriate response, we had acknowledged that the March decision was finely balanced. The RBNZ delivered a meaningful cut, but made clear that the decision required many important assumptions based on quite limited information.
Fixed
Fixed interest rates were lower than floating

% 11 9 7 5 05 06 07 08 09 10 11 12 Floating
5-year fixed
2-year fixed
GDP to fall 0.2%q/q. The earthquake will have a negative impact on near-term activity, but will be positive for growth in the medium-term when rebuilding gets underway.
Lags in policy transmission now shorter

The latest RBNZ stimulus should have more potency than before given the lags in the monetary policy transmission mechanism now are shorter. The yield curve is sharply upward sloping and more borrowers favor floating rate mortgages, which are relatively less expensive than those with fixed rates. The proportion of households with floating rate mortgages has risen significantly, such that changes to the OCR are quickly reflected in borrowing rates faced by households. In January, 57% of all mortgages issued were with floating rates, compared to just one-third when the last OCR cut was delivered in April 2009. Shorter-term wholesale interest rates declined sharply following the earthquake, reflecting concerns that the disaster would have a significant, negative impact on near-term growth. The rates market was quick to price in cuts from the RBNZ. The three-month overnight indexed swap (OIS) rate slumped from 3% pre-quake to 2.5% by March 9, the day prior the OCR announcement. The slump in wholesale rates prompted a number of banks to slash their fixed rates by up to 0.5% before the cut to the official cash rate. Floating interest rates fell shortly after the RBNZ decision.
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Pre-earthquake weakness
The economy was weakening before the recent earthquake. A handful of positive indicators in early 2011 had, though, hinted that the recovery was gaining traction. The trade data showed that net exports provided a small contribution to growth in 4Q10 and that the terms of trade soared to a 35year high. But, outside the external sector, the economic picture was weak. Indeed, Bollard acknowledged that even before the earthquake, the economy had underperformed, a fact that clearly influenced the March decision. The earthquake dealt a considerable blow to the economy, resulting in a loss of output from the Canterbury region and a delay in the reconstruction effort from the previous quake in September 2010. The result will be another contraction in the economy in 1Q11, with our forecast for
J.P. Morgan Australia Limited, Sydney Helen Kevans (61-2) 9220-3250 helen.e.kevans@jpmorgan.com
Economic Research RBNZ on hold until 2012 OCR changes more potent March 18, 2011
Slow start to reconstruction phase

Mortgage rates will remain low for some time. The Governor underscored that the emergency stimulus will be removed only once the rebuilding phase materialized. This will take time, particularly with aftershocks continuing. The latest Christchurch earthquake put existing repairs and rebuilding on hold, and the tremor caused substantial damage to houses, commercial property, and infrastructure already damaged by the earlier quake. Rebuilding efforts from the 2010 earthquake had proceeded at a slower pace than initially anticipated. Earthquake-related construction approvals from the September quake had yet to show up to any significant degree in the building consents data. Only 30 earthquake-related consents were identified in the January figures from a total of 867, a quarter of which were in the Canterbury region. Rebuilding could not get underway as claims had not been processed by insurers, one reason being the lack of information on land remediation, which aims to prevent lateral spreading of any future quakes. The scale of destruction from the second quake means repair work will be even slower to gather momentum. The rebuilding phase, therefore, is unlikely to materialize until next year; hence our forecast for the RBNZ to leave the OCR unchanged for an extended period. The reconstruction phase will be large, however, such that the string of rate hikes we anticipate in 2012 will push the OCR to 3.5% by year-end. Our forecast for 100bp of policy tightening in 2012 will depend, though, on how the economy develops in the aftermath of the earthquake, particularly regarding inflation.
Contraction in GDP in 1Q11

% 1.0 0.5 0.0 -0.5 -1.0 2008 2009 2010 2011 J.P. Morgan forecasts
Budget to remain in deficit until at least 2016

OBEGAL, % of GDP 5 J.P. Morgan forecasts
-5
-10
02
04
06
08
10
12
14
changes to its inflation projections in the most recent Monetary Policy Statement, forecasting medium-term inflation comfortably within the Banks 1%-3% target range. With NZD falling and global inflation pressures rising, the risks to these forecasts are to the upside.
Price indicators the ones to watch

Upward inflation pressure will intensify as rebuilding gets under way. Prices for many goods and services already have risen, such as those for insurance premia, construction and rent costs. The inflation impulse from the quake should prove only temporary provided inflation expectations remain anchored. Should it prove persistent, however, the RBNZ would be forced to tighten more assertively than we currently project. The faster transmission of policy changes suggests, though, that future tightening will have a more immediate impact. For now, the significant slack in the economy means there is little impetus for the RBNZ to shift the OCR toward neutral. Underlying inflation is benign, price expectations are low, and firms have lacked pricing power such that many were unable to pass on the October 1 increase in the goods and service tax (GST). The RBNZ, as such, made few
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Government to help with heavy lifting

The economy will be supported by more fiscal spending in the upcoming Budget in May. Treasury estimates the cost of rebuilding at around NZ$15 billion (8% of GDP), meaning the drain on public finances will be substantial. Before the earthquake, Treasury expected that the Budget would be in balance by 2015/16, with the operating deficit before gains and losses (OBEGAL) to improve markedly from 5.5% of GDP in the current fiscal year. This forecast was looking optimistic prior to the earthquake and now looks highly unlikely. The government has said it will prioritize spending to pay for the earthquake damage. Finance Minister Bill English has declared that the government will look at all options, including curbing interest free-student loans and Working for Family tax credits which it previously said wouldnt be changed. These changes will come on top of other measures already implemented, including the GST-hike last year.
JPMorgan Chase Bank NA, New York Robert Mellman (1-212) 834-5517 robert.e.mellman@jpmorgan.com
United States
Forecast still expects stronger real GDP growth in 2Q11 on increased hiring, much lower inflation CPI is up 5.0% saar in 1Q11; core inflation has also accelerated but is still running at low levels Passthrough of the weaker dollar into higher prices for imported manufactures has been very modest so far The prospects for strong growth in the first half are being threatened by a set of shocks to the economy and to confidence. The sharp increase in fuel prices had prompted a downward revision of the 1H11 real GDP forecast over the past few weeks to 3.0% (from 4.0%). The more recent news has been the extent of damage in Japan related to the earthquake, tsunami, and accident at the nuclear power plant. Natural disasters usually result in near-term dislocation and then rebuilding. And, the forecast for Japan economic growth has been revised down in the first half and revised up in the second half accordingly. The direct effects on US economic activity in this scenario are likely to be modest. Near-term export growth might be just a bit lower, and there is some concern about the nearterm effect on manufacturing from interruptions in the supply chains. The greater risk to growth is that the growing list of global worries (Japan, oil supplies from the Middle East and North Africa, Euro area fiscal problems, China inflation and policy tightening, the US political stalemate) could lead to risk aversion on the part of investors, a further decline in equity prices, and significant adverse wealth effects on consumer spending. The rebound in equity prices over the last two days provides tentative encouragement that a wave of persistent pessimism is not building. We are maintaining the forecast of 2.5% real GDP growth this quarter rising to 3.5% next quarter. And we see good reason for real consumer spending to reaccelerate before long. Business surveys and the more timely weekly readings on initial jobless claims are pointing to an upturn in employment growth. The latest weekly reading on initial jobless claims was a low 385,000, and the 4-week average of jobless claims has dropped from 418,500 in the week of the February labor market survey to 386,250 in the week of the March labor market survey. At least as important, the tentative stabilization of energy prices suggests that any acceleration of labor income in 2Q11 will be accompanied by a sharp decline in inflation from an estimated 5.0% saar pace for the CPI this quarter to only about 2.0% next quarter. Lower inflation next quarter will boost real income growth and provide important support for spending.
Core PCE price index, with forecast for February

%ch saar 2.5 2.0 1.5 1.0 0.5 0.0 2009 Over 3 months 2010 2011 Over year ago
Initial jobless claims

'000s, sawr 480 440 400 360 Oct 10 4-week average
Weekly
Nov 10
Dec 10
Jan 11
Feb 11
Mar 11
Manufacturing output and single-family housing starts

%ch saar, over 3 months, both scales 15 10 5 0 Jan 10 Manufacturing IP Housing starts 80 40 0 -40 -80 Apr 10 Jul 10 Oct 10 Jan 11
Any judgments about the effects of recent events on consumer and business behavior remain tentative, and it will be important to monitor the most timely incoming data, including the automakers guidance on March new car and light truck sales that should be available early next week. Incoming February supply-side data show a mixed performance in the first quarter. Manufacturing output accelerated to a 9.8% saar growth rate over the past three months. And the sky-high reading for new orders in the Philadelphia Fed survey for March (the highest since the early 1980s) points to further gains ahead. On the other hand, housing starts plunged in February to their lowest level in almost two years, and single-family starts are down 53.9% saar over
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JPMorgan Chase Bank NA, New York Robert Mellman (1-212) 834-5517 robert.e.mellman@jpmorgan.com
Economic Research United States March 18, 2011
the past three months. Manufacturing accounts for 11.5% of GDP, while new home construction has plunged to only 0.8% of GDP.
Three measures of core inflation

%ch saar, over 3 months 2.0 1.5 1.0 0.5 0.0 -0.5 Jan 10 Apr 10 Jul 10 Oct 10 Market-based core PCE prices Jan 11 Core PCE, with Feb forecast Core CPI
Assessing core inflation gets complicated

The inflation data for February confirm the recent surge in inflation and a more modest acceleration in core inflation. The CPI increased 0.5% in February and has risen 5.6% saar over the past three months. The core CPI rose 0.2% in February and has also accelerated to 1.8% saar over the past three months. The Fed prefers the core PCE price index as a measure of core inflation to the core CPI. Based on the CPI and PPI source data for February, the core PCE price index is forecast to rise 0.16% in February. If realized, this would bring the 3-month run rate for this measure of core inflation to 1.3% saar and its annual increase to 0.9%oya. These readings are off their lows, but still relatively modest and well below the Feds informal inflation target. While the 3-month run rate for core inflation has accelerated recently, it is far from clear just what this acceleration means for the inflation forecast or for Fed policy. Is higher core inflation a trend or a wiggle? It is not clear how much of the recent increase in core inflation is a trend that should be extrapolated and how much is one of those frequent wiggles in short-term inflation measures that may soon be reversed. The 3-month run rate for the core CPI had accelerated to 2.0% saar in October 2009 but fell to -0.2% saar by the following March. And there are reasons to expect at least some moderation ahead this time, too. For example, fully 0.4%-pt of the 1.8% run rate in the core CPI is accounted for by public transportation (mainly air fares), as the cost of higher fuel prices has been quickly passed on to the consumer. If the price of jet fuel were to stabilize near recent levels, as priced into the futures market, flat air fares would bring a 0.4%-pt decline in the run rate for the core CPI over the next several months. What is the best measure of core inflation? The CPI is up to a 3-month run rate of 1.8% saar, including the surge in air fares. The core PCE price index, the Feds preferred measure, is forecast to be up to more modest 1.3% run rate in the three months through February. Finally, many sophisticated inflation watchers focus on the market-based core PCE price index, a measure that excludes goods and services with imputed rather than market prices (for example, the price of the free use of an ATM machine). The market-based core PCE price index is running below
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Price of imported manufactures and the real broad value of the dollar
%ch nsa ar, over 6 months, both scales 4 2 0 -2 -4 Value of dollar Import price for manufactures -50 -25 0 25 50
2006
2007
2008
2009
2010
2011
Note: Manufactures in this chart include the price of imported capital goods, autos and parts, and nonauto consumer goods.
the core PCE price index lately, and if the recent differential holds, this measure of inflation would be running only 1.0% saar in the three months through February.
Modest import price response to the dollar

Import prices are also accelerating, up 1.4% samr in February and 6.9%oya. A substantial part of the increase in import prices reflects the global surge in commodity prices over the past several months. But the price of imported manufactures (capital goods, autos and parts, and nonauto consumer goods) has also accelerated, mainly in response to the weakening of the dollar. The real, broad trade-weighted dollar has been trending lower since its March 2009 peak and declined 12.4% at an annual rate in the six months through February. The price of imported manufactures has increased over the past six months, but is only up 1.2% nsa ar. Thus, only about 10% of the shift in the exchange rate has passed through into higher prices for imported manufactures, in line with the trend over the past couple of years. Foreign producers have tended to respond to the lower dollar by accepting lower profit margins rather than raise prices and risk losing share.
JPMorgan Chase Bank, New York Michael Feroli (1-212) 834-5523 michael.e.feroli@jpmorgan.com Daniel Silver (1-212) 622-6039 daniel.a.silver@jpmorgan.com
Data releases and forecasts

Week of March 21 - 25
Mon Mar 21 10:00am Existing home sales Nov Total (mn, saar) %m/m %oya nsa Months supply (nsa) Single-family Median price (%oya) 4.64 5.9 -24.6 9.6 9.4 0.1 Dec 5.22 12.5 -2.2 8.2 7.9 -1.0 Jan 5.36 2.7 3.3 7.6 7.5 -3.7 Feb 5.15 -3.9 2.6 Wed Mar 23 10:00am
most recent four months with the prior three months using proprietary data and includes distressed sales also showed a pickup in prices in January (using our own seasonal adjustment of the data).
New home sales Nov Total (000s,saar) %m/m %oya nsa Months supply Median price (%oya) 281 0.4 -23.1 8.3 1.2 Dec 325 15.7 -8.3 7.0 5.6 Jan 284 -12.6 -20.8 7.9 5.7 Feb 290 2.1 -16.4
We forecast that existing home sales declined 3.9% in February to an annualized rate of 5.15 million units. Existing home sales had been recovering modestly from the extremely low level reached after the expiration of the home buyer tax credit, with sales up almost 40% (not annualized) between July and January. However, it looks like the severe winter weather in December and January may have restrained sales. Pending home saleswhich generally become existing home sales in one or two monthsfell about 6% between November and January. Prices of existing home sales continued to fall in January, with the availability of distressed sales weighing on the market. Prices fell 3.7%oya in January, reaching the lowest level reported since early 2002.
Tue Mar 22 10:00am FHFA home price indexes Purchase only Oct %oya %m/m (sa) -4.0 0.1 Nov -4.6 -0.3 Dec -3.4 -0.3 Jan -4.4 -0.2
We believe that new single-family home sales increased 2.1% in February to an annualized rate of 290,000 units. New home sales have bounced around at very low levels since the end of the home buyer tax credit. Most recently, new home sales dropped 12.6% in January after jumping 15.7% the prior month in anticipation of the end of a state-specific tax credit in California. We think that the fallout from the tax credit was concentrated in January and look for a very slight pickup in new home sales in February as the weather improved after two months of severe winter storms. The volume of mortgage purchase applications declined 2.8% in February, but increased in early March; the month of the mortgage application does not exactly match the month of the new home sale. The number of new single-family homes for sale continued to press lower in January (to 188,000 units), approaching the all-time lowest level of inventories reported dating back to 1963 (181,000 units). The price data on new single-family home sales has been very volatile since early 2010; prices were reported up 5.7%oya in January.
Thu Mar 24 8:30am Jobless claims 000s, sa New claims (wr.) Wkly 4-wk avg Jan 8 Jan 15 Jan 22 Jan 29 Feb 5 Feb 12 Feb 19 Feb 26 Mar 5 Mar 12 Mar 19 447 403 457 419 385 413 388 371 401 385 380 417 413 430 432 416 419 401 389 393 386 384
We forecast that the FHFA house price indexa monthly house price measuredecreased 0.2% in January (-4.4%oya). Home prices were boosted in early 2010 when the home buyer tax credit was stimulating buying activity, but since the tax credits expiration, various home price indexes have looked very weak. We expect further weakening in the FHFA data based on the steep decline in mortgages applications in December (-22%), which was much larger than normal for the month (the data are not seasonally adjusted); we find that the mortgage data generally lead the FHFA data by about one month, although this relationship is somewhat loose. Other house price indexes already available for January have been mixed. The CoreLogic house price index which is a three-month moving average of house pricesshowed that distressed sales weighed significantly on prices in January. The CoreLogic index fell 1.2%m/m sa during the month when including distressed sales, but jumped a sizable 1.7% during the month when distressed sales were excluded. The FHFA index includes distressed sales (when its other criteria are met), though over the past two years, it has correlated slightly better with the CoreLogic data that excludes distressed sales. The Clear Capital house price indexa semimonthly series comparing prices from the
Continuing claims Wkly 4-wk avg 3897 4009 3936 3910 3938 3833 3791 3786 3706 4015 3980 3932 3938 3948 3904 3868 3837 3779
Insured Jobless,% 3.1 3.2 3.1 3.1 3.1 3.1 3.0 3.0 3.0
1. Payroll survey week
We forecast that initial jobless claims for the week ending March 19 declined 5,000 to 380,000. Claims should continue to trend lower as the labor market heals, though the level of claims may bounce around through the weekly reports. We expect some further payback in the upcoming data from the 30,000 jump in claims that
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occurred the week ending March 5claims fell only 16,000 in the intervening week. There has been downward momentum building in continuing claims since the economy started to pick up last fall. The four-week moving average for continuing claims dropped about 16% between September and the week ending March 5.
Initial jobless claims
000s, sa 700 600 500 400 300 200 2007 2008 2009 2010 2011
Fri Mar 25 8:30am
Gross domestic product %ch, q/q saar, unless noted 3Q10 Real GDP Final sales Domestic final sales Consumption Equip. and software Nonres. structures Residential investment Government Net exports (pct.pt.contr.) Inventories (pct.pt.contr.) Core PCE price index (%oya) GDP chain price index (%oya) Adj. corporate profits (%oya) 2.6 0.9 2.6 2.4 15.4 -3.6 -27.3 3.9 -1.7 1.6 0.5 1.2 2.1 1.2 1.6 26.4 Adv Second 4Q10 4Q10 3.2 7.1 3.4 4.4 5.8 0.9 3.4 -0.6 3.4 -3.7 0.4 0.8 0.3 1.3 2.8 6.7 3.1 4.1 5.5 4.5 2.7 -1.5 3.4 -3.7 0.5 0.8 0.4 1.4 Third 4Q10 3.2 6.5 3.2 4.1 5.4 7.0 3.4 -1.5 3.3 -3.3
0.6 16.3
Thu Mar 24 8:30am
Durable goods %m/m sa Nov New orders Ex transportation Nondef cap. gds ex air Shipments Nondef cap. gds ex air Inventories -0.1 4.6 3.3 0.5 1.5 0.9 Dec -0.6 2.7 4.0 2.3 2.4 0.8 Jan 3.2 -3.0 -6.2 0.3 -1.9 0.7 Feb 3.2 2.5 3.9 1.0 1.3
We expect fourth quarter real GDP growth to be revised up from 2.8%saar to 3.2% in the third release of the data, pushing GDP growth up to what was initially reported by the BEA for the quarter. The bulk of this revision should come from revisions to the change in inventories, which we expect to be revised up from $7.1 billion saar to $20.8 billion (adding 0.4%-pt to GDP growth) based on revisions to source data released by the Census Bureau. We also anticipate slight upward revisions to private residential and nonresidential investment based on data released in the monthly reports on construction spending. These upward revisions should be partly offset by very small downward revisions to net exports and equipment and software investment. Corporate profits for 4Q will also be released with the GDP data, and we believe weak pricing during the period should have weighed on profits. We forecast a 0.6% rise in corporate profits during the quarter (+16.3%oya) which would be the weakest quarter for profits since they plunged 26.3% in 4Q08 at the start of the financial crisis.
Fri Mar 25 9:55am Consumer sentiment Jan Univ. of Mich. Index (nsa) Current conditions Expectations Inflation expectations Short-term Long term Home buying conditions 74.2 81.8 69.3 3.4 2.9 151.0 Feb 77.5 86.9 71.6 3.4 2.9 154.0 Pre Mar 68.2 83.6 58.3 4.6 3.2 161.0 Fin Mar 68.0
We forecast that durable goods orders increased 3.2% in February and that shipments increased 1.0%. The important core capital goods components was very weak in January (orders down 6.2%, shipments down 1.9%) which is often the case in the first month of the year due to inadequate seasonal adjustment of the data. Weak months for CCG orders and shipments are generally followed by some bounceback the following month, and we expect CCG orders to have increased 3.9% and shipments to have risen 1.3% in February. Away from CCG, we expect solid gains in the transportation components of the report. The February IP report showed increased production of motor vehicles and parts during the month, and we forecast that orders and shipments of motor vehicles rose 3.4%. Our seasonal adjustment of available aircraft data also points to gains in civilian aircraft orders and shipments. We also anticipate increases in defense orders and shipments based on the strong month for Department of Defense spending (using our own seasonal adjustment of the data). Metal prices increased as well during the month, which could boost the nominal figures for related components.
We forecast that the final University of Michigan consumer sentiment index for March will be 68.0, 0.2pt lower than reported in the preliminary data for the month and 9.5pts below the February level. The news since the
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preliminary data has been dominated by the earthquake and tsunami in Japan and the resulting crises unfolding in the country. Geopolitical unrest has also persisted in the Middle East and North Africa, and oil prices remain elevated. Equity markets in the US (and around the world) have been rattled by this run of bad news and uncertainty, which could also adversely affect sentiment. Even with all of this recent bad news, we do not expect too significant a drop in sentiment between the preliminary and final March readings. The preliminary data which account for about teo-thirds of the monthly samplealready showed a sizable decline from Februarys level, and downward revisions have been rare in recent years; in the 26 months reported since the start of 2009, there have only been five downward revisions between the preliminary and final readings for a month. We will also continue to monitor inflation expectations in the University of Michigan data. These measures perked up significantly in the preliminary March report, with one-year-ahead expectations jumping 120bp to 4.6% and longer-term expectations increasing 30bp to 3.2%.
Import prices (Mar 15)

%m/m nsa, unless noted Dec Import prices %oya Ex-fuel import prices %oya 1.2 5.1 0.3 3.0 1.4 5.3 Jan 1.5 5.3 0.8 3.4 1.3 5.4 0.7 Feb 0.7 6.1 0.6 4.0 1.4 6.9 0.3 3.6
The import price index increased 1.4% in February (+6.9%oya). The headline reading was boosted by a big jump in petroleum prices (+3.7%), but nonfuel prices rose 0.3% during the month as well (+3.6%oya). The prices of imported fuels, foods, chemicals, and metals have all been pushing noticeably higher in recent months, and we have also seen some firming in consumer goods prices. The prices of imported fuels and lubricants have been increasing steadily since late in 2010; the related price index jumped about 50%ar over the six months through February. Imported food prices have also been increasing significantly lately, though there was some modest cooling in prices in February; prices were up about 20%ar over the three months through February, after increasing at an annualized rate of almost 30% in the prior two months. The prices of imported chemicals and unfinished metals continued to rise significantly in February, though the pace of growth also slowed a bit relative to prior months. Prices of imported consumer goods increased 1.9%ar over the three months through February, after trending lower or being flat through most of 2H10. The recent increases have been driven by apparel prices (due to increased cotton prices), which have increased at an annualized rate of 8.8% over the three months through February; this was by far the largest three-month increase in the history of the series dating back to 1994. The recent upward pressure on import prices has occurred in imports to the US from all of the reported regions and countries, reflecting the global increases in commodity prices. The export price index for the US has also been increasing, up 9.8% over the year through February. Homebuilders survey (Mar 15)
sa Jan Housing market Present sales Prospective buyer traffic 16 15 12 Feb 16 17 12 Mar 17 17 12
Review of past weeks data

Empire State survey (Mar 15)
Diffusion indices, sa Jan General bus. conditions New orders Shipments Unfilled orders Prices paid Prices received Composite 11.9 12.4 25.4 -11.6 35.8 15.8 54.4 Feb 15.4 11.8 11.3 -4.8 45.8 16.9 53.6 Mar 15.5 17.5 5.8 1.6 2.6 53.2 20.8 51.9
The Empire State manufacturing survey increased from 15.4 to 17.5 in March, reaching its highest level since June 2010. However, several of the key measures within the survey weakened in March, and the ISM-weighted composite decreased from 53.6 to 51.9. The Empire State survey has not been a very reliable indicator of the ISM manufacturing survey in recent months. Within the Empire State surveys ISM-weighted composite, new orders declined from 11.8 to 5.8, and shipments fell from 11.3 to 1.6. Inventories declined from 9.6 to 3.9, and the orders-inventories gap reached its narrowest level (1.9) since November, which indicates slowing momentum for manufacturing growth. Delivery times slid down from 0.0 to -1.3. The main bright spot in the Empire State survey was the employment measure, which increased from 3.6 to 9.1 in March. The measure of the workweekwhich is not part of the compositealso looked encouraging, up from 6.0 to 15.6 in March, reaching its highest level in about 1 years. The price measuresalso not part of the compositehave pushed significantly higher in recent months. In March, prices paid increased from 45.8 to 53.3 and prices received increased from 16.9 to 20.8, with both measures reaching multi-year highs.
The NAHB survey finally increased to 17 in March after holding at 16 the prior four months. The homebuilders survey has yet to show any significant improvement since the end of the home buyer tax credit, increasing only 4pts from the trough reached in August and September; the data on new home sales and housing starts and permits (reported separately) have also been stuck at very low levels since the tax credits expiration. All of its NAHB surveys components remained near depressed levels, though the expectations measure increased from 25 to 27 in March. The present sales index held at 17 while prospective buyer traffic was unchanged at 12.
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All of the regional indexes remained at low levels in March, although it appears that homebuilding in the South and West regions has recovered somewhat better than activity in the Northeast and Midwest regions so far in 2011. The index for the South increased from 18 to 20 in March while the index for the West rose from 13 to 17; the Northeast index edged down from 21 to 20 and the Midwest index held at 12. Producer price index (Mar 16)
%m/m sa, unless noted Dec Finished goods %oya (nsa) Core %oya (nsa) Energy Cars Trucks Core intermed. Core crude 0.9 4.0 0.2 1.3 2.8 -0.4 0.2 0.4 3.5 Jan 0.8 3.6 0.5 1.6 1.8 -0.1 0.2 1.0 4.0 Feb 0.7 4.8 0.3 1.9 1.0 -0.1 0.1 0.9 1.6 5.6 0.2 1.8 3.3 0.6 -0.1 1.1 2.3
Housing starts (Mar 16)

Mn units, saar Dec Starts Single-family starts Multifamily starts Permits 0.52 0.42 0.10 0.63 Jan 0.60 0.62 0.41 0.42 0.18 0.19 0.56 Feb 0.55 0.41 0.14 0.57 0.48 0.38 0.10 0.52
The February report on housing starts and permits was very disappointing and showed continued weak housing market following the end of the home buyer tax credit. Most other economic indicators have shown some signs of revival (and even some strength) over the past six months, but housing starts and permits (as well as some other housing indicators) continue to look exceptionally weak. Single-family permitsperhaps the most important indicator of the trend in housing growthfell 9.3% in February to an annualized rate of 382,000 permits. February was the weakest month for permits in almost two years, and permits were only about 10% above the all-time low reported for the data series. Single-family starts dropped 11.8% in February to an annualized rate of 375,000 units, which was also the weakest reading in almost two years and close to the historic low for the series. All of the reported regions have shown comparable weakness since the end of the tax credit, though there have been fluctuations in some months due to severe weather and changes in building codes in some areas. Multifamily starts and permits are notoriously volatile, but have also remained very weak through the monthly fluctuations. Multifamily starts plunged 46.1% in February to an annualized rate of 104,000 units, after surging 87.4% the prior month. Multifamily permits declined 4.9% in February to an annualized rate of 135,000 permits; this was the second straight monthly decline after a 45.7% increase in December. The multifamily data for the different regions has been mixed, but remains depressed across the board. CPI (Mar 17)
%m/m sa, unless noted Dec Total %oya nsa Core %oya nsa Core services Core goods Food Energy Housing Owners eq.rent Rent Lodging away from home Apparel New vehicles Used vehicles Airfares Communication Medical care 0.4 1.5 0.07 0.8 0.1 -0.1 0.1 4.0 0.2 0.09 0.20 1.0 0.1 -0.1 -0.1 2.7 -0.6 0.2 Jan 0.4 1.6 0.17 1.0 0.1 0.2 0.5 2.1 0.1 0.10 0.16 -1.0 1.0 -0.1 -0.3 2.2 -0.2 0.1 Feb 0.5 2.2 2.1 0.16 0.20 1.1 0.2 0.2 0.4 0.6 4.0 3.4 0.3 0.11 0.14 0.17 0.14 -0.9 0.0 0.4 -0.9 -0.1 1.0 0.0 0.1 0.0 2.1 -0.3 0.0 0.2 0.4
The producer price index jumped 1.6% in February (+5.6%oya), the largest monthly increase in more than 1 years. The headline reading was boosted by sizable increases in food prices (+3.9%) and energy prices (+3.3%) in February. The core PPI (ex. food and energy) increased a tamer 0.2% in February (+1.8%oya), which is just a slight firming from the average monthly increases reported over the past year. The energy PPI has been pushing higher over the past half year reflecting the increases in energy prices reported around the world. The energy PPI surged almost 30% over the six months through February. Gasoline prices and jet fuel prices have been major factors in the recent run up in energy prices. The 3.9% increase in the food PPI was the largest monthly increase in more than 35 years, and was largely attributable to an increase in vegetable prices (+50%). The food PPI has leapt more than 20% saar over the three months through February, reflecting the rise in most measures of agricultural prices. The 0.2% increase in the core PPI was largely attributable to a 0.6% increase in passenger car prices. The core measure excluding light vehicles was also up 0.2% during the month, boosted by apparel prices (related to cotton prices). We believe that the firming in the core index in January (+0.5%) was partially the result of some seasonality in the data not captured by seasonal adjustment, and the February increase in the core was more in line with the trend we have been seeing lately. Data in the PPI release point to a 0.2% increase in the PCE medical deflator for February.
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The consumer price index increased 0.5% in February (+2.1%oya), largely due to higher food and energy prices. Food and energy prices have consistently boosted the headline readings in recent months, and the core CPI (ex. food and energy) has looked much softer. The core measure increased 0.2% in February (+1.1%oya), which showed some firming from the recent trend. Data from the CPI (as well as the PPI) indicate that the headline PCE price deflator for March should increase 0.4% (+1.6%oya), but the core PCE deflator should remain tame, up only 0.16% (+0.9%oya). The trend of higher energy and food prices carried over into February. Energy prices soared 45%saar over the three months through February, reflecting the upward pressure on energy prices around the world. Gasoline, fuel oil, and gas service prices posted sizable increases in February. As most measures of agricultural and food prices have increased recently, the food CPI jumped 5%saar between November and February (mainly due to prices for food at home); there was a sizable 6.7% jump in vegetable prices (not annualized) in February, and prices rose for most other categories of food as well. Within the core measure, both core goods and services increased 0.2% in February, which was on the high end of their respective recent trends. Owners equivalent rent firmed further in February, increasing 0.14% during the month after increasing close to 0.10% the prior four months. The pace of growth in tenants rent has slowed slightly in recent months, with a 0.14% increase reported for February. Airfares continued to push higher in February as jet fuel prices continued to rise; airfares increased 32%saar over the three months through February. Vehicle prices also picked up in February, with new vehicle prices increasing 1.0% during the month after four prior monthly declines, and used vehicle prices increasing 0.1%. Apparel priceswhich have been lifted recently as cotton prices shot upfell 0.9% in February after jumping 1.1% the prior month. Industrial production (Mar 17)
%m/m sa,unless noted Dec Industrial production Manufacturing Motor vehicles & parts High-tech Mfg ex motor vehicles Business equipment Capacity utilization (%sa) Manufacturing 1.2 0.9 0.2 2.1 0.9 1.0 76.2 73.5 1.3 1.1 0.3 3.2 1.1 1.5 76.3 Jan -0.1 0.3 0.3 0.9 3.2 4.5 1.2 1.9 0.1 0.7 0.9 1.8 76.1 76.4 73.7 74.1 Feb -0.1 0.4 4.2 1.2 0.9 0.2 0.5 76.7 76.3 74.5 74.3 0.9 1.1 6.4
Away from utilities, manufacturing production increased 0.4% and mining production jumped 0.8%. Manufacturing production is increasing at a strong annualized pace of 9.2% so far in 1Q11. Solid motor vehicle production has provided a lift to the manufacturing data so far this quarter, but away from motor vehicles and parts, manufacturing production is still increasing at an annualized rate of 8.6% during the quarter. The regional manufacturing surveys and the ISM manufacturing index all looked very strong in the data available so far for the quarter. Overall capacity utilization edged down in February from 76.4% to 76.3% due to the weakness in utilities production. Manufacturing capacity utilization increased from 74.1% to 74.3% in February, reaching its highest level since August 2008. Philadelphia Fed survey (Mar 17)
Diffusion indices, sa Jan General bus. conditions New orders Shipments Inventories Prices paid Prices received Composite 19.3 23.6 13.4 6.8 54.3 17.1 56.4 Feb 35.9 23.7 35.2 2.1 67.2 21.0 59.5 Mar 32.0 43.4 40.3 34.9 12.0 63.8 22.6 61.4
The Philadelphia Fed manufacturing surveys impressive run continued into March. The headline index jumped from 35.9 to 43.4 during the month, reaching its highest level since the 1980s. The indexs ISM-weighted composite pushed higher from 59.5 to 61.4, which was its highest level since 2004. The March Philadelphia Fed survey was much stronger than the Empire State survey (reported earlier), so we will look to additional regional surveys reported in the coming weeks to get a clearer picture regarding manufacturing activity during the month. Most of the gain in the Philadelphia Fed surveys ISMweighted composite was due to the a 16.6pt jump in the new orders index to 40.3, but the other components of the composite continued to look favorable in March. The measure of shipments edged lower from 35.2 to 34.9, while the delivery times index slid down from 10.0 to 8.5. The employment index dropped from 23.6 to 18.2, which is still a solid reading. The inventories index increased from 2.1 to 12.0, but with the big jump in orders, the orders-inventories gap widened 6.7pts to 28.3, which was the largest gap since October 2009. The price measures reported in the Philadelphia Fed survey remained at high levels in March, but did not rise significantly during the month like the price indexes reported in Empire State survey. The Philadelphia Feds measure of prices received edged up from 21.0 to 22.6, while its measure of prices paid declined from 67.2 to 63.8.
Industrial production declined 0.1% in February, but the details were much better than the headline reading implied. There were also upward revisions released to the data for December and January. Februarys headline print was dragged down by a 4.5% plunge in utilities production as warmer temperatures returned throughout the country after two months of unseasonably cold weather.
37
JPMorgan Chase Bank NA, New York Daniel Silver (1-212) 622-6039 daniel.a.silver@jpmorgan.com
Focus: core inflation firms modestly

The recently released data on prices for February showed energy and food prices continuing to push higher, reflecting the inflation pressure indicated by most related global price indexes. Higher food and energy prices led the consumer price index up 0.5% in February (+2.1%oya), while the producer price index increased 5.6%oya basis, and the import price index rose 6.9%oya. Core inflation pressure (excluding food and energy) remains mild, though there has been some firming recently; the core CPI rose 0.2% in February (+1.1%oya). The energy CPI soared 45%saar over the three months through February. The PPI and the import price index also showed large increases in energy prices in recent months. The food CPI increased at an annualized rate of 5% over the most recently reported three months, and the PPI and import price index showed much larger increases in food prices. The core services CPI increased 0.2% in February which was on the high side of the range of monthly increases reported over the past year. The core goods CPI increased 0.2% in both January and February, after falling in each of the last four months of 2010. The core PPI also firmed in recent months, and was up 1.9%oya in February. Within the components of the core CPI, the table shows tenants rent going up faster than owners equivalent rent in 1Q, though the monthly increases in tenants rent have moderated lately. Airfares have shot up recently, reflecting higher jet fuel prices. Apparel prices came down in February after jumping significantly in January. Vehicle prices picked up in February after having been soft for some time.
Consumer price index

Years are %Dec/Dec, quarters are %q/q, saar 2008 2009 CPI 0.1 2.7 1 1.8 1.8 Core Core ex shelter 1.6 2.9 Core goods -0.6 3.0 Core services 2.7 1.4 Food and beverages Housing Rent Owners' equivalent rent Apparel Transportation New and used vehicles New Used Medical care Recreation Education Communication Tobacco Personal care Core PCE deflator 3 Cleveland Fed median CPI
1. Core is ex food and energy. 2. 1Q11 is January and February data. Core PCE deflator is January data. 3. Quarterly values are averages of year-over-year changes
2010 3Q10 1.5 1.4 0.8 1.1 1.1 1.4 -0.4 0.9 1.3 1.2 1.5 0.3 0.8 0.3 -1.1 5.3 0.6 -0.2 3.7 3.3 -0.8 3.9 -1.1 5.6 0.7 1.4 0.7 0.8 0.3 0.7 0.5 1.7 4.7 2.2 1.2 6.3 2.2 -0.9 3.4 -0.2 12.8 2.1 0.5 0.5
4Q10 1Q112 2.6 4.9 0.6 1.7 0.5 2.0 -1.2 1.2 1.3 1.9 2.1 0.7 1.5 0.9 -2.0 12.3 -1.2 -0.5 -2.1 3.4 -1.5 2.5 -1.9 0.7 -0.4 0.5 0.6 4.3 1.6 2.1 1.3 3.3 19.1 0.0 1.0 -1.0 2.5 0.8 5.9 -3.2 3.2 1.5 1.1 0.9
5.8 2.4 3.4 2.1 -1.0 -13.3 -3.5 -3.2 -8.1 2.6 1.8 5.6 1.7 6.3 2.6 1.8 2.7
-0.4 -0.3 0.7 0.7 1.9 14.4 5.5 4.9 9.2 3.4 -0.4 4.7 0.1 30.1 1.5 1.8 1.2
Consumer prices
%oy a, nsa 6 4 2 0 -2 -4 05 07 09 11 Headline CPI %oy a, nsa Core CPI 3.0 2.5 2.0 1.5 1.0 0.5
Import prices
%3m, nsa 10 5 0 -5 -10 -15 -20 05 07 09 11 Ex. petroleum Import price index %3m, nsa 4 2 0 -2 -4
Producer price index for finished goods

%oy a, nsa 10 5 0 -5 -10 05 07 Core PPI 09 11 PPI
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JPMorgan Chase Bank, London Greg Fuzesi (44-20) 7777-4792 greg.x.fuzesi@jpmorgan.com Raphael Brun-Aguerre (44-20) 7777-0282 raphael.x.brun-aguerre@jpmorgan.com
Euro area
We still expect the ECB to raise rates in April, but unfolding events will have to be watched Incoming activity data are mostly positive Modest labor market gain in 4Q10, but with some positives in the detail In the past week, Euro area policymakers have made significant announcements aimed at tackling the sovereign debt crisis in the region, Japan continues to deal with the aftermath of the disastrous earthquake, and the Middle Eastern and North African (MENA) continues to experience significant political turmoil. One question that arises from all this is whether the ECB is still likely to follow through on its strong vigilance signal and raise its policy interest rate in early April. The EUs comprehensive policy package is supportive of an April move. The ECB would have liked the package to go further, but given that its announcement has not triggered renewed financial market stress, it will make it easier for the central bank to raise rates. In fact, we think that European policymakers are now doing enough to contain the sovereign stresses, even if Portugal could still be forced to seek external support. Regarding the crisis in Japan and the political tensions in the MENA region, it is still far too early to tell what their impact will be. But, in many ways, what matters is how they affect the ECBs view about inflation over the medium term. Clearly, these events could hurt global demand by hitting confidence, via negative wealth effects (due to lower equity prices), and by triggering another spike in the price of oil. All of this remains very hard to gauge. But, for now, we expect only a short-term impact on Japanese growth, given the need for significant reconstruction spending later this year, and are not minded to change our Euro area forecast. In addition to the impact on the Euro area economy, the ECB will also watch the inflation implications of any increases in energy prices. In the near term, a larger inflation hump would further raise the risk of second-round effects. And, in the medium term, the renewed concerns about the safety of nuclear energy, could add to the structural increases in global demand for fossil fuels, about which the ECB is already worried. In this context, Germany has already decided to shut almost half of its nuclear reactors for three months until thorough safety checks have been completed. Given that 23% of German electricity is generated using nuclear power, this has led to a spike in wholesale electricity prices this week.
Euro area inflation

%oy a, dotted line show s ECB target, core is ex food, alcohol, tobacco, energy 5 4 3 2 1 0 -1 2005 2006 2007 2008 2009 2010 2011 Core Headline
Euro area exports, IP and construction output

%q/q saar, latest observation shows January level over 4Q10 average 40 20 0 -20 -40 Construction Exports IP 4Q10 1Q11
2008
2009
2010
2011
We still expect the ECB to raise its main policy interest rate 25bp to 1.25% in early April. This is not because the ECB will be stubborn about following through on its strong vigilance signal; after all the central bank always makes clear that it never pre-commits. Instead, our sense is that a fundamental change in the economic outlook, and possibly some renewed financial stress, would be needed for the ECB to delay its rate normalization cycle. If there is still a sense that the recovery is likely to continue at a steady pace, then one or two quarters of softer growth would not suffice to delay a rate move. In this context, it is important to note that the Euro area business surveys in February were at a level far above that consistent with the ECB staffs growth forecast. This provides a significant buffer. Clearly, an open mind is needed given that the events are still unfolding, but for now we think that the bar for the ECB to postpone its rate move is set rather high.
A quick macro round-up

In this weeks reports, Euro area IP (ex. construction) rose 0.3%m/m in January, construction output rose 1.8%m/m, while exports to outside of the region surged 3.6%m/m. This leaves the January levels of IP, construction output and exports up 4%, 1%, and 15% annualized above the 4Q10 aver39
JPMorgan Chase Bank, London Greg Fuzesi (44-20) 7777-4792 greg.x.fuzesi@jpmorgan.com Raphael Brun-Aguerre (44-20) 7777-0282 raphael.x.brun-aguerre@jpmorgan.com
Economic Research Euro area March 18, 2011
age. We would expect IP to strengthen further in February, while the modest gain in construction output has to be seen in the context of large declines in 2H10 of over 10% annualized. And exports look to be picking up after a softer patch in late 2010. Overall, it is still unclear whether Euro area GDP will print in line with our 3%q/q saar forecast for 1Q11, but together with the relatively solid indicators on consumer spending so far, the data do not appear far off it. On inflation, the final report for February confirmed Euro area HICP at 2.4%oya in February, up one-tenth on January. Energy price inflation increased substantially, rising 1.1%-pts to 13.1%oya, while the food component also contributed to the rise. On the other hand, core inflation (ex. food, alcohol, tobacco, and energy prices) declined one-tenth to 1.0%. It is not entirely clear why core inflation fell. For example, in France, the statistics office noted that an extended period of seasonal sales contributed to decline in core inflation there, although this is hard to reconcile as a sign of weakness given that French consumer spending is still on a firm upward trajectory. Our expectation is that core inflation will move sideways in the next two months before drifting higher over the forecast horizon.
Euro area employment

DI, sa, box shows 4Q10 average to date 60 55 50 45 40 35 98 Employment (private, ex. construction) 00 02 04 06 08 10 PMI employment index 4 2 0 -2 -4 -6 %q/q saar
Level of employment
1Q06=100 106 104 102 100 98 96 94 2006 2007 2008 Core, excl. Germany Periphery 2009 2010 Germany
Labor market still soft in 4Q10

This weeks employment report for 4Q10 showed that the improvement in the labor market was still quite modest. The level of employment rose 0.6%q/q saar (209,000 jobs), which was a bit better than we had expected. But, hours worked per employee fell more than we thought, with only part of this related to the severe winter weather, especially in Germany. As a result, total hours worked in the Euro area economy were unchanged at the end of last year. This implies that the modest growth of GDP (1.1%q/q saar) was achieved entirely through another increase in hourly labor productivity, which had fallen during the recession due to the labor hoarding by firms. Looking ahead, at least, productivity has now recovered to around its pre-recession level, and the business surveys suggest that firms in the region are hiring again, which is encouraging. And, the 4Q10 national accounts showed a 1.7%q/q saar gain in consumer spending, despite the weakness in labor income. This suggests that important supports came either from higher nonlabor income or from a further decline of the household saving rate. These detailed income data are not yet available. By sector, employment rose just 0.2%q/q saar in the private sector and a more solid 1.2%q/q saar in the public sector. Part of the weakness in the private sector still reflects the
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Euro area GDP and employment

1H08=100 101 100 99 98 97 96 95 94 2008 2009 GDP 2010 2011 Employment Hourly labor productivity
ongoing housing market adjustments in some countries. Excluding construction, private sector jobs were up 0.7%q/q saar, all of this in services. This is only slightly below what the composite PMI employment index is implying. By country, the labor market adjustments are still ongoing in the periphery, but there are encouraging signs of a broaderbased improvement in core countries. Job growth was decent at around a 1%-annualized pace in Germany, France, Belgium, and Austria, while Italy saw a surprising jump in 4Q10 (1.6%q/q saar). In the periphery, employment fell another 1.1%q/q saar in Spain and by 2.3%q/q saar in Portugal (data on Ireland and Greece are not yet available).
JPMorgan Chase Bank, London Greg Fuzesi (44-20) 7777-4792 greg.x.fuzesi@jpmorgan.com David Mackie (44-20) 7325-5040 david.mackie@jpmorgan.com

Output and surveys

Real GDP
1Q10 Euro area %q/q sa 0.4 %q/q saar 1.5 %oya 0.8 France %q/q sa 0.3 %q/q saar 1.1 %oya 1.2 GDP components (%q/q saaar) Private consumption 0.3 Government consumption -0.1 Fixed investment -2.9 Exports 20.7 Imports 8.0 Contribution to GDP growth (%q/q saar) Domestic final sales -0.4 Inventories -1.3 Net trade 2.9 2Q10 1.0 4.0 2.0 0.6 2.4 1.6 1.2 0.9 3.7 11.6 15.6 1.6 2.1 -1.4 3Q10 0.3 1.4 1.9 0.3 1.0 1.7 1.9 1.3 1.8 10.9 16.4 1.8 1.1 -1.9 4Q10 0.3 1.1 2.0 0.3 1.4 1.5 3.4 1.4 1.6 3.1 -4.6 2.7 -3.7 2.4
Of course, that episode was different in many ways from the current crisis in Japan, the Middle East and North Africa. For example, the PMI was gradually declining already before the terrorist attacks occurred, whereas the trend has been impressively up in recent months. The details of the PMI have also been improving recently, suggesting that growth has been broadening out impressively beyond Germany and beyond manufacturing. Even the PMI in the periphery has picked up markedly. In addition, to the uncertainties created by the Japanese crisis, the survey could also be impacted by the recent increases in energy and commodity prices, and by the ECBs signal to raise interest rates. Overall, we have penciled in a decline of the Euro area composite PMI of 1.2pts to 57.0, which would still leave it signaling GDP growth at a 3% annualized pace. The uncertainty around this estimate is clearly quite high.
Fri Mar 25 7:00am
Euro area composite PMI output index

DI, sa, dotted line shows average from 2000 to 2007 65 60 Sep 2001
We do not expect any revisions in the final report of French GDP. Purchasing managers index flash (manufacturing)
Dec Thu Mar 24 10:00am 9:30am 9:00am Euro area Overall region Germany France 57.1 60.7 57.2 Dec Thu Mar 24 10:00am 9:30am 9:00am Euro area Overall region Germany France 54.2 59.2 54.9 Dec Thu Mar 24 10:00am 9:30am 9:00am Euro area Overall region Germany France 55.5 60.3 56.3 Jan 57.3 60.5 54.9 Jan 55.9 60.3 57.8 Jan 57.0 61.3 57.6 Feb 59.0 62.7 55.7 Feb 56.8 58.6 59.7 Feb 58.2 60.9 59.0 Mar 58.0 61.5 55.8 Mar 55.8 57.6 58.7 Mar 57.0 59.7 58.0
55 50 45 40 35 98 00 02 04 06 08 10
Purchasing managers index flash (services)
Purchasing managers index flash (composite)
Euro area composite PMI output index

Standard deviations from average over 2000 to 2007 period 2 0 -2 -4 -6 Euro area ex Germany 2007 2008 2009 2010 2011 Germany
The survey period for the flash PMI fully covers the time since the earthquake in Japan. The questionnaire would have reached firms on Friday, March 11, the day of the earthquake. And responses received through to next week Wednesday (March 23) will be included in the flash report. It is certainly possible that the PMI will be noticeably affected by the uncertainties created by the earthquake, at least in the near term. Following the terrorist attacks in the US in September 2001, the Euro area composite PMI fell 2pts in September and another 3pts in October, before then fully reversing those declines over the following three months.
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JPMorgan Chase Bank, London Nicola Mai (44-20) 7777-3467 nicola.l.mai@jpmorgan.com Raphael Brun-Aguerre (44-20) 7777-0282 raphael.x.brun-aguerre@jpmorgan.com
National business surveys

Dec Fri Mar 25 10:00am Thu Mar 24 8:45am Jan Feb 111.2 107.9 114.7 106 21 16 19.0 5.8 3.1 13.0 5.0 Mar 110.3 106.0 114.5 German IFO survey 2000=100, sa Business climate 109.8 110.3 Business expectations 106.8 107.8 Current conditions 112.9 112.8 French (INSEE survey - manufacturing) Index Composite index 102 108 Index of past production 9 20 Expected outputpersonal 13 19 Expected outputgeneral 10.0 11.0 Belgium (BNB survey) % balance of responses, sa Overall 3.1 4.5 Manufacturing 1.4 2.9 Commerce 5.6 8.3 Construction -2.0 -3.6
Demand and labor markets

Consumer confidence (prelim)
Wed Mar 23 4:00pm Dec Jan Euro area (European Commission survey) % balance of responses Consumer confidence -11.0 -11.2 Feb -10.0 Mar -11.0
Wed Mar 23 3:00pm
We would expect the increased uncertainties globally and the recent increases in energy and commodity prices to have an effect on the German IFO. In addition, firms will also be responding to the ECBs interest rate signal and possibly the slightly more mixed global data. As a result, we expect the headline index to fall from its record high in February to 110.3 in March. If this forecast is correct, then the IFO would remain at a very high level in March, signaling that the German recovery would still be expected to proceed at a very solid pace for now.
German IFObusiness climate
Idx, dotted line shows long-run average 110 105 100 95 90 85 80 90 95 00 05 10 Sep 2001
Euro area consumer confidence rose 1.2pts in February, returning almost to its recovery high. The March survey will have been conducted in the first two to three weeks of this month and will therefore not have fully captured the impact of the events in Japan. This could be similar to what occurred after the terrorist attacks in the US on September 11, 2001, when confidence fell just 0.4pt in the September survey before then declining 2pts in the October reading. As a result, we would expect the events in Japan to have only a small impact on the March survey. An additional negative impact could come from the ongoing uncertainties in the North African and Middle Eastern region and the increases in energy prices, while the improving economic backdrop in the Euro area should be a support. Overall, we expect consumer confidence to reverse Februarys increase, which would still leave it above its long-run average. Domestic consumption
Fri Mar 25 8:45am Nov Dec Jan France Consumption of manufactured products, real terms %m/m sa 2.6 0.4 -0.5 %oya sa 1.4 0.1 2.4 Feb
French consumption of manufactured goods may have increased in February. The large 7.2%q/q saar increase in 4Q10 was related to a significant extent by surging car sales, given that the car scrappage incentive expired in December. There was then payback in January, with car registrations falling 14%m/m. But, registrations surprisingly rebounded in February, rising 10%m/m. As a result, consumption of manufactured goods could increase again in 1Q11 (the January level was already 2.6%q/q saar above the 4Q10 average).
Manufacturing orders
Oct Wed Mar 23 11:00am Euro area Values New orders (%m/m sa) New orders (%oya sa) 1.4 17.9 Nov 2.1 16.7 Dec 2.4 18.8 Jan
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JPMorgan Chase Bank, London Greg Fuzesi (44-20) 7777-4792 greg.x.fuzesi@jpmorgan.com David Mackie (44-20) 7325-5040 david.mackie@jpmorgan.com
Financial activity and public finance

Money and credit data
Nov Fri Mar 25 10:00am Euro area M3 (%m/m sa) M3 (%oya) M3 (%oya 3mma) Private loans (%oya) 0.6 2.1 1.4 1.5 Dec -0.2 1.7 1.6 1.8 Jan -0.5 1.5 1.8 2.1 Feb 0.5 2.0 1.7

Output and surveys
Euro area %m/m sa %oya Nov 1.4 7.7 1.5 Dec -0.1 8.2 0.3 8.8 Jan 0.1 6.4 0.3 6.7
M3 growth remained modest in January, but was affected by some of its volatile components, which all fell. In February, we expect those to bounce back, thereby pushing headline M3 growth to 2.0%oya. Based on adjustments for portfolio shifts and other distortions, the ECB has calculated that M3 growth has been running in the range of 2%-4%oya recently. This is a bit firmer than the headline number, but still led it to conclude that underlying monetary expansion was signaling contained inflationary pressures over the medium-term. As the main driver of money growth, bank loans to the private sector have continued to improve gradually in recent months. Loans to nonfinancial corporates turned positive in January (0.4%oya), although firms do of course have ample internal funds to use instead of new bank loans. More impressively, household mortgages in particular have jumped at over a 7% annualized pace over the past two months. The ECB has said that this is not due to any statistical distortions, but is a reflection of the improved housing markets in some Euro area countries. Overall, loans to the private sector have picked up to 2.7%oya in January.
Eurostats measure of Euro area industrial production ex construction rose 0.3%m/m in January and is tracking a gain of 4% annualized so far in 1Q, a pace of increase that has normally been consistent with GDP growth of 3% ar. Across sectors, the rise in IP in January looks to have been driven almost entirely by intermediate goods production, which rose 2.5%m/m, and is up 9.3% ar so far in the quarter. Output fell across capital, consumer, and energy goods although, within the consumer goods category, durable consumer goods output rose 2.5%m/m and is up 9.4% ar so far in 1Q. Across the region, German production (ex construction) was broadly flat in January and is up only 2.4% ar so far in 1Q. While this would be the weakest quarterly development in German industrial output over the past eight quarters, strong orders developments and high survey readings point to stronger output growth over the next few months. Elsewhere in the region, French output rose 1.1%m/m in January and is up a robust 8.1% ar in the quarter, which would be a significant reacceleration after three quarters in which growth averaged less than 4% ar. In Italy, on the other hand, production was disappointing, with the index falling 1.5%m/m in January and tracking a decline for the second consecutive quarter so far in 1Q. The weakness of Italian IP is surprising in the light of strong survey readings in January and February; we expect a rebound in Italian IP ahead. In the Euro area periphery, IP rose strongly in Spain (1.4%m/m), with the index tracking a solid 5.3% ar gain so far in 1Q. This would be the firmest quarterly development in Spanish IP for seven quarters. Meanwhile, Irish IP fell 1%m/m, but after a 3.1% gain in December; so far in 1Q, it is tracking a 3% ar increase. Less good news came from Portugal, where a 4.2%m/m IP decline in January more than offset a 4% gain in December. So far in 1Q, Portuguese IP is tracking a 5.3% ar contraction, after a 6.3% ar fall in 4Q. Finally, Greek IP fell 0.9%m/m; it is tracking a modest decline of 1.3% ar so far in the quarter. Manufacturing orders
Euro area loan growth

%oya, loans to nonbank private sector, adjusted for securitizations 12 9 6 3 0
99
01
03
05
07
09
11
Italy Values New orders (%m/m sa) New orders (%oya sa)
Nov -4.3 10.1
Dec 5.4 13.5
Jan -0.3 14.2
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JPMorgan Chase Bank, London Nicola Mai (44-20) 7777-3467 nicola.l.mai@jpmorgan.com Raphael Brun-Aguerre (44-20) 7777-0282 raphael.x.brun-aguerre@jpmorgan.com
Demand and labor markets

Employment
Euro area Sa 000s, diff. q/q %q/q %oya 2Q10 97 0.1 -1.3 159 -0.6 3Q10 -48 0.0 -1.8 -29 -0.1 4Q10 50 0.0 0.1 209 0.1 0.2
Inflation
Consumer prices
Euro area (final) HICP (%m/m nsa) HICP (%oya nsa) HICP (%oya core-X)1 HICP (%oya core-XX)2 HICP (%m/m ex-tobacco) France %m/m nsa Index ex tobacco nsa %oya nsa HICP (%oya) Italy (final) %m/m nsa %oya nsa HICP (%oya nsa) Dec 0.6 2.2 1.1 1.0 0.6 Jan -0.7 2.3 1.2 1.1 -0.7 Feb 0.4 2.4 1.2 1.1 0.4
1.1 1.0
Please see this weeks Euro area essay for commentary about the 4Q10 employment report.
External trade and payments

Foreign trade
Euro area bn, sa Trade balance Trade balanceyear earlier Exports %m/m sa Imports %m/m sa Nov Dec Jan -3.3 1.1 0.9 139.4 3.6 142.7 5.3
0.5 -0.2 0.6 0.5 120.03120.61 120.09120.32 121.00120.90 1.8 1.8 1.8 1.7 2.0 1.9 2.0 1.9 1.8 0.4 1.9 2.1 0.4 2.1 1.9 0.4 2.4 2.1 0.3
-3.2 -2.0 -2.3 -1.1 2.8 1.7 2.4 2.0 133.2 134.8 132.6 134.5 0.0 0.4 -0.4 -0.2 136.4 136.8 134.9 135.6 4.9 4.8 -1.1 -0.9
Euro area exports rose strongly in January, after a run of weaker reports. The 3.6%m/m surge put the level in January 15% annualized above the 4Q10 average. If this is maintained in the coming months, it would mark a noticeable reacceleration after a soft patch in late 2010. Trade flows between Euro area countries were slightly softer, but total (intra and extra) Euro area exports are still tracking a 8% gain so far in 4Q10.
Euro area nominal trade flows
Jan07=100, to outside the Euro area 120 110 100 90 80 Imports
The Euro area final inflation release confirmed that headline HICP inflation rose one-tenth in February. The rise was mainly driven by energy price inflation, which rose 1.1%-pts to 13.1%oya. In particular, transport fuel price inflation increased 1.1%-pts to 16.1%oya and household liquid fuel price inflation increased 5.8%-pts to 30.5%oya. Food price inflation (including alcohol and tobacco) also increased substantially to 2.3%oya, on the back of higher agricultural commodity prices. Core inflation, on the other side, declined one-tenth to 1.0%oya. This move down was driven by lower core goods price inflation, down 0.4%-pt to 0.1%oya. Indeed, core goods inflation suffered from the extended sales period in some countries, which have seen higher-than-expected price cuts. In France, headline HICP inflation moved down two-tenths. This outcome results from the sharp drop in core goods price inflation to 0.5%oya (due to the extended sale period), while service price inflation rose 0.3%-pt. Meanwhile, energy price and food price inflation rose a few tenths. In contrast, Italian headline HICP inflation rose two-tenths, pushed up by higher service price inflation, up two-tenths on the month, and higher food price and energy price inflation, reaching 9.9%oya and 1.9%oya, respectively. Producer prices
Germany %m/m nsa %m/m sa %oya nsa Dec 0.7 1.0 5.3 Jan 1.2 1.1 5.7 Feb 0.7 0.7 6.4
Exports
2007
2008
2009
2010
44
JPMorgan Securities Japan Co., Ltd. Masamichi Adachi (81-3) 6736-1172 masamichi.x.adachi@jpmorgan.com
Japan
Earthquake, tsunami, and nuclear plant crisis generate unprecedented uncertainty for economy and markets BoJ injects abundant liquidity into banking system, while increasing the size of asset purchase program Ongoing developments at the Fukushima nuclear plants are the near-term focus A catastrophe on a scale never faced by Japan since the end of WWII is still unfolding at the time of this writing. Although the situation has calmed somewhat from the middle of week, the concern that things may worsen lingers. We are relatively optimistic that the current crisis situation will stabilize in coming days, but uncertainty remains extremely high. In such a situation, significant market volatility is to be expected. The yen appreciated to a record high of 76 level against the USD on Thursday, and the Nikkei plunged on Monday and Tuesday, while the JGB market has been relatively calm. Against this backdrop, the BoJ has been injecting liquidity aggressively into the banking system, and the Bank eased policy by expanding the size of its asset purchase program to 10 trillion from 5 trillion . More impressively, the G-7 agreed to conduct coordinated USD purchases against JPY on Friday. At 9 am Tokyo time, the MoF/BoJ intervened in the USD/JPY market. The US, UK, Canada, and the ECB joined in when their markets opened. In terms of the economic outlook, the large shock likely will pull down the economy in 2Q, but we expect a rebound in 2H. Our updated forecast looks for 1.2% annualized growth in 1Q (revised down from 2.2%), a 1.0% contraction in 2Q (from +2.2%), a 3.0% growth on average in 2H (up from 2.3%), and higher growth in 2012, though our conviction on these numbers is not high at the moment (see more details on our views in the research note, Japan to recover from the disaster, but will take time, in this GDW).
Real GDP
%q/q saar 6 4 2 0 -2 2010 2011 2012 Previous forecast ( a week ago) Current
Nikkei Dow 225 equity price index

Index 11000 10500 10000 9500 9000 8500 Jan 3, 11 Jan 24, 11 Feb 15, 11 Mar 9, 11 Mar 31, 11
the total dead or missing was 16,893 at 2 pm on March 18, but it looks certain that the number will increase in coming days and even months. In addition, there are 382,612 people at the evacuation shelters. The tragedy has not ended here. The Fukushima Daiichi (Daiichi means first) nuclear plant (consists of 6 operating nuclear reactors), located 227 kilometers (km) northeast of Tokyo, was damaged by the tsunami, and there has been leakage of radiation due to the subsequent accidents throughout this week. The radiation leaked so far has not been considered to be dangerous, especially outside of the evacuation area, which has been expanded to a 20km radius (in addition, people within a 30km radius outside the evacuation area are recommended to stay indoors). But, some people, especially foreigners, have started to evacuate from Tokyo or Japan. The government has focused on cooling down the sites to prevent further damage to the reactors and spent nuclear fuel that would lead to a significant leakage of radiation. So far, we have not heard significant news on these efforts that began on Thursday. Meanwhile, the dose rate of radiation rose sharply at midday on Wednesday in many places, including Tokyoalthough the level observed was far below the danger zone. It has fallen to a very low level from Wednesday afternoon, suggesting that the leakage has been stabilizing.
45
What has happened over last seven days?

The immediate shock from the mega earthquake (9.0, initially reported 8.8 but subsequently revised up) that hit Japans northeast coast on March 11 was catastrophic, even shaking our office in central Tokyo. It can only be described as scary. The damage from the earthquake itself should be significant in the region close to the seismic area, but more damage was caused by the tsunami after the quake. The height of the wave is said to exceed 10 meters in many places. According to the National Police Agency,
JPMorgan Securities Japan Co., Ltd. Masamichi Adachi (81-3) 6736-1172 masamichi.x.adachi@jpmorgan.com
Economic Research Japan March 18, 2011
While the events at the Fukushima plants have dominated the concern, the power shortage due to the accidents at these plants and some thermal power stations has been caused considerable inconvenience even in the Tokyo region. Rail transit has been reduced by more than 20%, while so called scheduled power outage, rotating power shutdowns, has affected millions of households and firms around the Tokyo area. Even though the outages were scheduled, residents were initially generally unprepared, thereby intensifying the disruption. In addition, there has been many large aftershocks of the quake. Given the immense uncertainty, people rushed to purchase food, causing some shortages, such as for bread and milk. Also, some have evacuated to western parts of Japan or abroad. However, it is important to note that there is no sense of panic.
BOJ current account balances

Yen tn, outstanding, daily 35 30 25 20 15 10 5 2008 2009 2010 2011
Reuters Tankan business confidence

Index 50 25 0 -25 -50 -75 -100 2007 2008 2009 2010 2011 Nonmanufacturing Manufacturing
BoJ injected record liquidity into banking system

The BoJ on Monday increase the size of the Asset Purchase Program (APP) to 40 trillion from 35 trillion. Regarding the purchase of an additional five trillion yen in assets, Governor Shirakawa stated at the press conference that the BoJ increased the portion of risk assets relative to risk-free assets. The amount of the BoJs purchase of risk assets (commercial paper, corporate bonds, ETFs ,and J-REITs) under the new facility of the APP will be 3.5 trillion, as opposed to 1.5 trillion for the risk-free assets (JGBs and short-term government bills). According to Shirakawa, the rational for the change in the weighting in favor of risk assets is the increased risk that the spread between JGBs and corporate bonds, as well as between short-term government bills and commercial paper, would widen. Prior to the monetary policy meeting on Monday, the BoJ offered to inject 15 trillion into the overnight call market, its largest single operation ever, to meet the significant increase in banks precautionary demand for liquidity, although the actual amount taken by banks was 8.9 trillion. The reason that the actual amount of money injected was short of the BoJs offered amount was that banks did not rush to secure the liquidity, as they were convinced that the BoJ would provide as much liquidity as they want going forward. Large injections, mainly through overnight lending, continued throughout this week, leaving the size of the Banks current account balances at 31 trillion, the highest level since March 2006 when the BoJ conducted outright quantitative easing policy. It seems likely that the large liquidity injection will continue until the situation stabilizes. Meanwhile, the banking system (settlement and transactions) as
46
well as the equity market have not been damaged or trading suspended by the catastrophe, while one of the large banks ATM system suffered difficulties from Thursday.
Business sentiment was good before the disaster

Indicators released this week reiterated that economic activity had been picking up solidly until the earthquake. In the Reuters Tankan large firm survey for this month, which was conducted between late February and early March, the headline manufacturers business conditions DI edged up to 15, 8 pts above the recent bottom marked in December last year. The nonmanufacturing DI stayed at 3 reached in February, when it posted its first positive reading (which indicates that the conditions, on net, are good) since April 2008. Obviously, firms sentiment should have changed dramatically after the catastrophe. We will receive the first look at how sentiment has been affected by the disaster from the Manufacturing PMI (due on March 31) and the BoJ Tankan (April 1), for which most of the responses were probably collected after March 11. However, these surveys may be misleading as some respondents may not have answered the survey, being overwhelmed by dealing with the disaster.
JPMorgan Securities Japan Co., Ltd. Miwako Nakamura (81-3) 6736-1167 miwako.nakamura@jpmorgan.com

During the week
Thu Mar 24 8:50am
Customs-cleared international trade

bn sa, unless noted Nov Balance Exports (%m/m) Imports (%m/m) Balance (nsa) BoJ real export index (%m/m) BoJ real import index (%m/m) 468 2.1 5.5 159 -1.8 1.1 Dec 580 5.4 3.7 726 7.0 -2.1 Jan 192 1.0 8.5 -475 -5.8 3.4 Feb 720 6.0 -3.0 802 ___ ___
Nationwide department store sales

%oya, unless noted Nov Overall %m/m sa, by J.P. Morgan Same store -1.4 -1.3 -0.5 Dec -2.3 3.1 -1.5 Jan Feb -2.0 -2.8 -2.3 1.1.01.0 -1.1 ___
Based on the upbeat tone of major stores, we think department store sales, a proxy for luxury goods consumption, are picking up from extremely low levels.
Tue Mar 22 1:30pm
Index of all-sector activity

%m/m sa Oct All sector Tertiary sector Industrial production Construction Public sector -0.3 0.3 -2.0 0.5 0.0 Nov -0.2 0.6 1.0 -3.1 -0.7 Dec -0.2 -0.9 3.3 -0.1 0.0 Jan 2.6 2.1 1.3 ___ ___ Fri Mar 25 8:30am
The weakness in January exports was puzzling, as survey reports showed that manufacturers had become increasingly upbeat about rebounding foreign demand (prior to the massive earthquake last week). Hence, we think the January weakness was mainly due to the distortion from the Lunar New Year holidays in Asian trade partners and look for a meaningful rebound in February.
%oya
Consumer prices
Dec Tokyo Overall Core (ex fresh food) Ex food and energy Nationwide Overall Core (ex fresh food) Ex food and energy -0.1 -0.4 -0.5 0.0 -0.4 -0.7 Jan -0.1 -0.2 -0.3 0.0 -0.2 -0.6 Feb -0.1 -0.4 -0.3 0.0 -0.3 -0.6 Mar -0.1 -0.3 -0.3
METI all-sector activity indices

%3m/3m, saar 16 8 0 -8 -16 Mining and manufacturing 64 32 0 -32 -64
Fri Mar 25 8:50am
Tertiary sector 2007 2008 2009 2010 2011
We expect the rate of oya decline in the nationwide core CPI to increase again in February, after falling 0.2%-pt in January. Available data suggest a smaller boost from energy, and the preliminary Tokyo February report, where the rate of decline in the core core measure remained the same as in the previous month, implies that the underlying pace of the CPIs exit from deflation is very gradual. Corporate services prices
%oya Nov Overall Ex international transport -1.1 -1.2 Dec -1.3 -1.3 Jan -1.1 -1.0 Feb -1.2 ___
The corporate service price index for February probably extended its steady decline since mid-2010, on the back of still large economic slack.
47
JPMorgan Securities Japan Co., Ltd. Miwako Nakamura (81-3) 6736-1167 miwako.nakamura@jpmorgan.com
Economic Research Japan March 18, 2011

Industrial productionfinal (Mar 14)
%m/m sa Nov Production Shipments Inventories Inventory/shipments ratio Operating ratio Production capacity (%oya) 1.0 2.6 -1.8 -8.3 1.6 1.9 Dec 3.3 1.2 1.6 0.4 3.0 1.6 Jan 2.4 1.1 4.7 0.7 ___ ___ 1.3 0.6 4.0 -0.2 3.6 1.8
The report, from a survey conducted on February 15 prior to the March 11 earthquake, was broadly consistent with our previous view that the economy was rebounding solidly after contracting at the end of 2010. Now, the prospects for the economy are highly uncertain, and we need to wait for indicators compiled after the quake to assess its impact. Reuters Tankan survey (Mar 17)
DI, % saying good minus bad Jan Manufacturing Nonmanufacturing 11 -2 Feb 14 3 Mar ___ 15 ___ 3
Consumer sentiment (Mar 14)

Diffusion index, nsa Dec Jan Feb 42.0 40.6 Consumer sentiment 40.1 41.1 Standard of living 42.2 42.7 ___ 41.5 Income growth 40.8 41.0 ___ 40.6 Labor market conditions 36.4 38.6 ___ 38.8 Durable goods purchases1 40.8 41.9 ___ 41.5 1. The DI asks whether a respondent thinks that now is a good time to purchase durable goods.
The report, which was conducted between late February and early March, reiterated that economic activity had been picking up solidly. The massive earthquake now calls that view into question. The headline manufacturers business conditions DI edged up to 15, 8pts higher than the recent bottom marked in December last year. The nonmanufacturing DI stayed at 3 reached in February, when it posted a positive reading (which indicates that the conditions, on net, are good) for the first time since April 2008. Respondents comments suggest that further improvement in manufacturers sentiment reflected increasing volume of shipments/orders that were more than offsetting the drag from the rapid rise in input costs, and that consumers were increasingly willing to spend, though not very willing to purchase a home. Index of tertiary sector activity (Mar 17)
% change Nov Dec -0.8 -0.9 1.8 Jan 0.8 2.1 0.0 1.4
The headline index for February gave back part of the solid January gain, but stayed slightly above its 4Q average (40.5). That said, the massive earthquake that struck the east coast of Japan on March 11 is now weighing on consumer sentiment across the country. So it is hard to take much meaning from this release. The first monthly indicator which should show how the disaster has impacted sentiment will probably be the March Economy Watchers survey to be released on April 8. MoF business outlook survey (Mar 16)
DI, upward minus downward 4Q10 Large firms All industries Manufacturers Nonmanufacturers Small firms All industries Manufacturers Nonmanufacturers -5.0 -8.0 -3.4 -18.4 -10.0 -20.1 FY2010 4Q10 9.5 12.7 7.8 1Q11 ___ -1.1 ___ -3.2 ___ 0.0 ___-23.3 ___-26.7 ___-22.5 actual ___ 6.9 ___ 11.0 ___ 4.8 2Q11 ___ 1.5 ___ 4.0 ___ 0.2 ___-14.1 ___ -5.5 ___-15.9 FY2011 1Q11 ___ -0.5 ___ 1.6 ___ -1.7
%m/m sa %oya
0.5 0.6 2.4 2.5
The January index sent an upbeat message about the economy before the earthquake, as did other available indicators. It rose much more than it had fallen the previous month, to the highest level since November 2008. The strength was broad-based across sectors, with ten of thirteen subindices, including wholesale trading, retail trading, information/insurance, showing m/m increases. Construction spending (Mar 17)
% change Nov Public Private Residential Nonresidential Building and structures Civil engineering -13.9 7.0 1.9 13.3 13.2 13.4 Dec -15.1 11.3 1.1 23.9 14.8 35.2 Jan ___-13.9 ___ 12.8 ___ 2.7 ___ 25.6 ___ 19.4 ___ 33.8
FY2010 capex plans, %oya All industries Manufacturers Nonmanufacturers
The large manufacturers sentiment DI improved in 1Q, after dropping to a negative reading in 4Q (it had posted positive readings in each of the five quarters through 3Q). The details suggest that this reflected a reacceleration of foreign demand, as well as meaningful improvement in domestic demand. In addition, the Capex and the Employment DIs, overall, pointed to higher resource utilization, albeit modestly.
48
JPMorgan Chase Bank NA, New York Sandy Batten (1-212) 834-9645 sandy.batten@jpmorgan.com Silvana Dimino (1-212) 834-5684 silvana.dimino@jpmorgan.com
Canada
Output growth in 1Q off to a stellar start Incoming source data already posing risk to our above-consensus 1Q GDP forecast Oya core inflation rate falls to all-time low, but this is likely cycle trough After the sharp widening in the real trade deficit in January pointed to trade exerting a major drag on overall growth in 1Q, January data released this week showed that the Canadian economy started 1Q with a bang as both manufacturing and wholesale sales rose more than expected. Existing home sales slipped a bit in February, continuing the string of tepid reports on housing. And consumer prices remained benign in February with the core rate falling to an all-time low. Manufacturing sales increased a much larger-than-expected 4.5%m/m in January to their highest level since October 2008. The monthly increase in total sales was the largest since a 5.3% jump in July 2009. Real manufacturing sales rose even moreup 5.5%m/m. While the January gains were widespread (shipments rose in 17 of 21 industries), the increase was mostly concentrated in the transportation equipment sector. Sales of motor vehicles soared 26.0% in January. The gain reflects large increases at a number of assembly plants following slowdowns and production difficulties in December caused by severe weather conditions in southern Ontario. Related to the rise in motor vehicle assembly, sales in the motor vehicle parts industry rose 23.2%. Even excluding the jump in motor vehicle sales, other shipments rose 2.9%m/m in January. Other parts of the report were also quite strong. Inventories rose 1.2% in January. Unfilled orders rose 1.6% in January, mostly reflecting an increase in the aerospace product and parts industry. The overall gain was the first increase since August 2010. And new orders increased 8.6%in January. Wholesale sales jumped 1.5% in January, mainly as a result of higher sales in the motor vehicle and parts and the miscellaneous subsectors. In volume terms, wholesale sales were up 1.6% in January. Wholesale sales increased for the sixth consecutive month in January, with five of the seven subsectors advancing. The motor vehicle and parts subsector (+4.9%) posted the largest increase. Sales in that subsector rose to the highest level since June 2007. Inventories rose 1.8% in January, the largest monthly increase since January 2007.
Consumer prices
%oya 5 4 3 2 1 0 -1 98 Core Total
00
02
04
06
08
10
Contributions to Canada total CPI inflation

%-pt cont to oya %ch Total Jan 10 1.9 Feb 10 1.6 Mar 10 1.4 Apr 10 1.8 May 10 1.4 Jun 10 1.0 Jul 10 1.8 Aug 10 1.7 Sep 10 1.9 Oct 10 2.4 Nov 10 Dec 10 Jan 11 Feb 11 2.0 2.4 2.3 2.2 Food 0.2 0.2 0.2 0.2 0.1 0.1 0.1 0.2 0.3 0.3 0.2 0.2 0.3 0.3 Energy 0.7 0.4 0.5 0.9 0.5 0.1 0.7 0.4 0.5 0.8 0.6 1.0 0.8 1.0 HST 0.0 0.0 0.0 0.0 0.0 0.0 0.7 0.7 0.7 0.7 0.7 0.7 0.8 0.8 Other 0.9 1.0 0.6 0.8 0.8 0.8 0.3 0.4 0.4 0.6 0.5 0.4 0.4 0.1
With 2/3 of the key source data in for January GDP, the month is shaping up to be quite strong. And with our expected rise in retail sales (released March 22), monthly GDP should accelerate in January from the 0.5% rise in December. Consequently, 1Q would be off to a very strong start with upside risk even to our expectation for a 4.0%q/q saar increase and clearly for the BoCs 2.5% expectation. We continue to look for the Bank to remain on hold in the midst of the elevated global turmoil and uncertainty (now exacerbated by the Japanese earthquake) and benign domestic inflation (see below). However, with the economy picking up steam and policy still quite accommodative, it is only a matter of time before the Bank will restart its normalization of policy. We look for a 25bp hike in the overnight rate at the May 31 announcement. The Canadian total CPI rose 0.3%m/m nsa in February, the same monthly increase as in January. When seasonally adjusted, the total CPI was unchanged in February after a 0.3%m/m increase in January. The over-year-ago total CPI inflation rate slowed slightly in February to 2.2% from 2.3% in January and 2.4% in December. The core index rose 0.2%m/m nsa in February after having been un49
JPMorgan Chase Bank NA, New York Sandy Batten (1-212) 834-9645 sandy.batten@jpmorgan.com Silvana Dimino (1-212) 834-5684 silvana.dimino@jpmorgan.com Silvana Dimino (1-212) 834-5684 Silvana.Dimino@jpmorgan.com
Economic Research Canada March 18, 2011
changed m/m in January. When seasonally adjusted, the core index edged down 0.1%m/m after a 0.1% rise in January. The over-year-ago core rate fell to 0.9% from 1.4% in January. This was the lowest oya core rate in the history of the series dating back to 1984. Looking through the monthly volatility, the 3-month rate of core inflation fell to 0.7% saar from 1.0% in January, and the 6-month rate fell to 1.2% saar from 1.6%. Note that the oya rate of headline inflation continues to be elevated by increases in provincial sales taxes (in July 2010 and in January 2011), which are adding about 0.8%-pt to headline inflation (indirect taxes are excluded in calculating the core measure). Adjusting for this (which the BoC has stated it will ignore in evaluating inflation), both inflation measures are safely below the BoCs 2% target. A significant part of the drop in the oya core rate in February was due to a very favorable base effect, not a sharp softening of the inflation environment. Travel accommodation prices last February soared, boosted by the Vancouver Winter Olympics, and thereby pushed up the core rate. This jump in accommodation prices obviously did not occur this February, and so this depressed the core rate. Given the oneoff factor behind the sharp drop in the core rate, the February reading is probably the cycle low for the oya rate. Energy (notably gasoline) prices continued to make a major contribution to total oya inflation. They were up 10.6%oya in February versus a 9.0%oya increase in January. However, seasonally adjusted transportation prices (which include gasoline were up only 0.2%m/m in February after a 1.0% monthly jump in January). Also, food prices remain benignup 2.1%oya in February, the same increase as in January. Seasonally adjusted food prices were up just 0.2%m/m in February versus a 0.4% monthly rise in January.
Tue Mar 22 8:30am
Retail sales
%m/m sa, unless noted Oct Total %oya Ex autos %oya Ex autos & gasoline %oya Real retail sales %oya 0.8 3.7 0.8 3.5 -0.1 1.8 -0.1 2.8 Nov 1.5 5.4 0.9 4.4 0.9 2.9 1.5 5.3 Dec -0.2 4.9 0.6 4.6 -0.6 2.1 -0.4 4.4 Jan 1.2 5.2 1.0 3.4 0.8 0.7 0.7 4.7
A strong rebound is expected in January retail sales with increases expected in most categories. Large retailers reported strong over-year-ago increases in many categories, and consumer sentiment in January was upbeat. Auto sales will no doubt be one of the largest contributors to the increase as auto sales surged in January with many Canadian auto makers reporting record January sales. A big lift will also come from gasoline station sales due to higher gasoline prices as occurred in December. Outside of higher prices at the pump, mild inflation pressures will boost the level of real retail sales.

New motor vehicle sales (Mar 15)
Sa Nov Total (mn units, ar) %m/m %oya %m/m sa, unless noted Nov Sales New orders Unfilled orders Inventories Inventory-shipments ratio -0.6 0.6 0.2 1.1 1.35 -0.9 -0.3 -0.4 0.9 1.34 Dec 0.4 0.6 -1.9 -1.0 -1.6 -1.8 0.0 -0.2 1.34 1.33 Jan 4.0 4.5 6.0 8.6 0.0 1.6 2.0 1.2 1.32 1.29 1.617 1.622 0.1 0.2 6.9 7.2 Dec 1.539 1.528 -4.8 -5.8 1.4 0.8 Jan 1.665 1.577 3.0 3.2 9.8 4.4
Manufacturing report (Mar 16)
Wholesale sales (Mar 17)

Sa Nov Total,%m/m %oya 1.0 6.2 1.1 6.5 Dec 0.8 5.8 0.9 6.2 Jan 2.2 5.6 1.5 5.2
Consumer price index (Mar 18)

Tue Mar 22 8:30am
%m/m nsa, unless noted Dec Total CPI %oya BoC Core CPI %oya Ex food & energy %oya CPI-XFET (%oya) 0.0 2.4 -0.3 1.5 -0.4 1.6 1.0 Jan 0.3 2.3 0.0 1.4 -0.1 1.6 0.9 Feb 0.5 2.4 0.4 1.1 0.4 1.3 0.3 2.2 0.2 0.9 0.3 1.2 0.4
Leading indicators
%m/m Nov Smoothed (5 mth movavg) Unsmoothed 0.4 -1.2 Dec 0.4 1.3 Jan 0.3 0.4 Feb
50
Banco J.P.Morgan, S.A., Institucin de Banca Mltiple, J.P.Morgan Grupo Financiero Gabriel Casillas (52-55) 5540-9558 gabriel.casillas@jpmorgan.com Iker Cabiedes (52-55) 5540-9339 iker.x.cabiedes@jpmorgan.com
Mexico
We now expect front-loaded action from Banxico in 4Q11
Manufacturing and construction output %oya 20 10 0 -10 -20

2004 2005 2006 2007 2008 Construction
Manufacturing
Very limited direct impact from Japans earthquake

and tsunami Strong IP in January supports our 4.5% GDP growth forecast for 2011 Banco de Mxico today published the minutes of its monetary policy meeting that took place on March 4. In our view, the message conveyed was very similar to the one from the latest post-meeting communiqu. In particular, with the balance of risks for inflation having deteriorated, the board opened the door for rate hikes later this year by adding the word timely to its assessment on when it could opt to adjust monetary policy. However, the minutes contained more details about the debate that took place among board members, and we believe that the bias is definitely a more hawkish one. We highlight the boards concerns about the potential contamination of inflation expectations from rising commodity prices, particularly because of two issues: (1) The expectations channel, in our view, is the most important channel of transmission of monetary policy, being in an economy with a relatively low credit ratio to GDP (less than 15%); and (2) It is our belief that it is just a matter of time before the Minister of Finance decides to increase the gasoline price monthly adjustment, and this could be the trigger a deterioration of short- and medium-term inflation expectations. In this context, the gap between the international reference and the domestic sales price is now around 20%. As a result, we are changing our rate call and now expect a rate hike in Q411, instead of Q212. In fact, we now believe Banxico will act sooner not to combat inflation, but to battle any sort of contamination of inflation expectations, that could be boosted by higher or persistently high commodity prices, particularly energy prices. We believe it is difficult to pinpoint the timing of a rate hike as Banxico has not expressed a willingness to hike rates but rather a commitment to fight inflation. Nevertheless, taking into account the current lack of demand-side inflation pressures, our optimistic appraisal of inflation for this year, and the low probability of higher energy prices in 1H11, we believe that Banxico will not lift its reference rate until 4Q11. In this context, Banxico should raise the reference rate to 5% this year (currently at 4.5%) to anchor inflation expectations and should pause there, and then re-
2009
2011
Source: INEGI
sume rate hikes in 2H12 as part of a normalization process to raise rates to 6% by year-end 2012, and to 6.5% by the end of 1Q13.
Very limited direct impact from Japans earthquake and tsunami

We believe there will be very limited direct impact from Japans catastrophe on the Mexican economy. Even though Mexico is one of the very few countries that has signed a free trade agreement with Japan, Mexican exports to Japan represent only 0.6% of the total exports. According to Japans MoF, Mexican exports to Japan consist mainly of nonferrous metals, auto parts, electric and electronic machinery, optical and scientific instruments, fish, pork meat, and certain fresh fruits and vegetables, but as we had mentioned, these goods only account for 0.6% of total exports. On the other hand, however, Mexico imports around 5% of its total imports from Japan. The Japanese MoF states that 90% of the goods purchased by Mexico are capital and intermediate goods, particularly, specialized iron ore, semiconductors, auto parts, and panels for plasma TVs that are assembled in Mexico. As a result, there could be significant negative effects (from disrupted supply chains) on the imports side of the equation. We estimate that a three month disruption of supplies could affect Mexicos manufacturing production by 0.06%-pt (in real %oya terms), and this could translate into a subtraction of 0.01%-pt from GDP. However, this could be slightly offset by the possibility that, for example, more cars are produced in Mexico. As a result, we could see further production switches from Japan to Mexico in the medium term. Of course, much will depend on whether disruptions to the supply of the auto parts Mexico imports from Japan will still allow increased production in Mexico. Finally its is also worth noting Japan has been responsible for just 1% of total FDI inflows in the past few years, of which 80% has been directed towards manufacturing. Overall, there is
51
Banco J.P.Morgan, S.A., Institucin de Banca Mltiple, J.P.Morgan Grupo Financiero Gabriel Casillas (52-55) 5540-9558 gabriel.casillas@jpmorgan.com Iker Cabiedes (52-55) 5540-9339 iker.x.cabiedes@jpmorgan.com
Economic Research Mexico March 18, 2011
no doubt that the earthquake will have global consequences that will end up impacting the Mexican economy, but it is our take that the direct effects will be quite limited.
Wed Mar 23 9:00am
Central bank foreign reserves

US$ bn Feb 25 Gross international reserves 121.8 Mar 4 121.9 Mar 11 122.0 Mar 18 ___
Strong IP in January supports our 4.5% GDP growth forecast for 2011
IP came in on the strong side, jumping 6.6%oya in January, mainly due to strong manufacturing output (+8.8%oya, first chart). However, the surprise was construction output which grew 8.3% in January, after being essentially unchanged in all of 2010. In seasonally adjusted terms, all components except for mining increased in January. In our view, this confirms that the manufacturing sector continues to expand at a healthy pace following a long period of above-trend growth, ending the moderation recorded in 4Q10. In addition, construction output, which lagged the industrial recovery last year, has consistently improved, and Januarys figure suggests that it is now positioned to join the broader upward trend in manufacturing. We continue to expect that IP will expand around 5.3% this year as part of a more balanced recovery, with manufacturing expanding 5.2% and nonmanufac-turing activity up 5.4%. Against this backdrop, we remain confident in our GDP growth forecast of 4.5% for this year.
Wed Mar 23 9:00am
Retail sales
Oct Retail sales %oya %m/m sa 4.4 0.5 Nov 2.4 -0.2 Dec 2.6 0.7 Jan 4.1 0.8
Thu Mar 24 9:00am
Consumer prices
Jan 2H Feb 1H Feb 2H Mar 1H %2w/2w Core %oya Core 0.11 0.23 3.61 3.23 0.21 0.22 3.63 3.28 0.23 0.12 3.51 3.24 0.16 0.16 3.21 3.23
Thu Mar 24 9:00am
Labor market report

% of labor force Nov Open unemployment rate Sa 5.3 5.5 Dec 4.9 5.5 Jan 5.4 5.2 Feb 5.2 ___
Fri
Mar 25 8:00am
Trade balance (Feb 24)

Nov Balance (US$ mn) Exports (US$ bn) %oya %m/m sa Imports (US$ bn) %oya %m/m sa -105 28.2 25.9 3.2 28.3 25.6 0.6 Dec -219 26.9 16.4 2.5 27.1 17.0 2.8 Jan 63 24.6 28.2 3.7 24.5 24.9 3.3 Feb 132 25.8 21.3 0.2 25.7 23.1 2.9

Tue Mar 22 2:30pm
Real GDP by type of expenditure

%oya, real terms 1Q10 Supply and demand Private consumption Government consumption Fixed investment Exports Imports 8.0 3.9 1.1 -2.6 23.2 20.2 2Q10 12.9 7.8 5.3 1.9 33.5 31.8 3Q10 9.3 5.0 2.5 3.8 18.8 22.5 4Q10 8.3 6.1 3.6 7.5 9.2 20.0

Industrial production (Mar 14)
Nov %oya nsa Manufacturing %m/m sa Manufacturing 5.8 7.4 0.6 1.0 Dec 4.9 6.0 0.7 1.3 Jan 4.6 6.3 0.1 0.9 6.6 8.8 1.4 1.5
Tue Mar 22 2:30pm
Banamex CPI inflation expectations survey

%oya, except policy rate: %p.a., median value Feb 3 Feb 22 End-2011 End-2012 One year forward Banxico policy rate End-2011 End-2012 3.88 3.80 3.81 4.50 5.50 3.88 3.74 -4.50 5.50 Mar 7 3.90 3.76 3.70 4.50 5.63 Mar 22 ___ ___ ___ ___ ___
0.7 1.2
0.9 1.7
ANTAD same-store sales (Mar 15)

Dec %oya %oya, real terms 5.0 0.6 Jan 4.8 1.0 Feb 2.8 ___ 3.3 -0.1
52
JPMorgan Chase Bank, Sao Paulo Fabio Akira Hashizume (55-11) 3048-3634 fabio.akira@jpmorgan.com Julio Callegari (55-11) 3048-3369 julio.c.callegari@jpmorgan.com
Brazil
Retail sales printed above expectations in January, and should grow further in February CAGED survey showed that the economy continues to add jobs at a strong pace January IBC-Br reinforces the view that GDP growth should accelerate in 1Q11 from 4Q10 The narrow retail sales volume index (which excludes vehicles and building materials) increased 1.2%m/m sa and 8.3%oya in January exceeding consensus and J.P. Morgan forecasts (both at 0.8%). Most of the acceleration was driven by a rebound in food and beverage sales (table), which increased 1.2%m/m sa in January. Note that food inflation has affected the performance of this component in recent months, in contrast to the supportive figures registered in most other components. Although food inflation remained high in January (+1.16%m/m sa), it nevertheless continued to decelerate from the +2% peak registered in November. In addition to robust food and beverage sales, most other sectors continue to record reasonably strong sales, even in components more sensitive to credit conditions, such as furniture and home appliances, where sales increased 2.7% m/m sa and 19.1%oya. The broad retail sales measure (which includes vehicles and building materials) performed much worse than the narrow measure (-0.2%m/m sa, 11.2%oya), on the back of a 7.1%m/m sa decrease in vehicle sales. This outcome suggests that the recent macroprudential measures adopted by the BCB (including a higher capital requirement on auto loans) took a toll on car sales in January. However, the impact of the measures is apparently abating, and reports from car dealers showed that auto sales rebounded in February (2.4%m/ m sa versus -2.5% in January), suggesting that the outlook for February broad retail sales is favorable. Overall, the January narrow retail sales print reinforces the view that private consumption is on a strong footing, despite some moderation caused by higher food inflation and macroprudential measures. February retail sales should show an another increase in the narrow measure and a rebound in the broad indicator. Taking into account coincident indicators for February retail sales, we expect another sequential expansion in the narrow index (around 0.5%), which this time around will be assisted by a further slowdown in February food inflation. This trend points to an acceleration in narrow retail sales in 1Q11 compared to 4Q10. The broad measure will pick up in February on the back of higher auto sales, but some growth moderation in 1Q11 (versus 4Q10) still seems likely.
Retail sales volume: breakdown by sectors

%m/m, sa Dec 10 Jan 11 0.2 1.2 1.3 0.3 -0.4 1.2 3.1 0.5 1.8 2.7 1.6 0.5 2.8 -5.1 2.2 -2.3 -0.3 -2.5 0.3 5.0 3.2 -0.2 -7.1 1.1 %oya, nsa Dec 10 Jan 11 10.2 8.3 6.4 6.3 6.2 4.2 9.8 9.8 18.3 19.1 14.1 12.7 27.1 7.4 26.7 12.5 10.2 4.9 15.0 26.0 16.3 11.2 16.4 16.5
Narrow retail 1. Fuel 2. Food, beverages, and supermkts 3. Apparel 4. Furniture and home appliances 5. Pharmaceuticals 6. Computers, office supplies 7. Stationers, books 8. Others Broad retail (1 to 10) 9. Vehicles, parts 10. Construction material
Real retail sales growth (narrow and broad indexes)

%oy a Broad (includes auto 25 15 5 Narrow -5 2006 2007 2008 2009 2010 2011 and construction)
Net job creation in February (CAGED establishment survey)

000s of net job creation per working day, nsa 14 12 10 8 6 4 2 0 2000 2002 2004 2006 2008 2010
BCB proxy for monthly GDP signaling 1Q11 acceleration

IBC-Br, % change 3m/3m, saar 10 0 -10 -20
2006
2007
2008
2009
2010
2011
53
JPMorgan Chase Bank, Sao Paulo Fabio Akira Hashizume (55-11) 3048-3634 fabio.akira@jpmorgan.com Julio Callegari (55-11) 3048-3369 julio.c.callegari@jpmorgan.com
Economic Research Brazil March 18, 2011
Labor market conditions should continue to support retail sales growth

While food inflation is moderating on a sequential basis in 1Q11 (even if remaining high), bringing some relief to narrow retail sales, labor market conditions continue to favor strong domestic demand in the medium term. The CAGED establishment survey of payrolls (released March 16) printed another strong reading in February, with 280,000 jobs created in the month. This figure is higher than the 209,000 jobs recorded in February 2010 and above the historical February average of 117,000. Even after adjusting for more working days this February, the number is elevated (second chart). The CAGED print is especially strong, considering that unemployment is already at historically low levels. In fact, our seasonal adjustment points to more than 250,000 formal jobs created in February, which is the third highest reading in history. Next week, the entire labor report for February will be released, but the February CAGED print suggests that the unemployment rate will decline further, while the strong pace of employment expansion should underpin growth in labor income (both through job and wage growth). Large labor income gains and still high consumer confidence reinforce our belief that private consumption will remain robust, despite the ongoing tightening in credit conditions.

Weeks of March 21 - 25
Wed Mar 23 8:00am
Consumer prices (IPCA-15)

%m/m nsa Dec Total %oya %ytd Ex volatile Trimmed mean 0.7 5.8 5.8 0.5 0.5 Jan 0.8 6.1 0.8 0.8 0.6 Feb 1.0 6.1 1.8 1.1 0.5 Mar 0.52 6.04 2.26 0.56 0.47
Fri Mar 25 8:00am
National unemployment
% of labor force, new methodology Nov Open rate, nsa (30 days) 5.7 Dec 5.2 Jan 6.1 Feb 6.4
Fri Mar 25 8:30am
Current account balance

US$ bn, net inflows Nov Current account (CA) Trade balance Services Net transfers CA, 12-month sum CA, 12-month sum, %GDP Foreign direct investment -4.7 0.3 -5.3 0.2 -49.5 -2.4 3.7 Dec -3.5 5.4 -9.2 0.3 -47.0 -2.3 15.4 Jan -5.4 0.4 -6.0 0.2 -48.6 -2.3 3.0 Feb -3.7 1.2 -5.0 0.2 -49.1 -2.3 7.0
IBC-Br points to 1Q11 GDP acceleration

The IBC-Br (a proxy for monthly GDP calculated by the BCB) increased 5.1%oya and 0.7%m/m in January versus 3.7% and 0.1%, respectively, in December. This improvement was in line with the strong retail sales print released this week (+1.2%m/m sa) and the small advance in the manufacturing sector in January. The trajectory of the IBCBr is signaling 4.0%q/q saar carryover for 1Q11, which lends a positive bias to 1Q11 GDP growth. Note, however, that the IBC-Br overestimated both full-2010 real GDP growth (estimating it at 7.8% compared to the actual 7.5% print) and 4Q10 growth (4.3%q/q saar versus 3.0%). That said, most recent activity indicators have suggested that despite the continued poor performance of IP, the growth momentum of domestic demand remains in place. In addition to positive January readings, preliminary indicators for February (such as the CAGED job creation report and vehicle sales) reinforce the view that domestic demand remains strong and that 1Q11 GDP growth may be faster than initially thought. At this point, however, we are leaving our 1Q11 GDP growth projection at 3.9%q/q saar and our full-2011 GDP growth forecast at 4.0%.

Retail sales
%m/m sa %oya nsa Nov 0.7 9.9 Dec -0.1 10.1 Jan 0.8 1.2 7.3 8.2
General prices (IGP-10)

%m/m nsa Overall %oya Wholesale prices Consumer prices Construction costs Jan 0.5 11.2 1.2 0.9 0.5 Feb 1.0 11.0 1.2 0.9 0.4 Mar 0.9 0.8 11.0 10.9 1.1 1.0 0.6 0.3
Formal job creation (Caged)

Dec Monthly creation (000) Ytd, nsa -407.5 2136.9 Jan 167.9 2123.4 Feb 280.8 2194.9
54
JPMorgan Chase Bank, Sao Paulo Julio Callegari (55-11) 3048-3369 julio.c.callegari@jpmorgan.com JPMorgan Chase Bank, New York Ben Ramsey (1-212) 834-4308 benjamin.h.ramsey@jpmorgan.com
Andeans: Colombia, Ecuador, Peru, Venezuela

January real GDP growth printed 10.0% in Peru We see real GDP expanding 7.3% in full-2011 S&P has raised Colombia to investment grade Real GDP growth in Peru accelerated to 10.0%oya in January from 8.9% in December (J.P. Morgan: 10.4%; consensus: 9.0%). The increase was driven by manufacturing, which contributed 2.1%-pts to the overall print, while retail and construction activity contributed 1.7%-pts and 1.0%-pt, respectively. The improvement in real GDP growth was anticipated by the strong tone posted by construction leading indicatorsconstruction production and imports. The outlook remains positive for Peru, with growth momentum suggesting above-trend expansion again in 2011. While the estimated carryover for 2011 is close to 4.0%, we see the full-2011 GDP posting 7.3% growth (from a 8.8% growth in 2010). Therefore, although we do expect that the ongoing monetary tightening, fiscal restraint, and higher food and energy prices should moderate GDP growth in coming quarters (particularly in 2H11 when we expect GDP to expand 5.5% q/q saar), the strong performance in the initial months should assure above-trend growth for the entire year. Moreover, the most recent confidence survey has shown that business confidence remains high, despite the small sequential decrease (66 in January, down from 68 in December).
Peru: real GDP by sector

%oya Real GDP Agriculture Fishing Mining and hydrocarbons Manufacturing Eletricity and water Construction Retail and commerce Other services Jan-Dec 10 8.7 4.3 -17.2 -0.7 13.7 7.7 17.6 9.6 7.4 Nov 10 10.2 6.8 -34.0 -4.0 14.7 7.5 23.8 10.8 8.9 Dec 10 8.9 7.9 -21.6 1.3 9.5 6.2 12.5 10.9 9.3 Jan 11 10.0 4.7 26.5 -0.6 14.4 7.5 16.2 10.2 9.8
Peru: GDP expected to grow 7.3% in 2011 (from 8.8% in 2010)

%ch oya 15 10 5 0 -5
2006
2007
2008
2009
2010
2011
Peru: corporate demand expectations (next 3 months) at high levels

Diffusion index, 50=neutral 80 70 60 50 40
Colombia regains investment grade

S&P raised Colombias foreign currency rating to BBB-, i.e., investment grade, with a stable outlook. The move was generally expected, as the three major rating agencies have all had Colombias rating one notch below IG with a positive outlook, and Colombia CDS has been trading in line with Latin America IG peers since the end of last year. S&P noted in its press release that now that Colombia is investment grade, the bond issue rating (which at the bond level, rather than the issuer level, had already attained BBB- status in 2007 due to S&Ps EM recovery rating scale) and the foreign currency sovereign credit rating are in line. It is noteworthy that S&P does not seem to be basing its rating on any ex ante positive assessment of the Santos administrations fiscal reform effort, noting that the move owes to Colombias proven macroeconomic resilience, its market-based policy framework, and an outlook for stable debt dynamics. Indeed, S&P notes that any posi-
2008
2009
2010
tive surprises in terms of GDP growth and/or the fiscal reform effort could actually lead to further upgrades. We remain of the view that Moodys and Fitch are likely to follow suit and raise their respective ratings to IG some time this year. The other agencies have expressed some modest concern over the results of the ongoing fiscal reform effort, but we do not believe any possible watering down of the reforms currently in congress would keep the other agencies from also moving Colombia to IG.
55
JPMorgan Chase Bank, New York Tejal Ray (1-212) 834-8580 tejal.t.ray@jpmorgan.com
Economic Research Southern Cone / Andeans March 18, 2011
Argentina: Data releases and forecasts

Fri Mar 18 Fri Mar 18 Fri Mar 18 Wed Mar 23 Wed Mar 23 Wed Mar 23
Colombia: Data releases and forecasts

Nov 3.31 1Q10 -0.40 1Q10 6.8 Nov 0.39 Nov 12.8 Dec 53.21 Dec -2.20 2Q10 3.19 2Q10 11.8 Dec 0.24 Dec 10.6 Jan 55.69 Jan 2.11 3Q10 0.90 3Q10 8.6 Jan 0.51 Jan 10.3 Feb 53.96 Feb ___ 4Q10 ___ 4Q10 ___ Feb ___ Feb ___ Mar ___ Thu Mar 24
Budget balance
ARS bn
Real GDP
%q/q saar %oya sa 1Q10 5.53 4.45 2Q10 3.46 4.40 3Q10 0.85 3.55 4Q10 0.90 7.10

US$ bn

BanRep monetary policy meeting
Reference rate Jan 3.00 Nov 4.2 Nov 21.4 Feb 3.25 Dec 4.0 Dec 12.4 Mar 3.50 Jan 5.0 6.2 Jan 9.7 12.3
Real GDP
%oya
Trade balance
US$ bn
%oya
%oya
Retail sales
%oya
Consumer confidence
Index
Peru: Data releases and forecasts

Week of March 21 - 25 No data releases expected.

Consumer prices
Consumer prices (%m/m) %oya Wholesale prices (%m/m) %oya Dec 0.80 10.9 0.94 14.56 Jan 0.70 10.6 0.90 14.10 Feb ___ 0.7 ___ 10.0 ___ 0.9 ___ 13.6

Real GDP
%oya nsa %m/m sa Nov 10.19 2.12 Jan 3.25 Nov 0.60 Dec 8.93 0.07 Feb 3.50 Dec 1.08 Jan 10.4010.02 0.30 0.43 Mar 3.75 Jan ___ 0.23
Chile: Data releases and forecasts

BCRP monetary policy meeting

Reference rate
Trade balance
US$ bn

BCCh monetary policy meeting
Nominal ON rate target Jan 3.25 2Q10 6.59 2Q10 0.18 Feb 3.50 Mar 3.75 4.00
Venezuela: Data releases and forecasts

Real GDP
%oya 3Q10 4Q10 ___ 5.80 7.02 6.90 3Q10 4Q10 -0.42-0.05 ___ 1.22

US$ bn

No data released.
56
United Kingdom
Rising household inflation expectations and a surge in gas prices exacerbate inflation fears But the growth outlook has also turned more uncertain, worsening the MPCs policy dilemma The policy dilemma facing the MPC is becoming increasingly acute. Gains in energy prices, particularly the price of natural gas, are making a round of increases in domestic energy tariffs look increasingly likely at some point later this year. This creates the potential for a further bump up in headline inflation well beyond the 4.3%oya peak we had forecast for February. And as inflation itself rises, the survey measures of both short- and medium-term inflation expectations continue to move upward. Our composite measure of medium-term expectations has now moved up to match the mid-2008 high. The news on the growth side of the story is not uniformly bleak, but there were plenty of areas for concern even before the tragic events in Japan and sharp declines in equity prices (see UK growth: the good, the bad, and the ugly in this GDW). Nationwide consumer confidence tumbled to a new cycle low in February. Although next weeks Budget will be presented as one designed to kick-start growth, the Chancellor will likely stick to the significant tightening for 2011/12 laid out back in November (see UK Budget 2011: staying the fiscal course in this GDW). Amid all these moving parts, market pricing suggests the probability of a May hike from the MPC has been reduced to around 50%, and we would agree that the call now looks close.
Change in unemployment
000s sa, change over 3 months in 3-mo moving average 300 200 100 0 Claimant count -100 2005 2006 2007 2008 2009 2010 2011
Household survey
Private sector regular pay growth

% oya, 3mma 6 5 4 3 2 1 0 2005 2006 2007 2008 2009 2010 2011
Real private consumption vs Nationwide consumer confidence

Index, sa 110 100 90 80 70 60 50 40 30 Nationwide % q/q saar 8 6 4 2 0 -2 -4 -6 -8
Labor market is holding in

The labor market data remain a distinctly mixed bag. The pickup in overall employment growth seen through to mid2010 has faded. But the data are not weak enough to vindicate the notion of underlying stagnation in overall output suggested by the GDP data for 4Q (and threatened for 1Q after last weeks construction output data). And on the pay side of the data, concern that high inflation would generate higher settlements and a step up in actual pay growth finds no vindication in data running up to January. The data based on a survey of households report a small gain in overall employment in the three months to January. The composition of that change hints at underlying improvement: the number of full time employees saw a strong gain, while self and part-time employment fell. Moreover, the
Consumption
04
05
06
07
08
09
10
11
modest gain in overall employment has come despite more rapid shedding of jobs in the public sector than expected. The number of claimants of the jobseekers allowance fell in February, although unemployment as measured by the household survey rose, pushing the unemployment rate up to 8.0%. The gap between these two measures is within the normal bounds, and the coexistence of both rising and falling unemployment in the data should serve to underscore that the changes in both time series are relatively small.
57
Economic Research United Kingdom March 18, 2011
Inflation expectations creep higher

Household inflation expectations edged closer to 2008 levels in the Bank of Englands 1Q survey. Year-ahead expectations rose one-tenth to 4.0%. Although this is lower than the peak three years back, the inflation news in the UK is deteriorating quickly, and a further increase in these expectations appears likely. The more concerning move was in 2year-ahead expectations, which rose from 3.2% to 3.4%, and 5-year expectations, which increased from 3.3% to 3.5%. These readings have a short history, but have increased 1.5%-pts and 0.8%-pt, respectively, since the first available readings in 1Q09 (we would focus on changes rather than levels as it is not clear as to which measure of inflation households respond). Previously we stated that a move in 5-year inflation expectations to 3.5% would take our composite measure of medium-term expectations level with its 2008 peak, and so it has done. Any move up from here would take our composite out of the range established following MPC independence in 1997. The BoE initially downplayed the move in its own survey, on the grounds that inflation itself is high, and that the expectations of households do not pose a clear and immediate threat to inflation. But the problem with this view is that inflation is forecast to stay high for some time, which is likely to keep expectations running high for a while yet. Our analysis has previously indicated that wages show little sensitivity to short-run expectations. And a new question in the BoEs survey actually asks households what they plan to do in light of their expectations over the next 12 monthsa net balance of only 9% say they would push for higher wages. However, wage pressures could still build gradually over time, particularly if the rise in 2- to 5-year household expectations is allowed to persist for long. A concern is that these medium term expectations may also be reflecting a similar shift in sentiment among firms. The Bank of England raised its inflation forecast in its February inflation report, in part to reflect greater resistance to the compression in real wages. But the concern is that the rise in expectations is more persistent than the BoE has allowed for.
BoE inflation expectations survey

% 5 4 5yrs 3 2yrs 2 1 2007 2008 2009 2010 2011 1yr
Composite measures of inflation expectations

%, expectations normalized to be comparable with CPI inflation 3.5 3.0 2.5 2.0 1.5 1.0 2007 2008 2009 2010 2011 Greater than 1yr ahead Over the next year
Composite measure of medium-term inflation expectations

% 2.5 2.4 2.3 2.2 2.1 2.0 1.9 1.8 1.7 1.6 1.5
04
05
06
07
08
09
10
11
Medium-term inflation expectations

%, normalized to be comparable with CPI inflation (RPI prior to 2004) 6
Budget could introduce fuel stabilizer

One specific issue that Chancellor Osborne has hinted the Budget will address is rising fuel prices, which have already risen 16% over the past year. These gains are likely to be compounded by the 50% rise in wholesale gas prices seen since Decemberwhich could prompt increases in domestic utility tariffs of as much as 15%, and as soon as 3Q. This places significant pressure on the government to
5 4 3 2 1 85 90 95 00 05 10
58
respond in some way. An idea previously mentioned was a fair fuel stabilizer. In this plan, the Chancellor would adjust fuel duty, to offset changes in petrol prices arising from volatility in oil prices. The idea was that this could be costless for the government, as the Treasury derives additional revenues when oil prices increasevia taxes on North Sea oil production. But when the government asked the OBR to review the effect the mechanism would have on the public finances, it concluded that borrowing would actually be made more volatile as a resultbecause gains from additional oil revenues on the public finances would probably be more than offset by the adverse effect of higher oil prices on growth. The OBRs analysis gave the impression that a fuel stabilizer was unlikely to be implemented. But in the runup to the Budget the issue has been mentioned in the media on several occasions, raising the possibility that something along these lines will be announced by the Government next weekdespite not having the OBRs blessing.
Possible fiscal cost of "fuel stabilizer policy"

bn, ar, assumes a 10 rise in sterling oil prices costs the Exchequer 3.7 bn and that deviations in oil from 45 are fully offset by changes in fuel duty 10 5 0 -5 -10 2007 2008 2009 2010 2011
Possible effect of a "fuel stabilizer" on unleaded petrol prices

Pence per liter 140 130 120 110 100 90 80 2007 2008 2009 2010 2011 Full stabilization No stabilization
Effect on the public finances and inflation

To assess what impact this might have on the public finances, we have taken the extreme case that the government chooses to offset 100% of changes in petrol prices that are related to spot oil prices. According to the OBR, a 20% rise in oil pushes up petrol prices by 7.4 pence a liter. This would cost 3.7 billion in lost revenue to offset by changing fuel duty. If we assume a stabilizer had been implemented at the beginning of 2007 at 100p (and allowed to increase in line with duty and inflation) it would have increased borrowing by up to 10 billion in a single year. This is an extreme estimate, and the government could limit its exposure by implementing a 50% stabilizer, for example. What would be the effect on inflation? Again assuming 100% stabilization, fluctuations in the CPI would have been damped by up to +/- 1%-pt.
Possible effect of a "fuel stabilizer" on CPI inflation

%oya 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5
No stabilization Full stabilization
Other options still on the table

There are many logistical issues about a fuel stabilization policy. For example, around which level should petrol prices be stabilized? And how often should this level be reset? If prices were stabilized at current levels, then a drop in oil prices would immediately make the policy very unpopularsuggesting prices would have to be stabilized around a lower level than seen currently. This would essentially be a one-off cut in fuel duty to begin with, followed by a stabilization thereafter. Given some of these implementation difficulties, we think the Government is more likely to take the simpler approach of announcing a one-off
2007
2008
2009
2010
2011
cut in fuel dutyin addition to canceling the increase that was planned to come in from April anyway. As a rule of thumb, a 2.5p increase in fuel duty (3p including VAT) would raise CPI inflation by 0.1%-pt. Depending on the size of the cut announced, this would provide at least a partial offset to the effect on inflation of a rise in utility bills later this year. We will review our inflation forecast after the Budget and February CPI release next week.
59
Economic Research United Kingdom March 18, 2011

Mon Mar 21 12:01am
Wed Mar 23 9:30am
BBA lending
Sa Nov Secured lending (ch bn, sa) Loan approvals (000s sa)1 1.2 29.8 Dec 0.9 28.9 Jan 1.6 28.9 Feb
Rightmove house price index

Nsa Dec %m/m -3.0 Jan 0.3 Feb 3.1 Mar Wed Mar 23 12:30pm Feb 4.3 3.1 230.7 5.2 5.2
1. For house purchase.
Budget 2011
Tue Mar 22 9:30am
Retail prices
%oya Nov CPI Core CPI1 RPI (1987=100) RPI (1987=100) RPIX 3.3 2.8 226.8 4.7 4.7 Dec 3.7 2.9 228.4 4.8 4.7 Jan 4.0 3.0 229.0 5.1 5.1
See research note in this weeks datawatch.

Thu Mar 24 9:30am
Retail sales
Volumes, sa Nov Including auto fuel (%m/m) Ex auto fuel (%m/m) Ex auto fuel (%oya) Ex auto fuel (%3m/3m saar) 0.3 0.2 1.6 0.7 Dec -1.4 -1.0 0.3 0.0 Jan 2.0 1.5 5.3 1.0 Feb -0.6 -0.5 2.5 0.5
1. CPI ex food, energy, alcohol, and tobacco.
Delayed passthrough from the January VAT hike in the service sector is likely to push core inflation higher in the February release, from 3.0% to 3.1%. In addition, rising petrol and domestic utility tariffs will add to these pressures, pushing headline CPI inflation up from 4.0% to 4.3%. Risks to both headline and core are to the downside, as the level of airfares is now looking very higheven given the rise in oil pricesand there appears some scope for a downward adjustment there.
Tue Mar 22 11:00am
Early indications have pointed to a significant softening in spending in February, following weather related disruptions over the prior two months.

Nationwide consumer confidence index
Sa Index Dec 54 Jan 47 48 Feb 38
CBI industrial trends

% balance Dec Total order book Output expectations Output prices -3 13 16 Jan -16 17 31 Feb -8 23 32 Mar -10 20 34
DCLG monthly house price data Nsa

Nov All dwellings (%oya) 4.1 Dec 3.7 Jan 0.5
Tue Mar 22 9:30am
Public sector finances

bn, nsa Nov PSNCR PSNB PSNB (ex. fin. int.) Balance on current budget Net debt to GDP (%) 17.1 19.4 20.9 -15.8 149.5 Dec 25.4 14.5 16.0 -11.3 150.6 Jan -14.4 5.3 -3.7 10.4 149.2 Feb 5.0 6.5 -0.1
Labor market statistics Sa

Dec Claimant count (000s ch m/m) Claimant count rate (%) -3.4 4.5 Nov Jan 2.4 4.5 Dec 1.5 Feb -10.0 -10.2 -4.5 4.5 Jan
Average weekly earnings (3mma %oya sa) Headline Ex bonuses Private sector ex bonuses Three months to: 2.1 2.3 2.2 Jul 1.8 2.3 2.1 Oct 1.6 2.1 2.0 Jan 2.3 2.2 2.1
Barring any large surprises in either February or the March release, borrowing for the 2010/11 fiscal year overall would come in at close to 136 billionwhich would be a meaningful undershoot relative to the OBRs projection of a 148.5 billion deficit.
Wed Mar 23 9:30am
Labor force survey (all percentage rates, sa) Activity rate Employment rate Unemployment rate 63.5 58.5 7.8 63.3 58.3 7.9 63.1 63.3 58.2 58.3 7.9 8.0
BoEs minutes of March MPC meeting
A 3-5-1 vote is expected with Sentance, Weale, and Dale dissenting for higher rates, and Posen for more QE.
BoE/NOP Inflation attitudes survey

%oya, median expectations Inflation next 12 months 3Q10 3.4 4Q10 3.9 1Q11 4.0
60
JPMorgan Chase Bank International Limited, Moscow Anatoliy Shal (7-495) 937-7321 anatoliy.a.shal@jpmorgan.com
Russia
IP surprises on the downside... ... while producer inflation surprises on the upside Consumer inflation moderates, but likely temporarily Industrial production slowed to 5.8%oya in February from 6.7%oya. This was well below expectations (consensus: 7.5%, J.P. Morgan: 7.9%), though with the usual caveat that Russian IP is notoriously volatile. Weak IP numbers were also in contrast with strong manufacturing PMI (up from 53.5 to 55.2) and other business surveys. We therefore view the reported slowdown as a temporary breather, not as a break in the uptrend. Seasonally adjusted IP was down 0.1%m/m, after a 0.7%m/m gain in January. Mining was flat, utilities up, but manufacturing was down from January. In manufacturing, car productionthe prime driver of exceptionally strong manufacturing growth recentlywas still up a remarkable 110%oya in February (+1.6%m/m sa); however, it is likely to weaken from 2Q11, when the cash-for-clunkers program is likely to have expired. At the same time, manufacturing output was apparently dragged down by (volatile) investment engineering and selected export-oriented industries. Positively, construction materials continued to grow strongly.
Russia: industrial production

Index, Dec05=100, sa 120 115 110 105 100 95 2006 2007 2008 2009 2010 2011
Manufacturing and mining output

Index , Dec05=100 (sa by J.P. Morgan) 130 120 110 100 90 Mining Manufacturing
2006
2007
2008
2009
2010
2011
Output of new cars and imports: output buoyed by cash-for-clunkers Units, 000s (sa by J.P. Morgan) 180 160 140 120 100 80 60 40 20 0 2006 2007
Cost-side pressures continue to build

In contrast to slowing industrial output growth, there have been no signs of easing in producer price inflation. PPI once again printed above expectations at 3.3%m/m (consensus: 1%, J.P. Morgan: 1.4%), bringing the over-yearago number to 21.4% from 19.4% a month ago. The elevation is not only about commodity prices. As expected, output prices in mining and quarrying jumped 5.2%m/m following the rise in global commodity prices. However, the recent price trends in core sectors also look worrisome (charts). In February, inflation in the textile industry was running at 22.4%oya, in food processing 17.5%, in machinery and equipment 5.7%, automotive industry 15.8%.
Output
Imports
2008
2009
2010
2011
PPI: automobiles vs. machinery and equipment

%oya 25 20 15 10 5 0 -5 03 05 07 09 11 Vehicles and transport equipment
Machinery
CPI on track to print at 0.6-0.7% in March

CPI returned to a 0.2%w/w pace in March. The latest weekly CPI data shows the pace of price increases picked up from 0.1%w/w in the first week to 0.2% in the second week of the month. This small pickup in price growth owes primarily to the fact that gasoline prices, which were under administrative pressure in previous weeks, have stopped declining. Notwithstanding this small acceleration, we must note that inflation is currently running below our recent
The next Russia data watch will be published on April 4.

61
JPMorgan Chase Bank International Limited, Moscow Anatoliy Shal (7-495) 937-7321 anatoliy.a.shal@jpmorgan.com
Economic Research Russia March 18, 2011
expectations and seems to be on track to stay around 9.5%oya in March. Following a series of relatively low weekly CPI readings, CBR Deputy Chairman Alexei Ulyukaev already expressed the hope that CPI will not breach 10% this year (we expect this to happen in 2Q11). Moderate consumer inflation numbers in early March follow the lower-than-expected inflation print in February (9.5% vs. 9.7% expected). The slowdown was helped by the administered decline in energy inflation, as well as by moderation in food inflation. The latter was mainly a consequence of lower inflation in fruit and vegetables (down from 51.1% to 46.9%oya)the price shock from the summer drought has appeared to be fully reflected in end-consumer prices, which is very good news. Decreased import duties on selected grains and sugar might also have helped to tame the recent food price growth. Nevertheless, food inflation is likely to stay elevated in the coming months, being supported by meat price inflation (meat forms a quarter of food basket). Both global meat prices and the usual lags between domestic grain shocks and meat prices suggest meat inflation is likely to continue rising. CPI excluding food, energy, and regulated prices has continued to climb higher, rising from 5.4% to 5.6%oya in February. Seasonally adjusted dynamics though show that monthly increases eased somewhatfrom a 7.2% annualized rate in January to 6.3% in Februaryperhaps starting to reflect the recent strengthening of the currency and, hopefully, some moderation of inflation expectations. The benign CPI reading and soft IP report are alleviating immediate pressures on the CBR to tighten aggressively, especially as inflation remains below 10% (CBRs intolerance level). Nevertheless, since the CBR tended to look past the initial food price shock (until it started to affect inflation expectations), it is also likely to choose to ignore the recent moderation in food and energy inflation and to continue gradually normalizing its monetary policy.
PPI: food processing vs. light industry

%oya 30 25 20 15 10 5 0 03 05 07 09 11 Textile industry Food processing
Headline CPI and core inflation

%oy a 16 12 8 CPI ex food, energy, 4 0 and regulated tariffs Headline CPI
05
07
09
11
Review of past two weeks data

Industrial producer prices
%m/m nsa %oya Dec 1.0 16.7 Jan 2.1 19.4 Feb 1.4 3.3 19.6 21.4
Real economy indicators

Real terms, %oya Construction Agriculture Transportation Fixed investment Retail sales Average monthly wage due Unemployment Industrial production Dec 11.6 0.6 -0.3 10.1 3.4 6.3 7.2 6.3 Jan -1.1 0.7 4.9 -4.7 0.5 1.3 7.6 6.7 Feb 1.5 1.0 5.8 11.5 1.0 6.0 7.8 7.9 0.4 0.8 5.5 -0.4 3.3 2.4 7.4 5.8

Weeks of March 21 - April 4 PMI surveys
Manufacturing PMI Services PMI Dec 53.5 56.4 Jan 53.5 54.2 Feb 55.2 53.4 Mar 54.0 54.0
Federal budget
Ruble bn, cash flows Balance % of GDP Revenue Tax revenue Expenditure Noninterest % of GDP Dec -904 -19.5 867 881 1771 1763 38.0 Jan 148 4.4 805 703 657 632 18.8 Feb 0 -95 0.0 -2.5 750 700 700 700 750 795 730 771 19.5 20.6
Consumer prices
%m/m nsa %oya Dec 1.1 8.8 Jan 2.4 9.6 Feb 0.8 9.5 Mar 0.7 9.6
62
J.P. Morgan Chase Bank, Istanbul Yarkin Cebeci (90-212) 319-8599 yarkin.cebeci@jpmorgan.com
Turkey
CAD continues to widen on the back of higher oil prices and stronger domestic demand However, strong unexplained inflows lead to a decline in total financing needs Tourism revenues increase as Turkey benefits from the unrest in the MENA region January balance of payments data showed that while Turkeys current account deficit continued to widen due to higher oil prices and strong domestic demand, there was a sharp decline in total financing needs on the back of a sudden jump in unexplained inflows. The widening of the current account deficit once again underscored the need for tighter monetary and fiscal policies while the decline in borrowing needs could at least partly explain the resilience TRY has exhibited despite questions over the credibility of the CBRTs new policy mix and investor nervousness about Turkeys burgeoning CAD. BOP data also show a sharp slowdown in short-term borrowing by the banking system which should be seen by the CBRT as a sign of the effectiveness of its policy mix. All in all, we expect the January data to be well-received by the CBRT, and this should encourage it to remain on hold while it assesses data on domestic demand and loan growth over the next few more weeks. Turkey posted a US$5.9 billion current account deficit in January. This was slightly lower than our forecast of US$6.0 billion and the market consensus of US$6.1 billion. The widening of the trade deficit was responsible for the large CAD, but there was an encouraging 19% increase in tourism revenues. We expect this strong performance to continue as tourists switch from places of unrest like Egypt to Turkey. As the deficit was US$3.1 billion in January 2010, the 12month trailing CAD rose to US$51.4 billion (6.7% of GDP) in January from US$48.6 billion (6.4% of GDP) in December. Excluding energy imports, the 12-month trailing CAD was US$12.1 billion (1.6% of GDP) in January. As economic activity slows, we expect the widening in the CAD to moderate in the coming months. Assuming 4.5% GDP growth and an average oil price of US$104/bbl, we see the CAD reaching US$7.5 billion at year-end. Importantly, there was a net inflow of US$3.7 billion in net errors and omissions. As a result, total financing needs dropped sharply to US$2.2 billion (the lowest in the past five months) in January. These unexplained inflows could be partly explained by the underrecording of export rev-
Current account deficit

% of GDP, 12-mo trailing 4 2 0 -2 -4 -6 -8 2008 2009 2010 2011 Overall Excluding energy imports
Financing gap (current account balance + net errors and omissions)

US$ bn 5
-5
-10
2008
2009
2010
2011
enues. Unofficial exports to Middle Eastern countries are likely increasing as Turkey abolished visa requirements with Syria, Lebanon, and Jordan. Note that the number of tourists from Lebanon increased 270% while the corresponding increases were 109% for Iraq and 29% for Syria. A larger part of these unexplained inflows should be in the form of capital inflows, and we hope to see an explanation from the CBRT on these. Whatever the reason, these inflows led to a sharp fall in total financing needs to US$2.2 billion in January from US$7.8 billion in December (second chart). Thanks to the drop in the financing need and strong capital inflows, Turkeys official FX reserves rose US$0.9 billion in January. While FDI inflows remained weak, the bulk of the capital inflows was in the form of portfolio inflows. There was a total outflow of US$0.6 billion from the equity market but this was more than offset by a US$2.8 billion inflow to the bond market. Both the bank and nonbank private sectors were net long-term borrowers, and the rollover ratio was 112% for nonbanks and 324% for banks. This shows that the private sector is facing no difficulty in borrowing from abroad. Encouragingly, short-term borrowing by the banking system declined sharply to US$0.7 billion in January from US$4.2 billion in December. This decline should at least partly be due to the new CBRT policy.
The next Turkey data watch will be published on April 1.
63
J.P. Morgan Chase Bank, Istanbul Yarkin Cebeci (90-212) 319-8599 yarkin.cebeci@jpmorgan.com
Economic Research Turkey March 18, 2011

Weeks of March 21 - April 1
Wed Mar 23 7:00pm
The rise in the unemployment rate was due solely to seasonal factors in December. The seasonally adjusted unemployment rate fell to 11.0%, the lowest level since August 2008, but is still about 200bp above the pre-crisis level. Industrial production
CBRT rate decision

Dec CBRT 1-week repo rate (%) 6.50 Jan 6.25 Feb 6.25 Mar 6.25
%oya Nov Total Manufacturing Mining Utilities 9.4 10.1 7.6 4.6 Dec 16.7 18.5 1.7 8.4 Jan 13.8 18.9 14.4 20.5 15.2 14.9 10.0 12.0
CBRT remains hopeful on the efficacy of its policy mix in restraining loan growth and expects to see some results in the near term. CBRT seems determined to remain on hold until it sees evidence of this.
Fri Mar 25 10:00am
Capacity utilization
% Dec Total manufacturing Durables Nondurables 75.6 73.4 74.7 Jan 74.6 73.3 72.3 Feb 73.0 72.6 70.1 Mar 72.8 71.5 70.0
January industrial output data showed clearly that economic growth is significantly above the market consensus and that Turkeys output gap could be closed faster and earlier than what the CBRT has been expecting. The risks to our 2011 GDP growth forecast of 4.5% are skewed to the upside. Consumer confidence
Index Dec Consumer confidence Purchasing powercurrent Purchasing powerfuture Economic setting Employment 91.0 83.6 88.8 91.7 89.7 Jan 91.3 84.0 89.2 90.9 92.1 Feb 90.8 93.6 83.5 85.8 88.8 91.1 91.5 93.2 93.3 92.9
The capacity usage level is about 4%-5%-pts below the pre-crisis level, pointing to considerable slack in the economy.
Thu Mar 31 10:00am
Foreign trade
US$ bn, except as noted Nov Trade balance Exports (FOB) %oya Imports (CIF) %oya -7.7 9.4 6.0 17.1 35.7 Dec -8.7 11.9 18.1 20.6 36.9 Jan -7.3 9.6 22.1 16.9 44.3 Feb -6.9 10.1 22.2 17.0 44.3
Consumer confidence remains strong despite a weaker lira and increased uncertainty surrounding the CBRTs monetary policy. The improvement in labor market conditions may be a factor behind this improvement. Also likely supportive is the recovery in export demand. Balance of payments
US$ bn Nov Current account Trade balance Exports, fob Imports, fob Net invisibles and transfers Capital account Overall balance -6.1 -6.5 9.9 16.4 0.4 6.0 2.3 Dec -7.5 -7.2 12.4 19.4 -0.3 9.6 1.8 Jan -6.0 -5.9 -6.0 -5.9 10.0 10.1 16.0 0.0 5.5 3.1 1.5 0.9
Exports are gaining momentum as global economic activity recovers. Higher oil prices and robust domestic demand leads to rapid import growth.
Thu Mar 31 10:00am
Gross domestic product

%oya, real terms 1Q10 GDP Agriculture Manufacturing Construction Commerce Transport and comms. Financial services 11.8 0.1 21.2 8.3 20.7 11.7 4.4 2Q10 10.2 0.7 15.2 21.9 14.0 10.1 7.3 3Q10 5.5 -0.8 8.7 24.6 7.5 6.7 6.4 4Q10 6.5 2.0 12.5 15.0 7.3 3.8 5.0
See main text Central government budget

TRY bn, current prices Dec Expenditures Interest Non-interest Revenues Taxes Primary balance Budget balance 37.9 1.9 36.0 21.8 18.0 -14.3 -16.1 Jan 22.5 3.8 18.7 23.5 19.8 4.8 1.0 Feb 23.1 23.6 3.6 6.2 19.5 17.4 23.5 24.6 20.0 21.1 4.0 7.2 0.4 1.0
Stronger external demand along with robust domestic demand likely resulted in an 6.5%oya growth in 4Q. This should lead to full-year GDP growth of 8.3%.

Labor data
% Oct Unemployment Nonfarm payrolls (%y/y) Labor participation rate
64
Nov 11.0 4.7 48.6
Dec 11.5 11.4 4.9 4.6 48.2 48.4
11.2 3.8 49.0
There has been a cyclical rise in revenues, and encouragingly a significant portion of this has been saved. The lack of a pre-election boost in spending should be well-received by both the markets and the CBRT.
J.P.Morgan Chase Bank, London Sonja Keller (27-11) 507-0376 sonja.c.keller@jpmorgan.com
South Africa
Rates to remain unchanged next week, yet SARB to acknowledge risk of inflation breaching 6% this year Current account deficit could show an unexpected narrowing to 2.6% of GDP We project February CPI inflation to have remained at 3.7%oya, yet see a sharp uptick from June The MPC meeting will be the focus of next weeks busy data calendar, but close attention will also be paid to the February CPI report and the SARBs Quarterly Bulletin that could reveal a non-consensus further narrowing in the current account deficit. While the MPC is expected to keep the repo rate unchanged at 5.5%, inflation risks since the January meeting have clearly moved to the upside. Indeed, we expect the SARB either to revise up inflation projections further, currently at 4.6%y/y for 2011 (J.P. Morgan: 4.7%) and 5.3% in 2012 (J.P. Morgan: 5.6%), or make upside risks more explicit. The January MPC statement emphasized that the inflation trajectory was expected to remain within the target range over the entire forecast period, yet the upcoming statement may acknowledge a substantial risk that the 6% mark could be breached this year. While next weeks CPI report for February will probably show inflation contained at 3.7%oya, we expect a sharp uptick in inflationary pressures from June and see inflation at 6.1%oya at year-end.
Current account balance and its components

% of GDP 5 0 -5 -10 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
Trade balance
Invisibles balance Current account
Commodity exports
R bn, 3mma 16 14 12 10 8 6 4 2 0 Precious metals Mineral products and coal
Base metals 99 01 03 05 07 09 11
Consumer inflation and the target

%oya 15 Inflation target range 10 CPI inflation (CPIX before 2009)
J.P. Morgan forecast
Strong trade surplus helps to narrow current account deficit further

We know from the output data that GDP expanded just 4.4%q/q saar in 4Q10. The SARB Quarterly Bulletin released on March 22 will provide details on the expenditure side of the economy for the quarter, as well as outline the balance of payments. We believe that the current account deficit could surprise with a further narrowing to 2.6% of GDP from 3.0% in the previous quarter and 4.6% in 1Q10. High-frequency data suggest that the trade balance, which showed a surplus of 1.2% of GDP in 3Q10, likely improved further to a surplus of 2.6% of GDP for three reasons. Net exports of precious metals and base metals jumped more than 20%q/q in 4Q10, helped by strong commodity prices and output gains (second chart). At the same time, vehicle exports picked up strongly in 4Q10 after several strike actions hampered domestic vehicle production and exports in 3Q10, while vehicle imports also eased somewhat. Moreover, an 18% rise in coal prices pushed exports of mineral products (including coal) higher, which more than offset higher crude oil import prices.
0 01 02 03 04 05 06 07 08 09 10 11
The income, services, and transfer balance likely deteriorated to a deficit of 5.2% of GDP in 4Q10 from 4.2% in the prior quarter as dividend outflows probably rose strongly. However, as a result of the strong trade balance, the current account deficit likely narrowed further to 2.6% of GDP. While we expect real household consumption expenditure (HCE) growth to have remained solid due to real wage gains, the pace of the recovery likely slowed to 4.5%q/q saar in 4Q10 from 5.5% in the first nine months of the year. Also, the recovery in fixed investment probably remained slow with growth led by a pickup in private sector investment. We expect full-year GDP growth to reach 3.7%y/y in 2011 and 3.8% in 2012.
The South Africa data watch will be published next on March 25, 2011
65
J.P.Morgan Chase Bank, London Sonja Keller (27-11)507-0376 sonja.c.keller@jpmorgan.com
Economic Research South Africa March 18, 2011

Tue Mar 22 10:00am

Monetary and credit aggregates
%oya, except as noted M3 M0 Private sector credit %m/m nsa Credit to households Total domestic credit Nov 7.2 7.7 4.6 -0.2 7.2 3.8 Dec 6.9 7.2 5.6 0.9 6.9 4.3 Jan __ __ __ __ 7.1 __ 8.2 6.5 5.0 -0.5 7.5 3.4
Real GDP by expenditure type

%q/q saar, 2005 prices 1Q10 Real GDP (market prices) 4.6 Household consumption 5.8 Gross fixed capital formation -2.4 Domestic final demand 12.0 2Q10 2.8 4.9 1.3 1.6 3Q10 2.6 5.9 0.9 5.8 4Q10 4.4 4.5 1.0 4.3
See main text.

Tue Mar 22 10:00am
Trade balance
R bn, except as noted 1Q10 2Q10 13.2 0.5 -80.1 -66.9 -2.5 3Q10 32.4 1.2 -111.6 -79.2 -3.0 4Q10 __ 2.6 __ __ -2.6 Trade balance Exports %m/m Imports %m/m Nov 8.4 60.2 20.8 51.8 -2.4 Dec 10.3 53.9 -10.4 43.6 -15.9 Jan __ __ __ __ __ -4.9 44.8 -17.0 49.7 14.0
Balance of payments
R bn saar, except as noted Trade balance % of GDP Invisibles balance Current account balance % of GDP -12.9 -0.5 -103.3 -116.1 -4.6
Kagiso BER PMI

PMI (% weights) Business activity (25) New sales orders (30) Suppliers performance (15) Inventories (10) Employment (20) Memo: prices paid Business expectations PMI nsa Dec 51.7 54.5 53.2 49.8 56.2 45.0 63.1 62.5 55.1 Jan 54.6 51.0 59.6 56.5 58.9 47.8 71.3 67.1 47.8 Feb 53.8 __ __ __ __ __ __ __ __ 54.8 51.6 59.0 56.1 54.7 51.6 81.7 61.3 52.0
See main text.

Wed Mar 23 10:00am
Consumer prices
%oya, except as noted CPI %m/m, sa Core Nov 3.6 0.2 3.4 Dec 3.5 0.2 3.3 Jan 3.7 0.4 3.0 Feb 3.7 0.6 3.0
Thu Mar 24 3:00pm
Monetary policy announcement We expect the SARB to leave rates unchanged. See main essay.
New vehicle sales

%oya, except as noted Passenger car sales %m/m nsa Light commercial vehicles Heavy/medium commercial Total vehicle sales %m/m nsa Dec 38.9 -9.9 14.7 8.8 29.6 -10.9 Jan 22.1 23.9 7.7 7.6 26.7 26.2 18.4 18.5 12.5 14.2 Feb __ __ __ __ __ __ 31.1 3.3 11.3 28.2 25.2 9.0
SARB official reserves

US$ bn, except noted Gross reserves (R bn) Gross reserves International liquidity Dec 290.6 43.8 43.4 Jan 326.4 45.5 44.5 Feb __ 329.4 __ 47.3 __ 44.8
Manufacturing production
Volume output Manufacturing (%oya) %m/m sa Nov 4.6 2.7 Dec 0.2 -0.2 Jan __ __ 1.3 0.4
2.6
-0.3
Retail sales
%oya Real Nominal Nov 8.0 9.0 Dec 8.3 9.3 Jan __ __ 6.4 7.7
9.2
66
J.P. Morgan Australia Limited, Sydney Stephen Walters (61-2) 9220-1599 Helen Kevans (61-2) 9220-3250 helen.e.kevans@jpmorgan.com stephen.b.walters@jpmorgan.com Ben Jarman (61-2) 9220-1669 ben.k.jarman@jpmorgan.com
Australia and New Zealand

Small downgrade to near-term Aussie GDP growth forecasts; next RBA hike now in August, not May Skittish financial markets pricing in significant risk of rate cuts this year NZ GDP to rise in 4Q10, so economy will avoid another recession As was the case elsewhere this week, the unfolding situation in Japan dominated headlines in Australia and New Zealand. In the background, there was no top-tier economic data to mull over, and the release of the minutes from the most recent RBA Board meeting two weeks ago offered little new information. Indeed, as always, the problem with the minutes is that, in theory at least, they depict discussions from the recent past. The March minutes, therefore, did not reflect officials assessment of the disaster in Japan, escalating tensions in the Middle East, and the extreme volatility in financial markets. The sell-off in risky asset markets this week, for example, led AUD and NZD sharply lower, both falling more than 5% against USD. The downgrades to our GDP growth forecasts in Japan, alongside smaller downgrades for the US and China, prompted us to revise lower our near-term growth forecasts for Australia. We upgraded expected growth in 2012, though, owing to a brighter outlook for energy exports, in particular. We also have changed the RBA call; we now expect the next hike in August, rather than May, but still anticipate the RBA delivering roughly one hike per quarter from there (second chart). The economic fundamentals underpinning the strength of the Australian economy remain intact, and the medium-term outlook is even stronger. The changes to our New Zealand growth forecasts are not material, and will be finalized following the release of the 4Q10 GDP numbers next week. We think the economy will have avoided another technical recession; our forecast is for GDP growth of 0.4%q/q in 4Q10, following the unexpected contraction (-0.2%) in 3Q10. In the medium term, the disaster in Japan likely will be positive for the New Zealand economy. Japan is New Zealands fourth largest trading partner, accounting for 7.5% of exports. About onequarter of those exports are of aluminum, followed by wood, dairy products, meat, and fruit and vegetables. Demand for aluminum and, to some extent, wood will rise when rebuilding does get underway in Japan.
Australia: overnight indexed swap (OIS) rates

%, implied cash rate at each RBA meeting in 2011 5.0 4.9 4.8 4.7 4.6 4.5 Apr May Jun Jul Aug Sep Oct Nov Dec 2-Mar 17-Mar
Australia: RBA cash target rate

% 8 7 6 5 4 3 2 2007 2008 2009 2010 2011 2012
RBA to err on side of caution

Until this week, our base case was that RBA officials would lift the cash rate in May, but recent events mean this now is unlikely. We believe a rate hike in May is still a risk, but is no longer our base case. Indeed, the uncertainty over the impact of Japans earthquake and the crisis in its nuclear facilities, and the resulting dislocation in financial markets, mean the probabilities have shifted in favor of a later hike. August now is our preferred month. Although market pricing suggests a significant chance of a rate cut from the RBA in coming months (first chart), we believe the risks of an ease are small. The upbeat medium-term story for the Aussie economy is intact, and our view that the next rate move will be up remains unchallenged. The RBA will tighten policy to stay ahead of the hugely expansionary impacts of the mining boom. In the meantime, a delayed hike allows officials to gather more information on the impact of the disasters in Japan and to see the 2Q CPI report in late July. The RBA staff then also has the opportunity to explain the decision in detail in the quarterly statement that follows the August Board meeting. Waiting, though, carries risksthe RBA may be
67
Economic Research Australia and New Zealand March 18, 2011
forced to be more assertive later in pushing the cash rate further into restrictive territory, given the even larger terms of trade and mining investment booms. In fact, if demand for Aussie commodities does rise as Japan rebuilds, and commodity prices increase in anticipation of this, boosting the terms of trade, the resources boom would be even more supportive than before over the medium term.
Australia: exports
% of total, 6mma 30 25 20 15 10 China Japan
Minor downgrades to near-term growth

We have pushed through modest adjustments to our Aussie GDP forecasts in the wake of the recent downgrades to the near-term US and China growth forecasts, and the adjustments to the Japan forecasts in the wake of last weeks earthquake. We have made the following adjustments to the Australian forecasts, based on what we know now, though the ultimate impact of Japans earthquake, ensuing tsunami, and nuclear crisis remains unclear. We now anticipate slightly weaker GDP growth of 2.6% in 2011 (down from 2.8%). The downgrade to our 2011 forecast owes mainly to near-term weakness in commodity export volumes to Japan. Most of this weakness will be concentrated in the June quarter. We expect higher export volumes from 3Q11, though, as Japans rebuilding effort kicks in. Japan receives 18% of Australias exports, down from nearly 30% in late 2008, but remains Australias second most significant export partner (behind China, top chart). Two-way trade of more than A$54 billion was recorded between Australia and Japan in the last financial year. Japan now receives 39% of Australias exported coal (coking and thermal), 17% of its iron ore, and 65% of its liquefied natural gas (LNG). The upward revision to our 2012 forecasts (from 4.2% to 4.5%) puts our GDP growth forecast even further above trend, owing partly to further anticipated gains in energy and bulk commodity export volumes. The upside is limited, though, by capacity constraints in the coal and LNG industries, in particular. The LNG sector probably will benefit the most from the disaster as Japan may increase utilization of gas-fired power stations following the explosions at the nuclear plant in Fukushima. LNG would likely be the alternative fuel replacement, and coal also probably would be a substitute.
5 0 00 02 04
06
08
10
Australia: household saving

% of disposable income 15 10 5 0 Trend -5 00 02 04 06 08 10 Seasonally adjusted
derlying theme of Australia is one of an unprecedented boom in mining investment and commodity prices. References to the expansionary and inflationary nature of resources booms have been prominent and consistent in RBA commentary for more than a year. This particular story now is even more supportive, given that rebuilding in Japan should boost demand for energy and bulk commodities. The commentary on business investment is broadly the same as before (mining investment is poised to rise to a record-high share of GDP), and employment growth will be solid. Consumers, however, are being cautious, as best evidenced by the significant rise in the household saving rate over the past year. The saving rate has risen from just 2% at end-2007 to stabilize at a two-decade high just short of 10% in recent quarters (second chart). Discretionary spending has weakened considerably, most recently falling to a two-year low, home sales are down, and demand for credit remains subdued. The cautious consumer is providing an important, and necessary, offsetting influence to the booms elsewhere in the economy. The Board minutes also provided more color on the impact of the Queensland floods. RBA officials expect that the flooding shaved 0.5%-pt off 4Q10 and 1Q11 growth. On domestic inflation, the RBAs staff forecasts now show
No material change says RBA

The strong fundamentals underpinning the Australian economy in the medium term remain unchanged. Indeed, the key message from the Board minutes this weekalbeit the meeting preceded the events in Japanwas that the un-
68
higher near-term headline inflation, mainly reflecting the sharp rise in banana prices after Cyclone Yasi, which wiped out three quarters of the national crop. The headline inflation forecasts for 2012 now, though, are slightly lower owing to an expected unwind of the banana-effect.
New Zealand: real GDP

%q/q 2.5 1.5 0.5 -0.5 -1.5 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 J.P. Morgan forecasts
No double dip for New Zealand

In New Zealand, we have not pushed through changes to the near-term GDP growth forecasts, as we await the release next week of the fourth quarter GDP numbers. The threat of a double-dip recession became real following the unexpected contraction in GDP in 3Q10. Our forecast is for the economy to have expanded 0.4%q/q in the December quarter, a subpar result, but one which means that another technical recession has been avoided. The most recent recession was experienced throughout 2008 and into early 2009 when the economy contracted for five straight quarters. We do, however, expect that the economy will again contract in 1Q11, owing mainly to the impact of the most recent earthquake in Christchurch (February 22). In the December quarter, stronger investment will have underpinned growth. Residential investment slumped over the quarter, but this was more than offset by a spike in nonresidential investment. Government spending and net exports also should add to growth, albeit more modestly. The drags will stem from the change in inventories and household spending. Among the expenditure components of GDP, the latter will subtract from growth the most over the quarter, with continued caution among consumers partly to blame. The biggest dent to consumption in the December quarter was likely due to the hike to the goods and services tax on October 1.
New Zealand: retail sales and house prices

%oya 25 20 15 10 5 0 -5 -10 02 04 06 08 10 -5 REINZ house prices 5 Retail sales %oya 10
Labor market recovery key

The recent decline in market interest rates may lessen the current caution among New Zealanders, but a sustained recovery in the housing and labor markets is what is really needed. The recent decline in house prices has coincided with a drop in retail spending (second chart), while the lackluster recovery in the labor market, with the unemployment rate just 0.2%-pt below its recession peak of 7.0%, has discouraged discretionary spending. The labor market should recover throughout the year, with our forecast for the unemployment rate to fall from 6.8% to 6.2% by year-end. The solid rise in imports of capital goods (up 17%oya in January) signals increased business investment in coming quarters, which should foster a rise in firms hiring intentions and employment growth.
On the other hand, the outlook for the housing market is more subdued, despite the pickup in activity last month. House prices surprisingly rose in February, as did sales volumes, but it took nearly two months for transactions to be completed. The jump in the number of days it took to sell a house was the clearest indication of continued caution among buyers. The median time to sell a house was 58 days in February, the highest in over two years, compared to an already elevated 51 days in January. And despite the rise in home sales, sales volumes still are well below the 5,206 sales recorded in May last year. Slow sales have kept inventory levels elevated, such that the backlog of unsold property sitting on the market will depress house prices further in coming quarters.
More downbeat for the time being

Not surprisingly, New Zealanders are more downbeat. The Westpac consumer confidence index showed that confidence deteriorated markedly in the March quarter, with confidence toward current and future conditions both falling below the neutral 100 threshold. The headline index fell 9.6%m/m in 1Q11, marking the largest decline since 2Q08, and the first drop in the index below 100 since 1Q09. The index now has fallen for three straight quarters.
69
Economic Research Australia and New Zealand March 18, 2011
The survey captured the impact on sentiment of the earthquake in Christchurch, which had already been weakened by the quake that hit the same area in September last year. A sharper fall would have been prevented, though, by the expectation that, having now delivered a rate cut, the RBNZ will be on the policy sidelines for the remainder of the year. We believe that Governor Bollard will leave the official cash rate at a record low 2.5% for the remainder of the year. The added stimulus will not be removed until the rebuilding phase materializes, which is likely to be a 2012 story; hence, our forecast is for the next OCR hike to be delivered in 2Q12.
New Zealand: Data releases and forecasts

Wed Mar 23 8:45am

Sa 1Q10 NZ$bn % of GDP 0.2 -2.4 2Q10 -1.0 -3.2 3Q10 -1.8 -3.1 4Q10 -2.1 -2.4
Australia: Data releases and forecasts

Week of March 21 - 25 No major data releases.
Thu Mar 24 8:45am
The CAD probably widened despite an improvement in the trade balance. The unadjusted trade balance should, thanks to stronger exports, return to a modest surplus. The income balance will remain in deficit owing to a drop in foreign investors earnings on their investments. We suspect that the CAD will deteriorate further from here, although do not forecast the deficit to return to the 8%-9% of GDP-levels recorded in recent years. Real GDP
Sa 1Q10 %qoq %oya 0.6 1.8 2Q10 0.1 1.8 3Q10 -0.2 1.5 4Q10 0.4 0.9

New motor vehicle sales
Sa Dec %m/m %oya 1.0 -3.2 0.9 Jan -1.9 -2.8 -2.4 Feb -1.0 -1.9 0.2 -1.5

REINZ house price index sa Dec Jan -2.6 -2.6 Feb -0.6 -3.6 2.3 -0.6 %m/m %oya -5.3 -7.3 -0.6 -1.6
Dwelling starts
Sa 2Q10 %q/q %oya 2.1 1.1 46.4 48.1 3Q10 -13.2 -13.0 12.4 15.1 4Q10 -1.3 -5.3
The fall in dwelling commencements in 4Q was much larger than anticipated (J.P. Morgan: -1.3%; consensus: -1.4%), although not nearly as sharp as the 13% tumble in the preceding quarter. The number of commencements also fell in year-on-year terms, slipping 7.3%oya, marking the first decline in five quarters. We are pessimistic on the outlook for building activity, not least because first home buyers have all but withdrawn from the market. This group is very important in driving new dwelling creation, but now represents a lower share of new housing finance commitments, due to the steady rise of borrowing rates and the withdrawal of subsidy support. The recent drop-off in immigration rates notwithstanding, Australias supply imbalance will be exacerbated by a return to sluggish dwelling creation. With house prices having appreciated fairly substantially throughout 2009, there is scope for rental yields to normalize, meaning the pressure valve for undersupply of new housing is likely to be higher rents.
The REINZ house price index was up 2.3%m/m, reversing much of the 2.6% decline in January, but prices remain 5.6% below the November 2007 peak. The stratified median house price rose NZ$10,000 to NZ$360,000, with prices up across most of the nation. Christchurch was among the exceptions however, having been hit by an earthquake on February 22. The median house price declined in Christchurch, the nations second largest city, by NZ$5,000 to NZ$325,000, as sales numbers dropped to 244 from 271.
Westpac NZ consumer confidence Index 3Q10 Index %m/m 114.1 -4.4 4Q10 108.3 -5.1 1Q11 99.1 97.9 -8.5 -9.6
70
JPMorgan Chase Bank, Hong Kong Grace Ng (852) 2800-7002 grace.h.ng@jpmorgan.com
Greater China
China: fine-tuning near-term GDP forecast; expect trend growth in 2H11 PBoC hiked RRR 50bp again; February M2 growth eased again; new loans at 535.6 billion yuan Hong Kong: unemployment rate continued to decline, fell to 3.6% in December-February period On the back of the hit to real income and consumer spending from higher fuel costs, our US team has revised down the forecast for 1H11 GDP for the second time in two weeks, with US growth now expected to average 3% ar in the first two quarters, versus the original forecast of 4%. Also, a smaller downward adjustment has been made to the Euro area growth forecast. Meanwhile, after the Tohoku earthquake in Japan, our Japan team has revised down 1Q and 2Q11 GDP growth from 2.2% to 1.7% and from 2.2% to 0.5%, respectively, but revised up 3Q and 4Q GDP from 2.5% to 4.0% and from 2.0% to 2.5%, respectively. The latest changes in the external environment, coupled with recent indicators from China suggesting that the economy has moved onto a more moderate growth path in early 2011, easing from the sharp acceleration in 4Q10, have prompted us to fine-tune our outlook for the near-term GDP growth trajectory for China, revising down the 1H11 forecast modestly, while expecting trend growth through 2H11. Our full-year 2011 real GDP forecast now stands at 9.4%oya (previously 9.6%).
China real GDP forecast %q/q saar Previous %oya Previous 4Q10 12.7 12.7 9.8 9.8 1Q11 8.7 9.5 9.4 9.6 2Q11 8.8 9.0 10.0 10.3 3Q11 9.0 8.7 9.8 10.0 4Q11 9.0 8.7 8.9 9.0
US retail sales and Chinese exports to US

%3m/3m, saar, both scales US retail sales ex motor vehicle, 15 parts, and gasoline 10 5 0 -5 -10 -15 2005 2006 2007 2008 2009 2010 2011 China exports to US 75 50 25 0 -25 -50
China: trade with Japan by major products (2010) Imports from Japan Machiney, electrical equipment Base metals and articles Vehicles, aircraft, vessels & transport equip Products of chemcial or allied industries Optical, photographic, muscial instruments Exports to Japan Machiney, electrical equipment Textiles and textile articles Foodstuffs Products of chemcial or allied industries US$ bn 176.8 84.9 19.6 16.7 14.8 14.7 121.2 47.4 21.8 9.0 6.8 % of Total 12.7 6.1 1.4 1.2 1.1 1.1 7.7 3.0 1.4 0.6 0.4
Hit to near-term G-3 growth outlook

Historically, a 1%-pt change in US GDP growth (with its associated impact on the global economy) leads to about a 5%-pt change in Chinas export growth. This would in turn impact Chinas GDP growth by about 0.8-1.1%-pt. (By comparison, exports to Japan constitute about 7.7% of Chinas total exports, and imports from Japan are about 12.7% of Chinas total imports.) As such, the recent downward revision to the US and other advanced economies near-term growth forecasts would likely have a moderate impact on China. A closer look at Chinas latest trade data suggests that, average seasonally adjusted exports in JanFeb were was 6.5% (not annualized) above the average monthly level in 4Q10. This suggests that the underlying trend in Chinas exports was still rising at a gradual pace through February, though the growth pace in the near term may remain moderate given the downward revision to GDP forecasts across the major advanced economies. Indeed, the disappointment in Chinas February exports was led by slowing exports to Europe, while the export momentum to the US also eased somewhat.
China: manufacturing PMI and GDP

Index, sa 60 55 50 45 40 Manufactuirng PMI (Markit) Real GDP 20 15 10 5 0
Jan-Feb average 2005 2006 2007 2008 2009 2010 2011
71
JPMorgan Chase Bank, Hong Kong Lu Jiang (852) 2800-7053 lu.l.jiang@jpmorgan.com
Economic Research Greater China March 18, 2011
Impact of tightening begins to appear

The Chinese economy appears to have moved onto a more moderate growth path in early 2011, easing from the sharp acceleration in 4Q10. The governments assortment of policy measures to cool the housing market, manage inflation, and prevent overheating risks appear to be impacting the real economy. In particular, while fixed investment continued to register solid growth in Jan-Feb (though new investment projects have eased), retail sales disappointed, dragged down by a notable slowing in auto sales partly on the back of the expiration of preferential tax treatment. Housing-related spending, such as furniture sales, also contributed to the recent slowing in overall retails sales, reflecting softer property transactions on the back of housing policy tightening. The central bank has been normalizing monetary policy since early last year, and this has lead to some moderation in M2 and loan growth. From August last year, this process was put on hold with the sequential trend growth in M2 and loans rebounding as policymakers became concerned about slowdown in global activity, the impact of the Europe sovereign crisis, etc. More recently, however, with the easing of these external concerns, but with growing concerns over domestic inflation, the renewed, rather notable moderation in the growth pace of monetary indicators during the past two months suggests that monetary policy normalization has resumed. This resumption is consistent with the recent modest easing in the real economic indicators and should eventually temper some of the overheating concerns.
China: real GDP and M2 growth

%q/q, saar 20 15 10 5 Feb figure 0 04 05 06 07 08 09 10 11 5 Real GDP M2 %3m/3m, saar 25 20 15 10
China: auto production and sales

%oya, 3mma 60 Production 40 20 0 -20 05 06 07 08 09 10 11 12 Sales
China: real estate investment and floor space started

%oya, 3mma, both scales 50 40 30 20 10 0 2006 2007 2008 2009 2010 2011 Floor space started Real estate FAI 120 100 80 60 40 20 0 -20
Look for trend growth in 2H11

Looking further ahead, on the external environment, the generally supportive global demand outlook for 2H11 should support steady growth for Chinese exports. On the domestic front, public investment projects, especially at the local government level, are expected to increase solidly going forward. In addition, while private real estate investment will likely slow ahead from policy tightening, public economic housing investment should gather more momentum, with strong support from the central government, given the policy target to start constructing 10 million affording housing units this year. On domestic consumption, while the impact of the expiration of preferential tax treatment and restrictions on auto purchases in certain cities may drag down near-term auto sales growth, solid overall employment growth and broad-based wage gains should support overall household income and hence consumer demand this year.
China: real estate investment and domestic spot steel prices

%oya, both scales 50 40 30 20 10 0 2005 2006 2007 2008 2009 2010 2011 Real estate investment Spot steel price 60 40 20 0 -20 -40
72
JPMorgan Chase Bank, Hong Kong Grace Ng (852) 2800-7002 grace.h.ng@jpmorgan.com
Another 50bp RRR hike

The Peoples Bank of China announced on Friday that the reserve requirement ratio (RRR) for financial institutions yuan deposits would be raised again by 50bp, effective March 25. The latest move would drain about 360 billion yuan from the banking system. After this hike, the reserve requirement ratios stand at 20.0% for large banks and 18.0% for medium and small financial institutions. This is the third hike in the RRR in 2011. The hike, following six RRR hikes in 2010 and two earlier this year, each by 50bp, is a further move by the central bank to manage the overall liquidity situation and the pace of new loan creation. While the latest macro data flow suggests that policy changes intended to cool the housing market, manage inflation, and prevent overheating risks appear to be impacting the real economy, the latest RRR hike suggests policymakers see the need for further normalization of monetary conditions, and are still cautious to manage the pace of new loan creation going forward. Technically, a RRR hike remains a cheaper and more highprofile move than open market operations for liquidity management, with the 1-year PBoC bill yield at 3.1992% vs. 1.62% interest on required reserves. Importantly, our rate strategists suggest that a significant amount of PBoC bills will mature in the near term, totaling 230 billion yuan for the rest of March, and 855 billion yuan for the months of April and May combined. As such, though M2 money supply growth has slowed rather notably, and with the merchandise trade balance likely to remain in deficit in March and possibly April, near-term liquidity management through RRR changes is still an important policy instrument. On the macro policy front, CPI inflation rate is expected to pick up again, breaching the 5% handle in March (our forecast is 5.3%oya), and remain elevated through midyear. We thus expect the monetary policy normalization process to continue, including at least one more RRR hike, and two more interest rate hikes, as well as further CNY appreciation (with year-end USD/CNY forecast at 6.3), with these policy actions largely front-loaded in 1H. Going into 2H11, as headline CPI inflation begins to moderate gradually, helped by a more favorable base effect and as the various macro policies begin to impact the real economy, uncertainty and market concerns over policy tightening may begin to ease. The behavior of global commodity prices remains the key risk to Chinas inflation outlook in 2H11.
China: reserve requirement ratios for financial institutions

% 20 15 10 5 RRR for large banks
RRR for medium and small banks 03 05 07 09 11
China: money supply and loan growth

%oya 40 30 20 10 0 06 07 08 09 10 11 12 M2 Loans M1
China: financial institutions' new loan creation

Bn yuan, nsa 2000 1500 1000 500 0 Jan 2011 2010
2009
Apr
Jul
Oct
Jan
M2 growth eased again in February

Chinas M2 money supply growth eased further, with M2 rising 15.7%oya in February (J.P. Morgan: 17.1% consensus: 17.0%), compared to 17.2%oya growth in January, registering the slowest growth in %oya terms since July last year. Seasonally adjusted M2 rose a moderate 0.8% m/m in February, following no growth in January, with the sequential trend growth pace easing to 13.5%3m/3m saar in February. M1 money supply growth came in at 14.5%oya in February, stabilizing from 13.6%oya in January, but mod-
73
JPMorgan Chase Bank, Hong Kong Grace Ng (852) 2800-7002 grace.h.ng@jpmorgan.com Lu Jiang (852) 2800-7053 lu.l.jiang@jpmorgan.com
Economic Research Greater China March 18, 2011
erating from the average 21.8%oya in 4Q10. Bank loans rose 17.7%oya in February, compared to 18.5%oya in January. New loan creation was 535.6 billion yuan in February (consensus: 600 billion yuan), compared to 1,040 billion yuan in January, and 700.1 billion yuan last February.
February headline inflation is likely to pick up further on a monthly basis, reflecting further increases in commodity prices, particularly food imports, as well as larger increases in prices during the holiday season.
Thu Mar 24 4:30pm
Merchandise trade
HK$ bn Nov Balance Exports %oya Imports %oya -23.5 273.0 16.6 296.6 16.4 Dec -43.5 253.0 12.5 296.5 14.8 Jan -16.0 283.7 27.6 299.6 19.0 Feb -31.3 203.9 11.7 235.2 16.4
Hong Kong: unemployment fell further

Hong Kongs labor market continues to improve. The seasonally adjusted unemployment rate declined further, posting a better-than-expected result at 3.6% in December-February period, compared to an average of 3.8% during the November-January period. Seasonal factors contributed to the February decline as employment actually declined modestly to 3,576 in February from 3,582 in January, reflecting some moderation in business activity and labor demand after the Lunar New Year holiday. Going forward, we expect the latest changes in the external environment, particularly the downward revisions to the US and Mainland China growth outlook, will offer some restraint to Hong Kongs exports. On the other hand, domestic demand is likely to remain solid on the back of steadily improving labor market conditions as well as a still buoyant real estate sector and the implementation of various multiyear public infrastructure projects. Strong tourism inflows will likely continue to support hiring in retail and related services. Our forecast for Hong Kongs real GDP in 2011 now stands at 4.7%oya (previous forecast 4.8%oya).
Hong Kongs exports likely eased after the surge in January generated by the front loading activity before the Lunar New Year holiday, and also corresponding to the weaker trade figures in Mainland China.

Labor market survey (Mar 17)
Sa, 3mma Unemployment rate % avg Employed Ch, m/m, 000 persons Dec 4.0 13.4 Jan 3.8 15.1 Feb 3.8 3.6 __ 41.1
Taiwan: Data releases and forecasts

Mon Mar 21 4:00pm
China: Data releases and forecasts

Week of March 21 - 25 No data releases.
Export orders
% change Nov %oya %m/m sa 14.3 3.3 Dec 15.3 3.8 Jan 13.5 1.9 Feb 10.7 2.0

Monetary aggregates (Mar 14)
%oya Dec M2 Bank lending 19.7 19.9 Jan 17.2 18.5 Feb 17.1 15.7 __ 17.7
Wed Mar 23 4:00pm
Thu Mar 24 4:00pm
Labor market survey

% Nov Unemployment rate, sa Unemployment rate, nsa 4.8 4.7 Dec 4.7 4.7 Jan 4.7 4.6 Feb 4.7 4.7
Hong Kong: Data releases and forecasts

Tue Mar 22 4:30pm

No data released.
Consumer prices
74
JPMorgan Chase Bank, Seoul Jiwon Lim (822) 758-5509 jiwon.c.lim@jpmorgan.com James Lee (822) 758-5512 james.dh.lee@jpmorgan.com
Korea
Quarterly profile of 2011 GDP forecast fine-tuned Large number of government job applications pushed up February jobless rate The data calendar was relatively light, but the crisis in Japan dampened financial markets further this week with the developments at the Fukushima nuclear reaction becoming a major concern. While it is too early to estimate with any precision the impact on the Korean economy, we note that the earthquake in Japan came on top of a series of unexpected events since early this year, such as weather-driven food price increases and geopolitical risks in the MENA region, that have weighed on consumer and investor confidence in Korea as well as its key trading partners. As for the direct trade link, only 6% of Koreas exports go to Japan. However, more than 15% of Koreas imports come from Japan, and thus any reduction raises concern over possible disruption in supply channels, notably in the tech sector, although major manufacturing companies are reported to have 1-2 months of inventory. Reflecting this, we trimmed our 1H growth forecast modestly, but boosted the 2H outlook, keeping our forecast of full 2011 GDP growth at 4.2%. This forecast still assumes that both food and crude oil prices recede in 2H, and the developments at the Fukushima nuclear power plants does not worsen further and will be followed by broad-based rebuilding in Japan.
Korea's trade partners

% of total during 2010 Exports to China EU US Japan Hong Kong Total (US$ bn) 25.1 Middle East 11.5 China 10.7 Japan 6.0 US 5.4 EU 466.4 Total (US$ bn) Imports from 19.0 16.8 15.1 9.5 9.1 425.2
Unemployment rate
% of total labor force 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2005 2006 2007 2008 2009 2010 2011 Distortion caused by government hiring program
Labor force participation rate

% of total population above age 15, sa 62.5 3mma 62.0 61.5 61.0 60.5
Jobless rate up, but details remain firm

The seasonally adjusted unemployment rate rose to 4.0% in February from 3.6% in January, but mainly because the labor force rose more than employment, together with some lunar holiday impact. The labor force surged 317,000 (or 1.4%m/m sa) in February, more than reversing the 131,000 (or 0.5%m/m sa) decline in January. As a result, the labor force participation rate jumped to 61.4 from 60.6, recording the largest gain in the seasonally adjusted series twelveyear history. The sharp rise in the labor force was attributed in part to government job applications; the government job creation program intends to add 30,000 jobs from March to June. Though on a smaller scale than last year, this still attracted 130,000 applications, raising both the labor force and the number unemployed as the actual hiring will start from March. Meanwhile, employment rose 223,000 (or 1.0%m/m sa) in February, after a soft patch in January due to unusually harsh winter weather. The average workweek was also extended to 45.8 hours in February, after staying at 45.4 hours in the prior three months. In the details, private sector hiring continued to lead the creation of new positions, while the public sector shed jobs for the third con-
05
07
09
11
Changes in employment
000s, sa 200 150 100 50 0 -50 -100 -150 -200 Public services only Total
2007
2008
2009
2010
2011
secutive month. In terms of industries, both construction and agriculture displayed strong gains, although this in part reflected a rebound from weather-driven weakness in Janu75
JPMorgan Chase Bank, Seoul James Lee (822) 758-5512 james.dh.lee@jpmorgan.com
Economic Research Korea March 18, 2011
ary. Hiring in manufacturing and private service sectors was firm, up 24,000 (or 0.6%m/m sa) and 98,000 (or 0.6%), respectively.
Housing prices (Mar 18)

% change from previous week, apartment prices only Week of Feb 28 0.3 Mar 7 0.4 Mar 14 __ 0.3

Fri Mar 25 6:00am
Consumer survey
100=neutral reading, nsa Dec Index 109 Jan 108 Feb 105 Mar 103
BoK Watch
Financial markets volatile With the news of the Japan earthquake and the trouble at the Fukushima nuclear power plant taking center stage, Koreas financial market has been extremely volatile. For example, the 3-yr benchmark KTB yield fell as much as 13bp to 3.59%, but eventually closed the week with yields just 7bp lower at 3.65%. Meanwhile, USD/KRW turned up early this week as global risk aversion kicked in, but the move was eventually capped by perceptions that a bout of KRW weakness would not be welcomed by the government whose policy priority has temporarily shifted to price stability. USD/KRW saw further pressure on Friday on the news of coordinated G-7intervention to support JPY. As a result, JPY/KRW fell about 3.8% on Friday, almost recovering to the pre-earthquake level.
Consumer sentiment likely pulled back in March, as prices of necessary goods remained elevated.

Export and import prices (Mar 15)
%oya, in local currency terms Dec Export prices Import prices 4.3 12.7 Jan 4.9 14.1 Feb 5.8 5.6 19.2 16.9
Imported good prices in local currency rose 3.1%m/m nsa in February, after staying flat in January for seasonal reasons. By J.P. Morgans calculation, imported good prices rose 2.7%m/m sa in February, about the same pace as in the previous three months. The price gain was concentrated in raw materials that surged 5.5%m/m sa in February. Imported goods in contractual currency terms moved up 3.3%m/m sa in February. Meanwhile, export prices rose 1.2%m/m sa and 1.7% each in local currency and contractual currency terms. Stage of processing price index (Mar 15)
%oya Nov Index 8.6 Dec 9.8 Jan 11.4 11.1
Interest rates
%p.a. Feb 18 Overnight call Three-month CD fixing One-year MSB Three-year Treasury bond Three-year corporate bond 2.75 3.15 3.57 3.96 4.74 Mar 3 2.75 3.23 3.66 3.93 4.71 Mar 10 2.99 3.39 3.59 3.71 4.52 Mar 17 3.00 3.39 3.57 3.66 4.48
The headline SPPI rose 1.7%m/m nsa to be up 11%oya in February. The seasonally adjusted SPPI increased 1.4%m/m sa in February, decelerated modestly for two straight months. Domestically produced goods prices rose 1.0%m/m sa in February, moderating from the 1.8% gain in January, but imported goods prices rose 2.6% in February, about the same pace as in January. Unemployment rate (Mar 16)
% of total labor force Nov Seasonally adjusted Not adjusted 3.5 3.5 Dec 3.6 3.8 Jan 3.5 3.8 4.0 4.5
Deposit changes at deposit money banks

KRW tn Dec Total deposits Demand Time and savings -2.8 -7 4.2 Jan 4.6 2.1 2.5 Feb 15.1 2.1 12.9 Mar 1-14 0.2 -0.4 0.6
See main story.
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JPMorgan Chase Bank, Singapore Matt Hildebrandt (65) 6882-2253 matt.l.hildebrandt@jpmorgan.com
ASEAN: Indonesia, Malaysia,

Philippines, Singapore, Thailand, Vietnam
Policy tightening in Vietnam has become more aggressive and consistent over the last month But, inflation still likely to spike this month from hike in domestic energy and electricity prices Policy direction more constructive but near- and medium-term problems still need to be addressed We are becoming more positive on the outlook for Vietnam, primarily due to the more assertive and consistent policy direction of late. Since early February, we have seen much more aggressive, consistent, and prudent policies prioritizing economic stability over growth. Tighter monetary policy, slower credit growth, more prudent fiscal policy, and a more flexible exchange rate should lead to a more stable currency and balance of payments position. Inflation stabilized in February despite the devaluation, as most business in the country was already being priced at the unofficial exchange rate. Thus, by bringing the official VND rate in line with unofficial black market rate, the devaluation did not have much effect on the real economy. However, the government raised domestic energy and electricity prices, both of which are partly subsidized. These price hikes will cause a jump in inflation this month. As a result we see inflation still rising over the next few months before stabilizing and eventually slowing gradually later in the year. Despite these improvements, some policy concerns remain. FX reserves are still unknown, bank deposit rate caps are still in place and inconsistent with recent policy tightening, monetary policy effectiveness is unclear, and transparency within the economy and communication by the government is poor. Over the medium term, freeing up deposit rates, clarifying and developing the monetary policy framework, and improving transparency and communication should be achieved to reduce future economic volatility.
Vietnam: official exchange rate

VND per USD 21000 20000 19000 18000 17000 16000 15000 2005 2006 2007 2008 2009 2010 2011
Vietnam: monetary policy rates

% 16 14 12 10 8 6 4 2007 2008 2009 2010 Discount rate 2011 Refinance rate Repo rate (OMO)
Vietnam: compulsory reserve requirement and inflation

% 30 25 20 15 10 5 0 2005 2006 2007 2008 2009 2010 2011 CRR Inflation %oya 30 25 20 15 10 5 0
Vietnam: trade balance US$ bn, both scales 1 0 -1 -2 -3 -4 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Monthly 12-month rolling sum 6 0 -6 -12 -18 -24 Jan 11
More prudent policy direction being taken

Immediately following Tet New Year, the government devaluated the official VND rate by 8.5%, much larger than the usual 2%-5% moves of the past. This brought the official rate in line with the unofficial black market rate, and to provide more credibility going forward, the government announced that it would it would set the daily official rate with more flexibility than in the past to keep it more in line with market prices. The government introduced several
77
Economic Research ASEAN March 18, 2011
other measures as well to stabilize the economy, including: hiking the repo, refinance, and discount rates by 100bp, 200bp, and 500bp, respectively, bringing them all to 12%, lowering the fiscal deficit target 0.3%-pt to 5.0% of GDP, cutting spending on specific SOE projects 10%, and lowering credit (25% to 19%) and M2 (20% to 16%) growth targets. The government also has ordered state-owned enterprises to remit foreign exchange earnings to the SBV, and it is rationing USD loans to essential importers. This will reduce the trade deficit and lead to a rise in FX reserves.
Vietnam: important monetary policy rates

Base rate: Refinance rate: former main policy rate and center of interest rate corridor; seems to have lost effectiveness except for use in civil law
Inflation still to rise temporarily

In addition to the positive moves mentioned above, the government also raised domestic fuel and electricity costs to rationalize subsidy expenses. These moves will likely raise inflation around 1.5%-pts, and we now expect inflation to peak between 14%-15% from its February print of 12.3%oya. However, even with this jump in prices, our forecast shows inflation starting to slow from March onwards, which leads us to think that the worst of the recent inflation scare has past. Thus, we expect the over-year-ago inflation rate to stabilize in coming months before gradually slowing later in the year.
theoretically marks the upper bound of the interest rate corridor; meant as a punitive lending rate for liquidity-short banks; access requires higher administrative hurdles and can invite greater operational scrutiny; banks reportedly use as a source of capital for government approved projects Discount theoretically marks the lower bound of the interest rate corridor; rate: subject to quotas; mostly major state-owned banks access this window Repo rate: rate at which the SBV performs open market operations; appears to be the de facto policy rate Compulsory this rate determines the amount of reserves a bank must hold against reserves: deposits to maintain fluid operations
Vietnam: inflation
%oya 30
20 CPI 10 Core
Policy improvements still needed

While the government is finally sending more clear and consistent signals about prioritizing economic stability over growth, some policy concerns remain. In particular, the monetary framework remains weak and transmission from policy to market rates is poor due to operational opaqueness, policy inconsistency, and regulatory distortion. As a result, market rates have not moved much in response to policy rate tightening (most market rate tightening occurred before December), and the bank deposit rate cap of 14% keeps lending rates lower than would be otherwise despite some circumvention by banks of this restriction . Policy communication is also poor. The market is not informed of policy meetings before they take place, and the monetary framework is confusing. Our understanding is that the refinance rate is meant to be the upper bound of the policy rate corridor while the discount rate the lower bound. Currently, all rates, including the repo rate, are at 12% and the base rate, which had previously been the policy rate but seems to have been abandoned, is still at 9%. In addition to improving communication, transparency must improve. The government has not released FX reserve data since 3Q10, leaving the market uninformed of the actual level. This encourages market uncertainty and speculation about the actual level currently, which at times, can be more harmful than just confirming lower than ideal FX reserve levels.
78
03
05
07
09
11
Vietnam: contribution to CPI by major components

%-pt contribution to %oya CPI inflation 14 12 10 8 6 4 2 0 Mar 10 May 10 Jul 10 Sep 10 Nov 10 Jan 11 Other Housing Transport Total food products
Vietnam: consumer prices

% 40 30 20 10 0 -10 2006 2007 2008 2009 2010 2011 Annualized
Over-year-ago
Indonesia: Data releases and forecasts


No data released.
The Philippine fiscal balance posted a surplus of PHP13.4 billion in January following Decembers sizeable PHP44.6 billion deficit. This is a very positive start for 2011 considering that the government averaged a monthly deficit of PHP26 billion in 2010, and this marks the first time since 1998 that the budget is starting the year in the black. Moreover, the improvement was due to a combination of expenditure restraint and rise in revenues. Boosting revenues has been particularly troublesome for the government in the past but perhaps its efforts are starting to pay off. The government recently released its full-year budget figures that showed the deficit narrowing to 3.7% of GDP in 2010 from 3.9% of GDP in 2009. The PHP314 billion deficit compared favorably to the official target of PHP325 billion (revised up around midyear last year from below PHP300 billion initially), and it shows that since coming to the power the Aquino administration has made some important strides in improving the fiscal position. The government is targeting a deficit of PHP300 billion this year, about 3.3% of GDP, but we think the outcome could surprise on the upside slightly. To be sure, the January figure was flattered with PHP24 billion in dividend payments from state agencies. However, even without the dividends the deficit would have been only around PHP11 billion, less than half the size of the 2010 monthly average. Importantly, revenues rose sharply, up 57.6%m/m sa (including dividends) while spending was down almost 9%. This trend will likely be reversed in coming months but the fiscal position does appear to be on a gradually improving trajectory. OFW remittances (Mar 15)
% change Nov %oya %m/m sa 10.5 0.1 Dec 8.1 -2.0 Jan 7.8 7.6 0.6
Malaysia: Data releases and forecasts

Wed Mar 23 5:00pm
Consumer prices

No data released.
Philippines: Data releases and forecasts

Thu Mar 24
BSP monetary policy meeting

% p.a.
Dec Reverse repo rate 4.00
Jan 4.00
Feb 4.00
Mar 4.25
Inflation has risen quickly in recent months. Though only at 4.3%oya, it appears set to breach the upper bound of BSPs 3%-5% inflation target range. We thus expect BSP to hike the policy rate 25bp next week, the first rate hike of a tightening cycle, as an attempt to keep inflation expectations anchored.
Fri Mar 25 9:00am
Overseas foreign worker (OFW) remittances rose 0.6%m/m sa in January, leaving inflows up 7.6%oya, slightly higher than the 8.1% growth in December 2010. In level terms, remittances fell hard due to seasonal factors and were only US$1.47 billion for the month compared to the $1.69 billion record set in December. However in seasonally adjusted terms, the level compared more favorably at $1.60 billion versus $1.62 billion in December. The soft start to the year combined with the weak December print leaves our annual remittance forecast lower than in 2010. While 2010 remittances rebounded nicely from the global recession, up 8.2% in 2010 after slowing to 5.6% in 2009, remittance growth this year is forecast to soften to around 7%. Given the large size of remittances, estimated at almost US$19 billion in 2010 (10% of GDP), the slower growth forecast is not a big concern, especially since remittances are nearly three times as large as the trade deficit.
Merchandise trade
US$ bn, nsa Oct Imports %oya 4.9 28.4 Nov 4.9 35.3 Dec 4.9 25.3 Jan 4.9 15.6

Government budget
Pesos bn Nov Balance Revenue Expenditure 0.5 111.5 111.1 Dec -44.6 103.2 147.8 Jan __ 13.4 __135.9 __122.5
79
Economic Research ASEAN March 18, 2011
Singapore: Data releases and forecast

Wed Mar 23 4:00pm
Consumer prices
Passthrough from high oil prices will likely persist, which should push inflation higher.
Fri Mar 25 1:00pm
This dichotomy between electronics and non-electronics is also observed across the region, with electronics softening more than expected despite what has ostensibly been fairly strong forward looking indicatorsnotably the new orders component of the global PMI and also in the new orders component of the Singapore electronics PMI. While some of this softness in electronics could reflect the Lunar New Year effect, this impact should also be been seen in the other export sectors but this has not been the case. Nonetheless, there is little evidence to suggest that the recent data should mark a turn in what has otherwise been a positive uptrend in external demand following some softness in 3Q10. Looking ahead, exports to Japan are expected to have softened in March owing to the recent catastrophe though this is expected to be a temporary dip rather than suggesting a broader downshift in demand. The key metric for external demand remains the PMIs, and this will need to be closely watched given recent developments in commodity markets and the impact from natural disasters.
% change Nov %oya %m/m sa 40.4 1.3 Dec 9.0 -12.1 Jan 10.5 15.4 Feb 3.9 -2.9
We expect IP to have softened last month as January saw a big boost from electronics and nonelectronics production. We expect some payback, and February is unlikely to repeat.
Thailand: Data releases and forecasts


Retail sales (Mar 15)
% change Nov %oya %m/m sa -4.6 0.8 Dec -1.1 2.7 Jan -6.0 -0.4 0.3 -3.1

No data released.
Retail sales fell a sharp 3.1%m/m sa and 4.7%3m/3m saar. However, the decline reflected volatile auto sales that are subject to government sales quotas. Exlcuding auto sales, retail sales were up 1.4%m/m sa and 7.7%3m/3m saar. Merchandise trade (Mar 17)
US$ bn, nsa Dec Trade balance Exports Non-oil domestic (NODX) %m/m sa, US$ terms %oya, US$ terms 4.6 32.4 11.3 12.7 20.0 Jan 4.7 33.0 11.3 6.9 32.2 Feb 4.3 3.8 30.0 28.4 10.8 10.1 -1.8 -4.6 27.6 21.7
Vietnam: Data releases and forecasts

During the week Consumer prices %oya Dec All items %m/m sa 11.8 1.8 Jan 12.2 1.5 Feb 12.3 1.1 Mar 13.8 2.0
Higher domestic electricity and energy prices should lift CPI inflation despite monetary tightening by SBV.
February non-oil domestic exports (NODX) fell 4.6%m/m sa in US$ terms. Sequential trend growth was up a strong 26.5%3m/ 3m saar after some softness in January which owed in part to the volatility in the pharmaceuticals sub-sector. While some of the weakness might owe to the Lunar New Year effect, this softness was not apparent across all the various product subgroups. In this context, electronics exports softened further, echoing a trend that has been in place since 4Q10 even as nonelectronics and non-pharmaceuticals exports rose solidly, bolstered by exports of ships and machinery.

No data released.
80
J.P. Morgan Chase Bank, Mumbai Jahangir Aziz (9122) 6157-3385 jahangir.x.aziz@jpmorgan.com Sajjid Z Chinoy (9122) 6157-3386 sajjid.z.chinoy@jpmorgan.com
India
RBI, as expected, raised policy rates 25bp and signaled continuation of anti-inflationary stance February inflation surprises on the upside as nonfood manufacturing inflation surges Tepid year-on-year January IP growth masks strong sequential momentum As was widely expected, the RBI raised policy rates 25bp at its mid-quarter review. The repo rate was raised to 6.75% from 6.5% and the reverse repo rate was raised to 5.75% from 5.5%. With February inflation accelerating to 8.3% driven by a sharp increase in nonfood manufacturing inflation (see below), a rate hike at the mid-policy review was a foregone conclusion. Furthermore, with the RBI repeatedly emphasizing a calibrated approach to monetary tightening, market participants had correctly anticipated that the hike would be 25bp in magnitude.
India: February inflations stays stubbornly high

% oya 20 15 10 5 0 -5 Aug 07 Nonfood Feb 08 Aug 08 Feb 09 Aug 09 Feb 10 Aug 10 Feb 11 Food Headline
India: mfg ex-food momentum running close to double digits

% 3m3/m, saar 20 Headline 15 10 5 0 -5 Nonfood manufacturing -10 -15 Aug 07 Feb 08 Aug 08 Feb 09
RBI increases March inflation forecast to 8%oya

The RBI has again revised up its March inflation forecast to 8%oya (J.P. Morgan: 8%). Recall, March inflation had been forecast to print at 5.5% by the RBI until as recently as December. It was revised up to 7% in the January review and has now been revised up again, more realistically, to 8%oya. The fact that March inflation has been revised up by a whopping 250bp over the last two meetings, and policy rates have been hiked hiked 50bp suggests a disconnect between the central banks concerns and its actions.
Aug 09
Feb 10
Aug 10
Feb 11
expectations of a moderation (consensus: 7.8%). Furthermore, December inflation was revised upwards by a whopping 100bp to 9.4%oya from the initial estimate of 8.4%. It was widely anticipated that primary food inflation would moderate in February after surging more than 9% sequentially over the last three months. As expected, primary food inflation moderated to 10.6%oya (- 3.9%m/m sa) from 15.6% in January, driven primarily by a reduction in fruits and vegetables inflation. These prices had surged due to idiosyncratic supply shocks over the last few months, and prices have mean-reverted once these shocks were reversed.
RBI signals continuation of anti-inflationary stance

While broadly reiterating its FY11 GDP growth forecast of 8.5%oya, the RBI cited concerns that the investment climate is being adversely impacted by continuing uncertainty about global energy and commodity prices and could hurt growth in the next fiscal year. Despite this, however, the central bank explicitly stated that it will persist with its anti-inflationary stance. With inflation still stubbornly high and significantly above the central banks comfort zone more rate hikes are expected in 2011 including a likely 25bp hike at the next review on May 3.
... and nonfood manufacturing inflation momentum surges

The moderation in food inflation, however, was more than offset by a sharp surge in the prices of nonfood manufactured prices in February, which rose 1.6%m/m sathe highest month-in-month increase since 2004. The sequential momentum of nonfood manufacturing inflation has risen secularly over the last five months and is currently tracking 9.1%q/q saar.
The India data watch is published biweekly, next on April 1.
February inflation exceeds market expectations...

February WPI inflation printed at 8.3%oya, accelerating further over Januarys print of 8.2%oya and belying market
81
J.P. Morgan Chase Bank, Mumbai Jahangir Aziz (9122) 6157-3385 jahangir.x.aziz@jpmorgan.com Sajjid Z Chinoy (9122) 6157-3386 sajjid.z.chinoy@jpmorgan.com
Economic Research India March 18, 2011
This is not surprising in light of the sustained increase in manufacturing input prices over the last six months as well as the fact that capacity is increasingly constrained in the manufacturing sector in the absence of any meaningful capacity addition over the last two years. For these reasons, we expect nonfood manufacturing inflation, and therefore headline inflation, to remain sticky for much of 2011.
India: industrial production

Index sa, Sep08=100 180 160 140 120 100 80 Sep 08 Mar 09 Sep 09 Capital
Consumer durables
January IP growth tepid, but sequential momentum strong

January IP growth printed at 3.7%oya, higher than market expectations (consensus: 2.9 %; J.P. Morgan: 3.1 %) even as December IP was revised up to 2.5%oya from the initial estimate of 1.6%oya. While the year-on-year growth rates appear to be tepid (December 2010 primarily on account of the high base from December 2009), they are masking the strong sequential momentum of IP growth in the last two months which, when annualized, has been running at double digits. Specifically, December IP grew at 2.8%m/m sa and, on top of that, January IP rose 1.6%m/m sa. For a change, the sequential growth was also broad-based. While basic and intermediate goods posted stable year-onyear growth in January, their sequential monetum continued to be strong (2.2%m/m sa and 2.3% m/m sa).The decline in capital goods on a year-on-year basis (-18.1%oya) was deceptive because sequential growth was buoyant (6.1%m/m sa). Finally, consumer goods also posted healthy sequential gains. While consumer durables growth moderated to 1.3 % on a monthly sequential basis, this is only because the December numbers were revised upwards such that durables surged in December (17 % m/m, sa). Encouragingly, nondurables posted healthy sequential growth for a second month, after spectacular non-performance for most of 2010.
Consumer nondurables
Mar 10 Sep 10

Weeks of March 21 - April 1
Fri Apr 1
Merchandise trade
US$ bn, nsa Dec Trade balance Exports %oya Imports %oya Oil Non-oil -8.9 18.9 26.5 27.7 12.1 7.7 20.0 Jan -2.6 22.5 36.4 25.1 -11.0 6.9 18.2 Feb -7.9 20.6 32.4 28.5 13.1 7.8 20.7 Mar __ __ __ __ __ __ __
Fri Apr 1
Manufacturing PMI survey

2005=100, sa Jan Index 56.8 Feb 57.9 Mar __

Industrial production (Mar 11)
%oya nsa Nov Dec 1.6 1.2 3.8 1.0 6.0 2.5 2.0 5.7 2.0 Jan __ 3.7 __ 1.2 __ 1.6 __ 3.3 __ 10.5 Overall %m/m, sa Mining Manufacturing Electricity 3.6 -2.7 7.4 3.2 4.6
Exports surge likely driving IP momentum

The strong sequential momentum in IP is not entirely surprising because there is an increasingly strong correlation between merchandise export growth and IP growth. With exports surging over the last few months (and the provisional information on February exports pointing to a whopping 50.2%oya increase), it was broadly expected that IP would grow strongly in sequential terms. Furthermore, with new export orders bouncing back sharply in the February PMI, strong global demand and export growth should provide support for IP growth even as the domestic economy seems to be slowing down gradually.
Wholesale prices (Mar 14)

%oya Dec Overall Primary Energy group Manufactured products 8.4 9.4 16.5 18.4 11.2 11.3 4.5 5.3 Jan 8.2 17.3 11.4 3.8 Feb __ 8.3 __ 14.8 __ 11.5 __ 4.9
82
JPMorgan Chase Bank, Singapore Sin Beng Ong (65) 6882-1623 sinbeng.ong@jpmorgan.com
Asia focus: regional trade trends with Japan

The direct regional economic impact from the catastrophe in Japan remains unclear at this point as events unfold. While Emerging Asias trade exposure to Japan has been declining over the past decade, falling to 10.2% of total trade in 2010 from 15% in 2000, it is not insubstantial given the openness of the region to trade (table and first chart). Part of the decline in regional trade with Japan owes to the changing trade patterns following Chinas accession to the WTO in 2001, which effectively led to shifts in regional supply chains, reflected for instance in the offshoring of Japanese production to China, possibly at the expense of other regional manufacturing hubs (chart below). This boosted Chinas exports, reflected to some degree in the higher share of machinery and transport equipment back to Japan which is either further processed for re-export or consumed as final demand. At another level, although relative import shares from Japan have also declined, the data do not fully capture the intricacies of the production networks around the region. Of Chinas imports from Japan, around 18% of the total consists of machinery and transport equipment, and this figure has been relatively stable since 2005. These imports may reflect key intermediate inputs into final products which may
China and Malaysia: machinery and tranport equipment exports
% of exports to Japan 60 50 40 30 20 10 93 95 97 99 01 03 05 From Malaysia 07 09 From China
be hard to substitute in the short term. How this potential sand in the wheels of the regional production network might affect trade flows remains to be seen.
EM Asia: exports
%oya 30 20 10 0 -10 -20 00 %-pt contribution to oya growth from Japan 02 04 06 08 10 Overall Ex. Japan 3 2 1 0 -1 -2
Emerging Asia: trade with Japan

% of total 2000 EM Asia total trade Exports to Japan China total trade Exports to Japan Imports from Japan Hong Kong total trade Exports to Japan Imports from Japan Indonesia total trade Exports to Japan Imports from Japan Korea total trade Exports to Japan Imports from Japan Malaysia total trade Exports to Japan Imports from Japan Philippines total trade Exports to Japan Imports from Japan Singapore total trade Exports to Japan Imports from Japan
2
2002 14.1 11.1 17.3 16.4 14.9 18.1 8.4 5.4 11.3 18.6 21.1 14.1 14.3 9.3 19.6 14.2 11.1 17.8 17.3 15.0 19.2 9.7 7.1 12.5 16.0 9.1 24.2 19.2 15.0
2004 13.5 10.1 17.1 14.5 12.4 16.8 8.8 5.3 12.1 18.7 22.3 13.1 14.2 8.5 20.6 12.7 10.1 15.9 18.7 20.1 17.4 8.2 5.8 11.0 16.4 7.6 25.9 19.0 14.2
2006 11.5 8.9 14.4 11.8 9.5 14.6 7.7 4.9 10.3 16.8 21.6 9.0 12.4 8.2 16.8 10.9 8.9 13.3 15.3 16.7 14.0 6.8 5.5 8.3 14.7 7.3 22.8 16.7 12.9 20.5
2008 10.4 8.0 13.1 10.4 8.1 13.3 7.2 4.3 9.8 16.1 20.3 11.7 10.4 6.7 14.0 11.5 10.7 12.5 13.5 15.7 11.6 6.5 4.9 8.1 12.9 6.9 19.3 15.2 11.3 19.1
15.4 12.2 18.8 17.5 16.7 18.4 8.9 5.5 12.0 20.7 23.2 16.1 15.7 11.9 19.8 16.4 13.1 20.5 16.7 14.7 18.9 12.3 7.5 17.2 19.0 11.1 27.4 19.5 15.0
2010 Change1 10.2 -3.3 7.5 13.1 10.0 7.7 12.7 6.8 4.2 9.2 14.6 16.3 12.5 10.4 6.0 15.1 11.4 10.4 12.6 13.7 15.2 12.3 6.2 4.7 7.9 13.3 6.6 20.7 15.7 10.5 21.3 -2.6 -4.0 -4.5 -4.7 -4.1 -2.0 -1.1 -3.0 -4.1 -6.0 -0.6 -3.8 -2.5 -5.4 -1.4 0.3 -3.4 -5.0 -4.9 -5.1 -2.1 -1.2 -3.1 -3.1 -1.0 -5.2 -3.3 -3.6 -2.6
Imports from Japan
China: imports of machinery and transport equipment

% of total imports 30 To Korea and Taiwan 25 20 15 10 To Japan 95 97 99 01 03 05 07 09
Taiwan total trade Exports to Japan Imports from Japan Thailand total trade Exports to Japan
93
Imports from Japan 24.5 23.5 23.9 1. 2010 less 2004 2. Total trade (exports+imports) with Japan
83
JPMorgan Chase Bank N.A., New York Daniel Silver (1-212) 622-6039 daniel.a.silver@jpmorgan.com
US economic calendar
Monday 21 Mar
Existing home sales (10:00am) Feb 5.15mn
Tuesday 22 Mar
FHFA HPI (10:00am) Jan -0.2% (-4.4%oya) Richmond Fed survey (10:00am) Mar
Dallas Fed President Fisher speaks at Frankfurt Finance Summit (7:30am) Cleveland Fed President Pianalto speaks on economy in Akron (8:00am)
Wednesday 23 Mar
New home sales (10:00am) Feb 290,000
Fed Chairman Bernanke speaks to bankers in San Diego (12:00pm)
Thursday 24 Mar
Initial claims (8:30am) w/e prior Sat 380,000 Durable goods (8:30am) Feb 3.2% Ex transportation 2.5%
Auction 10-year TIPS (r) $11 bn Announce 2-year note $35 bn Announce 5-year note $35 bn Announce 7-year note $29 bn Fed Governor Duke speaks to economists in Virginia (7:30pm)
Friday 25 Mar
Real GDP (8:30am) 4Q final 3.2% Consumer sentiment (9:55am) Mar final 68.0
Minneapolis Fed President Kocherlakota speaks in France (5:00am) Dallas Fed President Fisher speaks in Brussels (7:30am) Chicago Fed President Evans speaks to reporters in Chicago (8:30am) Atlanta Fed President Lockhart speaks on economy in Florida (9:15am) Philadelphia Fed President Plosser speaks on monetary policy in New York (12:15pm)
28 Mar
Personal income (8:30am) Feb Pending home sales (10:00am) Feb Dallas Fed survey (10:30am) Mar
Auction 2-year note $35 bn Atlanta Fed President Lockhart speaks on US economy in Atlanta (12:40pm) Chicago Fed President Evans speaks on economy in South Carolina (4:00pm)
29 Mar
S&P/Case-Shiller HPI (9:00am) Jan Consumer confidence (10:00am) Mar
Auction 5-year note $35 bn St. Louis Fed President Bullard speaks on monetary policy in Prague
30 Mar
ADP employment (8:15am) Mar
Auction 7-year note $29 bn St. Louis Fed President Bullard speaks in London (1:00pm)
31 Mar
Initial claims (8:30am) w/e prior Sat Chicago PMI (9:45am) Mar Factory orders (10:00am) Feb KC Fed survey (11:00am) Mar
Richmond Fed President Lacker speaks at credit symposium in Charlotte (10:30am) Fed Governor Tarullo speaks at credit symposium in Charlotte (12:30pm)
1 Apr
Employment (8:30am) Mar ISM manufacturing (10:00am) Mar Construction spending (10:00am) Feb Light vehicle sales Mar
Philadelphia Fed President Plosser speaks on economy in Harrisburg, PA (8:15am) New York Fed President Dudley speaks in Puerto Rico (9:00am)
4 Apr
Atlanta Fed President Lockhart speaks on economy in Florida (9:05am) Fed Chairman Bernanke speaks at conference in Atlanta (7:15pm)
5 Apr
ISM nonmanufacturing (10:00am) Mar FOMC minutes
Atlanta Fed President Lockhart gives remarks in Georgia (8:25am) Philadelphia Fed President Plosser moderates panel in Georgia (11:15am) Minneapolis Fed President Kocherlakota gives remarks in Minneapolis (12:45pm)
6 Apr
Atlanta Fed President Lockhart gives remarks in Georgia (8:20am)
7 Apr
Initial claims (8:30am) w/e prior Sat Consumer credit (3:00pm) Feb Chain store sales Mar
Announce 3-year note $32 bn Announce 10-year note (r) $21 bn Announce 30-year bond (r) $13 bn Richmond Fed President Lacker speaks on financial regulation in Virginia (8:20am)
8 Apr
Wholesale trade (10:00am) Feb
Atlanta Fed President Lockhart speaks on economy in Knoxville (8:00am)
11 Apr
Fed Vice Chairman Yellen speaks to Economic Club in New York (12:00pm)
12 Apr
NFIB survey (7:30am) Mar International trade (8:30am) Feb Import prices (8:30am) Mar Federal budget (2:00pm) Mar
Auction 3-year note $32 bn
13 Apr
Retail sales (8:30am) Mar Business inventories (10:00am) Feb JOLTS (10:00am) Feb Beige book (2:00pm)
Auction 10-year note (r) $21 bn
14 Apr
Initial claims (8:30am) w/e prior Sat PPI (8:30am) Mar
Auction 30-year bond (r) $13 bn Announce 5-year TIPS $12 bn Minneapolis Fed President Kocherlakota speaks on economic development in Montana (9:20am)
15 Apr
CPI (8:30am) Mar Empire State survey (8:30am) Apr TIC data (9:00am) Feb Industrial production (9:15am) Mar Consumer sentiment (9:55am) Apr preliminary
Richmond Fed President Lacker speaks on economy in Baltimore (6:45pm)
84
JPMorgan Chase Bank, London Greg Fuzesi (44-20) 7777-4792 greg.x.fuzesi@jpmorgan.com
Euro area economic calendar

Monday 21 Mar
ECB member Gertrude TumpelGugerell speaks in Salzburg, Austria (5:00pm) ECB president Jean-Claude Trichet speaks in Brussels, Belgium (3:00pm)
Tuesday 22 Mar
Spain: Trade balance Jan Netherlands: CBS cons. conf. (9:30am) Mar
Wednesday 23 Mar
Euro area: EC cons. conf. prelim (4:00pm) Mar -11.0%bal, sa Industrial new orders (11:00am) Jan Belgium: BNB bus. conf. (3:00am) Mar
Thursday 24 Mar
Euro area: PMI flash (10:00am) Mar Mfg 58.0 Index, sa Services 55.8 Index, sa Composite 57.0 Index, sa Germany: PMI flash (9:30am) Mar Mfg 61.5 Index, sa Services 57.6 Index, sa Composite 59.7 Index, sa France: PMI flash(9:00am) Mar Mfg 55.8 Index, sa Services 58.7 Index, sa Composite 58.0 Index, sa INSEE bus. conf. (8:45am) Mar Italy: ISAE cons. conf. (10:00am) Mar Netherlands: GDP final (9:30am) 4Q
Friday 25 Mar
Euro area: M3 (10:00am) Mar 0.5%m/m, sa Germany: Gfk cons. conf. (8:00am) Mar IFO business survey (10:00am) Mar 110.3 Index, sa France: INSEE cons. conf. (8:45am) Mar Cons. of mfg goods (8:45am) Feb GDP final (7:00am) 4Q 1.4%q/q, saar Spain: PPI (9:00am) Feb Netherlands: CBS bus. conf. (9:30am) Mar ECB member Jos Manuel Gonzlez-Pramo speaks in Washington, D.C., U.S.A (9:15pm)
28 Mar
Germany: Import prices (8:00am) Feb Retail sales (8:00am) Feb
29 Mar
Germany: CPI 6 states and prelim (8:00am) Mar France: Consumption of mfg goods (8:45am) Feb Italy: ISAE bus. conf. (9:30am) Mar
30 Mar
Euro area: EC bus. conf. (11:00am) Mar EC cons. conf. (11:00am) Mar Italy: Contractual wages (10:00am) Feb Spain: HICP flash (9:00am) Mar Belgium: CPI (11:15am) Mar
31 Mar
Germany: Employment (9:55am) Feb Unemployment (9:55am) Mar France: PPI (8:45am) Feb Italy: PPI (10:00am) Feb CPI prelim (11:00am) Mar
1 Apr
Euro area: PMI Mfg final (10:00am) Mar Unemployment (11:00am) Feb Germany: PMI Mfg final (9:55am) Mar France: PMI Mfg final (9:50am) Mar Italy: PMI Mfg (9:45am) Mar Spain: PMI Mfg (9:15am) Mar
4 Apr
Euro area: PPI (11:00am) Feb
5 Apr
Euro area: PMI services & composite final (10:00am) Mar Retail sales (11:00 am) Feb Germany: PMI services & composite final (9:55am) Mar France: PMI services & composite final (9:50am) Mar Italy: PMI services & composite (9:45am) Mar Spain: PMI services & composite (9:15am) Mar
6 Apr
Euro area: GDP final (11:00am) 4Q Germany: Industrial new orders (12:00pm) Feb
7 Apr
Euro area: ECB rate announcement (1:45pm) 25bp hike expected Governing council meeting of the ECB, Frankfurt Germany: Industrial production (12:00pm) Feb Netherlands: CPI (9:30am) Mar
8 Apr
Germany: Foreign trade (8:00am) Feb Netherlands: Industrial production (9:30am) Feb
11 Apr
France: Industrial production (8:45am) Feb Italy: Industrial production (10:00am) Feb
12 Apr
Germany: CPI final (8:00am) Mar Zew bus. survey (11:00am) Apr Spain: CPI final (9:00am) Mar
13 Apr
Euro area: Industrial production (11:00am) Feb France: CPI (8:45am) Mar
14 Apr
Euro area: ECB monthly bulletin (10:00am)
15 Apr
Euro area: HICP final (11:00am) Mar Foreign trade (11:00am) Feb Italy: Foreign trade (10:00am) Feb CPI final (10:00am) Mar
Highlighted data are scheduled for release on or after the date shown. Times shown are local.
85
JP Morgan Securities Japan Co., Ltd Miwako Nakamura (81-3) 6736-1167 miwako.nakamura@jpmorgan.com
Japan economic calendar

Monday 21 Mar
Holiday: Japan
Tuesday 22 Mar
All sector activity index (1:30 pm) Jan 2.6%m/m, sa Auction 2-month bill
Wednesday 23 Mar
Flow of funds (8:50am) 4Q BoJ Board member Miyaos address in Oita prefecture (11:10am) Auction 3-month bill
Thursday 24 Mar
Trade balance (8:50 am) Feb 802 billion yen, nsa Auction 2-year note
Friday 25 Mar
Nationwide core CPI (8:30 am) Feb -0.3%oya Corporate service prices (8:50 am) Feb -1.2%oya
During the week: Nationwide department store sales Feb -2.0%oya
28 Mar
29 Mar
All household spending (8:30 am) Feb Unemployment rate (8:30 am) Feb Job offers to applicants ratio (8:30 am) Feb Total retail sales (8:50 am) Feb Shoko Chukin small business sentiment Mar
30 Mar
IP preliminary (8:50 am) Feb
31 Mar
PMI manufacturing (8:15 am) Mar Nominal wages (10:30 am) Feb Housing starts (2:00 pm) Feb Construction orders (2:00 pm) Feb
1Apr
BoJ Tankan (8:50 am) 1Q Auto registrations (2:00 pm) Mar Auction 3-month bill
4 Apr
Monetary base (8:50 am) Feb
5 Apr
PMI services/composite (8:15 am) Mar Auction 3-month bill Auction 10-year bond
6 Apr
Coincident CI (2:00 pm) Feb BoJ Monetary Policy Meeting Auction 6-month bill
7 Apr
BoJ Monetary Policy Meeting and statement BoJ Governor Shirakawas press conference (3:30 pm)
8 Apr
Current account (8:50 am) Feb Economy Watchers survey (2:00 pm) Mar BoJ monthly economic report (2:00 pm)
During the week: Cabinet Office private consumption index Feb
11 Apr
Private machinery orders (8:50 pm) Feb BoJ Governor Shirakawas address at branch managers meeting
12 Apr
M2 (8:50 am) Mar Minutes of Mar 14 BoJ Monetary Policy Meeting (8:50 am) Auction 2-month bill Auction 30-year bond
13 Apr
Corporate goods prices (8:50 am) Mar Auction 3-month bill
14 Apr
Reuters Tankan (8:30 am) Apr Auction 5-year note
15 Apr
IP final (1:30 pm) Feb Auction 1-year bill
86
JPMorgan Chase Bank N.A., New York Silvana Dimino (1-212) 834-5684 silvana.dimino@jpmorgan.com
Canada economic calendar

Monday 21 Mar 22 Mar
Retail sales (8:30am) Jan 1.2% Ex autos 1.0% Leading indicators (8:30am) Feb FY2011 Federal Budget presented to Parliament (11:30am)
Tuesday
Wednesday 23 Mar 24 Mar
Thursday 25 Mar
Friday
Saturday, 26 March BoC Governor Mark Carney speaks at an Inter-American Development Bank seminar on Global imbalances and Latin America in Calgary, Alberta (10:30am)
28 Mar
BoC Deputy Governor Jean Boivin speaks on The Great Recession in Canada: Perceptions and Reality at a Montreal CFA Society event in Montreal, Quebec (12:45pm)
29 Mar
30 Mar
IPPI (8:30am) Feb
31 Mar
Monthly GDP (8:30am) Jan Payroll employment (8:30am) Jan
1 Apr
4 Apr
BoC Business Outlook Survey (10:30am) 1Q BoC Senior Loan Officer Survey (10:30am) 1Q
5 Apr
6 Apr
CFIB Business Barometer Index (7:00am) Mar Ivey PMI (10:00am) Mar
7 Apr
Building permits (8:30am) Feb
8 Apr
Employment (7:00am) Mar Housing starts (8:15am) Mar
11 Apr
12 Apr
International trade (8:30am) Feb New house price index (8:30am) Feb BoC rate announcement (9:00am)
13 Apr
Monetary Policy Report (10:30am)
14 Apr
Manufacturing sales (8:30am) Feb New vehicle sales (8:30am) Feb TNS Canada Consumer Confidence Index (9:00am) Mar
15 Apr
Nonresidential construction (8:30am) 1Q Existing home sales (9:00am) Mar
87
JPMorgan Chase Bank, New York Tejal Ray (212) 834-8580 Laura Karpuska (55 11) 3048-3322
Latin America economic calendar

Monday 21 Mar
Holiday: Colombia and Mexico
Tuesday 22 Mar
Mexico: Central bank reserves Aggregate S/D 4Q 8.3%oya
Wednesday 23 Mar
Argentina: IP Feb Trade balance Feb Brazil: FGV CPI IPC-S Mar 15 0.65% m/m nsa IPCA-15 Feb 0.52% m/m nsa Mexico: Retail sales Jan 4.1%oya
Thursday 24 Mar
Brazil: Unemployment rate Feb 6.4% m/m nsa Colombia: GDP 4Q 4.1% oya sa Mexico: Unemployment rate Feb 5.2% CPI Mar 1H Core CPI Mar 1H Holiday: Argentina
Friday 25 Mar
Brazil: Fipe CPI Mar 17 0.39% m/m nsa Current account Feb -US$3.7bn FDI Feb US$7.0bn Mexico: Trade balance Feb US$132 mn Holiday: Argentina
During the week: Venezuela: Unemployment rate Feb
28 Mar
Argentina: Economic activity Jan Mexico: Economic activity Jan
29 Mar
Brazil: Banking Credit Report Feb Mexico: Central bank reserves
30 Mar
Brazil: FGV IGP-M Mar Central government budget Feb Chile: IP Feb Retail sales Feb Mexico: PS budget balance Feb
31 Mar
Argentina: Construction activity Feb Brazil: Primary budget Feb Net debt as % of GDP Feb Colombia: Unemployment Feb
1 Apr
Brazil: FGV CPI IPC-S Mar 31 IP Feb PMI Manufacturing Mar Trade balance Mar Chile: BCCh minutes Colombia: BanRep minutes Mexico: Banxico expectations survey Remittances Feb Peru: CPI Mar WPI Mar
During the week: Argentina: Government tax revenue Mar
4 Apr
Brazil: FIPE CPI Mar Mexico: PMI manufacturing Mar PMI nonmanufacturing Mar
5 Apr
Chile: Economic activity Feb Colombia: PPI Mar Mexico: Central bank reserves Consumer confidence Mar
6 Apr
Brazil: Vehicle sales Mar Colombia: CPI Mar Ecuador: CPI Mar
7 Apr
Brazil: IGP-DI Mar IPCA Mar Chile: Trade balance Mar Mexico: CPI Mar Core Mar Peru: BCRP meeting
8 Apr
Brazil: FGV CPI IPC-S Apr 7 Chile: CPI Mar Mexico: Fixed investment Jan
During the week: Venezuela: CPI Mar
Colombia: Vehicle sales Mar
Brazil: CAGED Formal Job Creation
11 Apr
Brazil: IGP-M 1st release Apr Mexico: IP Feb
12 Apr
Brazil: Retail sales Apr Chile: BCCh meeting Mexico: Central bank reserves Auto report Mar Peru: Trade balance Feb
13 Apr
14 Apr
15 Apr
Argentina: CPI Mar WPI Mar Brazil: FGV IGP-10 Apr Colombia: Trade balance Feb Mexico: Banxico meeting Peru: GDP Feb Unemployment Mar
88
JPMorgan Chase Bank, London Malcolm Barr (44-20) 7777-1080 Allan Monks (44-20) 7777-1188 Nicola Mai (44-20) 7777-3467
UK/Scandinavia economic calendar

Monday 21 Mar
United Kingdom: Rightmove HPI (12:01am) Mar
Tuesday 22 Mar
United Kingdom: CPI (9:30am) Feb 4.3 %oya Public sector finances (9:30am) Feb PSNB 5.0 bn, nsa CBI industrial trends (11:00am) Mar -10 %bal (Total order books)
Wednesday 23 Mar
United Kingdom: MPC minutes (9:30am) A 3-5-1 vote is expected with Sentance, Weale, and Dale dissenting for higher rates, and Posen for more QE. BBA mortgage lending (9:30am) Feb The Chancellor of the Exchequer presents his Budget Statement (12:30pm) Sweden: Business tendency (9:15am) Mar Consumer conf. (9:15am) Mar Norway: AKU unemployment (10:00am) Jan
Thursday 24 Mar
United Kingdom: Retail sales (9:30am) Feb -0.6 %m/m, sa Sweden: PPI (9:30am) Feb
Friday 25 Mar
28 Mar
Sweden: Retail sales (9:30am) Feb Trade balance (9:30am) Feb
29 Mar
United Kingdom: Business investment final (9:30am) 4Q GDP final (9:30am) 4Q M4 & M4 lending final (9:30am) Feb BoP (9:30am) 4Q Net lending to individuals (9:30am) Feb
30 Mar
United Kingdom: Index of services (9:30am) Jan CBI survey of distributive trades (11:00am) Mar Sweden: Wage Stats (9:30am) Jan
31 Mar
United Kingdom: GfK cons. conf. (12:01am) Feb BoE credit conditions survey 1Q Norway: Credit indicator (10:00am) Retail sales (10:00am) Feb
1 Apr
United Kingdom: PMI mfg (9:30am) Mar Sweden: PMI (08:30am) Mar Norway: Labor directorate unemployment (10:00am) Mar PMI mfg (9:00am) Mar NEF HPI (11:00am) Mar
During the week :
United Kingdom: Nwide HPI (8:00am) Mar
4 Apr
United Kingdom: PMI construction (9:30am) Mar BoE housing equity withdrawal (9:30am) 4Q
5 Apr
United Kingdom: PMI services (9:30am) Mar
6 Apr
United Kingdom: BRC retail sales monitor (12:01am) Mar Industrial production (9:30am)Feb New car regs. (9:00am) Mar Markit jobs report (12:01am) Mar
7 Apr
United Kingdom: MPC rate announcement & Asset purchase target (12:00pm) No change expected Norway: IP Mfg (10:00am) Feb
8 Apr
United Kingdom: PPI (9:30am) Mar Construction output (9:30am) Feb Sweden: Industrial production (9:30am) Feb Industrial orders (9:30am) Feb
During the week :
United Kingdom: Halifax HPI (8:00am) Mar
11 Apr
Norway: CPI (10:00am) Mar PPI (10:00am) Mar
12 Apr
United Kingdom: RICS HPI (12:01am) Mar DCLG HPI (9:30am) Feb Trade balance (9:30am) Feb CPI (9:30am) Mar Sweden: CPI (9:30am) Mar United Kingdom: Nwide cons. conf. (8:00am) Mar
13 Apr
United Kingdom: Labor market statistics (9:30am) Mar
14 Apr
15 Apr
Norway: Trade balance (10:00am) Mar
During the week :
89
JPMorgan Chase Bank, London Anthony Wong (44-20) 7777-3750 anthony.x.wong@jpmorgan.com
Emerging Europe/Middle East/Africa economic calendar

Monday 21 Mar
Poland: Current account (2:00pm) Jan EUR-1475mn
Tuesday 22 Mar
Poland: Core inflation (2:00pm) Jan & Feb 1.6%oya & 1.8%oya South Africa: Current account (10:00am) 4Q 2.6% of GDP Quarterly Bulletin (10:00am) 4Q
Wednesday 23 Mar
Hungary: Retail sales (9:00am) Jan -1%oya Poland: Retail sales value (10:00am) Feb 8.5%oya Turkey: Monetary policy announcement (2:00pm) No change South Africa: CPI (9:00am) Feb 3.7%oya
Thursday 24 Mar
Czech Rep: Monetary policy announcement (1:00pm) No change South Africa: Monetary policy announcement (3:00pm) No change
Friday 25 Mar
Turkey: Capacity utilization (4:30pm) Mar 72.8% Russia: Monetary policy announcement 25bp hike in deposit rate
Holiday: South Africa During the week:
28 Mar
Hungary: Monetary policy announcement (2:00pm) No change Israel: Monetary policy announcement (5:30pm) No change
29 Mar
Romania: Monetary policy announcement (5:30pm) No change South Africa: Trade balance (2:00pm) Feb
30 Mar
Hungary: PPI (9:00am) Feb South Africa: Credit & money (8:00am) Feb Budget (2:00pm) Feb
31 Mar
Hungary: Current account (8:30am) 4Q Poland: Current account (2:00pm) 4Q Turkey: GDP (10:00am) 4Q 6.5%oya Foreign trade (10:00am) Feb -$6.9bn South Africa: PPI (11:30am) Feb Russia: GDP 4Q10
1 Apr
Czech Rep: PMI (9:30am) Mar Hungary: PMI (9:00am) Mar Poland: PMI (9:00am) Mar Russia: Manufacturing PMI (8:00am) Mar Turkey: PMI (10:00am) Mar South Africa: Kagiso PMI (10:00am) Mar Vehicle sales (10:00am) Mar
During the week:
4 Apr
Czech Rep: Retail sales (9:00am) Feb Romania: Retail sales (10:00am) Feb Turkey: CPI (10:00am) Mar PPI (10:00am) Mar
5 Apr
Poland: Monetary policy announcement +25bp Russia: Services PMI (8:00am) Mar
6 Apr
Czech Rep: Industrial output (10:00am) Feb Trade balance (10:00am) Feb Hungary: Central bank minutes (2:00pm) Industrial output (9:00am) Feb
7 Apr
South Africa: Gross reserves (8:00am) Mar
8 Apr
Hungary: Trade balance (10:00am) Feb Romania: Industrial output (10:00am) Feb Turkey: Industrial production (10:00am) Feb
During the week:
11 Apr
Czech Rep: CPI (10:00am) Mar Poland: Current account (2:00pm) Feb Romania: CPI (10:00am) Mar Trade balance (10:00am) Feb
12 Apr
Hungary: CPI (9:00am) Mar
13 Apr
Czech Rep: Current account (10:00am) Feb Poland: CPI (2:00pm) Mar Romania: Current account (2:00pm) Feb Israel: Trade balance Mar
14 Apr
15 Apr
Czech Rep: PPI (9:00am) Mar Turkey: Unemployment (10:00am) Jan Israel: CPI (6:30pm) Mar
During the week: South Africa: Retail sales Feb, Manufacturing production
90
JPMorgan Chase Bank, Singapore Matt Hildebrandt (65) 6882-2253 Prachi Priya (65) 6882-2311
Non-Japan Asia economic calendar

Monday 21 Mar
New Zealand: Credit card spending Feb Taiwan: Export orders (4:00 pm) Feb 10.7%oya
Tuesday 22 Mar
Taiwan: Unemployment rate (4:00 pm) Feb 4.7%, sa Hong Kong: CPI (4:15 pm) Feb 2.3%oya
Wednesday 23 Mar
New Zealand: Current account balance 4Q Singapore: CPI (1:00 pm) Feb 5.9%oya Taiwan: IP (4:00 pm) Feb 16.2%oya
Thursday 24 Mar
Hong Kong: Trade balance (4:15 pm) Feb HK$-31.3bn New Zealand: GDP 4Q Philippines: BSP monetary policy meeting 25 bp hike
Friday 25 Mar
Korea: Consumer survey (6:00 am) Mar 103, Index Malaysia: CPI (5:00 pm) Feb 2.2%oya Philippines: Imports (9:00 am) Jan 15.6%oya Singapore: IP (1:00 pm) Feb 3.9%oya
During the week:
Philippines: Budget balance Feb Vietnam: CPI Mar 13.8%oya
28 Mar
Taiwan: Leading index (4:00 pm) Feb
29 Mar
New Zealand: Trade balance Feb Korea: Current account (8:00 am) Feb
30 Mar
Korea: GDP 4Q New Zealand: Building consents Feb
31 Mar
Australia: Building approvals Feb Private sector credit Feb Hong Kong: Retail sales Feb Korea: IP (8:00 am) Feb Leading index (8:00 am) Feb Service sector activity (8:00 am) Feb India: CAB 4Q Taiwan: CBC monetary policy meeting Thailand: Trade balance (2:30 pm) Feb PCI (2:30 pm) Feb PII (2:30 pm) Feb IP (2:30 pm) Feb
1 Apr
China: PMI Mar Korea: CPI (8:00 am) Mar Trade balance (9:00 am) Mar India: Trade balance Feb Indonesia: Inflation (12:00 pm) Mar Trade balance (12:00 pm) Feb Thailand: CPI (12:30 pm) Mar
During the week:
Vietnam: Trade balance Mar GDP 1Q
4 Apr
Malaysia: Trade balance (6:00 pm) Feb
5 Apr
Australia: Trade balance Feb RBA board meeting Philippines: CPI (9:00 am) Mar Singapore: PMI (9:30 pm) Mar Holiday: China, Hong Kong, Taiwan
6 Apr
Australia: Home loans Feb Taiwan: CPI (4:00 pm ) Mar
7 Apr
Australia: Unemployment rate Mar Malaysia: IP (12:00 pm) Feb
8 Apr
Korea: Money supply Feb
Holiday: Taiwan During the week:
Holiday: Thailand
11 Apr
Malaysia: IP (12:00 pm) Feb Taiwan: Trade balance Mar
12 Apr
Australia: NAB business confidence Mar India: IP Feb Indonesia: Bank Indonesia monetary policy meet Korea: BoK monetary policy meet Philippines: Exports Feb
13 Apr
Australia: Westpac consumer confidence Apr Korea: Unemployment rate Mar
14 Apr
Australia: New motor vehicle sales Mar India: WPI Mar New Zealand: Retail sales Feb Singapore: Real GDP adv. (8:00 am) 1Q
15 Apr
China:CPI (10:00 am) Mar PPI (10:00 am) Mar FAI (10:00am) Mar Retail sales (10:00 am) Mar IP (10:00 am) Mar Philippines: OFW remmittances Feb Korea: Export price index Mar Import price index Mar Singapore: Retail sales (1:00 pm) Feb Trade balance (1:00 pm) Mar
Holiday: Philippines During the week:
Holiday: Thailand
Holiday: Thailand
91
JPMorgan Chase Bank NA, New York Michael Mulhall (1-212) 834-9123 michael.r.mulhall@jpmorgan.com
Global Data Diary

Week / Weekend 19 - 25 March Monday 21 March
Euro area Trichet speech Taiwan Export orders (Feb) United States Exstng home sales (Feb)
Tuesday 22 March
United Kingdom CPI (Feb)
Wednesday 23 March
Thursday 24 March
Friday 25 March
Germany GfK cons conf (Mar) IFO bus survey (Mar) Japan CPI (Feb) Singapore IP (Feb) Russia CBR mtg: +25bp United States GDP final (4Q) UMich cons sent fnl (Mar)
Euro area Czech Republic EC cons conf prelim (Mar) CNB mtg: no chg Indstrl new orders (Jan) Euro area: PMI flash (Mar) Taiwan France IP (Feb) INSEE bus conf (Mar) Turkey Hong Kong CBRT mtg: no chg Trade report (Feb) United Kingdom Japan: Trade report (Feb) MPC minutes (Mar) Philippines United States BSP mtg: +25bp New home sales (Feb) Bernanke speech South Africa SARB mtg: no chg UK: Retail sales (Feb) United States Durable goods (Feb)
26 Mar - 1 Apr
Germany Retail sales (Feb) CPI prelim (Mar)
28 March
Hungary NBH mtg: no chg Israel BoI mtg: no chg
29 March
Japan All hhold spending (Feb) Labor market report (Feb) Retail sales (Feb) Shoko Chukin (Mar)
30 March
Euro area EC cons conf final (Mar) EC bus conf (Mar) Japan IP prelim (Feb) Korea GDP (4Q) United States ADP employment (Mar)
31 March
Germany Labor mkt rprt (Feb/Mar) Japan PMI mfg (Mar) Korea IP (Feb) Taiwan CBC mtg: +12.5bp United Kingdom GfK cons conf (Feb) United States Factory orders (Feb)
1 April
Euro area Unemployment (Feb) Japan BoJ Tankan (1Q) Auto regs (Mar) Korea CPI (Mar) Trade report (Mar) United States Employment (Mar) ISM mfg (Mar) Auto sales (Mar) Global PMI mfg (Mar)
United States Romania Personal income (Feb) BNR mtg: no chg Pending home sales (Feb) United States Case-Shiller HPI (Jan) CB cons conf (Mar)
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Economic Research

March 18, 2011

Global Data Watch

The sun also rises

Oil and equity prices

800 70 Sep 10 Oct 10 Dec 10 Feb 11 Mar 11

Economic Research Global Data Watch March 18, 2011

Global service-sector activity

A limited policy response

Ripple effects most prominent in EM Asia

Economic Research Global Data Watch March 18, 2011

Customs trade with Japan

DM US Germany UK EM China ASEAN Brazil Mexico CEEMEA

Latins remain focused on inflation

EMU delivers on commitment

Economic Research Global Data Watch March 18, 2011

Global economic outlook summary

3.4 2.4 6.2 4.1

3.2 2.3 5.7 3.8

2.6 1.6 5.2 3.2

Economic Research Global Data Watch March 18, 2011

G-3 economic outlook detail

Economic Research Global Data Watch March 18, 2011

Central Bank Watch

Latin America GDP-weighted average

United Kingdom Bank rate

JPMorgan Chase Bank, London Jan Loeys (1-212) 834-5874 jan.loeys@jpmorgan.com

Economic Research Global Data Watch March 18, 2011

The J.P. Morgan View: Markets

A correction, not a reversal

JPMorgan Chase Bank, London Nikolaos Panigirtzoglou (44-20) 7777-0386 nikolaos.panigirtzoglou@jpmorgan.com

2011 global GDP growth forecasts: J.P. Morgan versus consensus

JPMorgan Chase Bank, London Jan Loeys (1-212) 834-5874 jan.loeys@jpmorgan.com

Economic Research Global Data Watch March 18, 2011

Ten-year Government bond yields

Commodities - quarterly average

Source: J.P. Morgan, Bloomberg, Datastream

Economic Research Global Data Watch March 18, 2011

Selected recent research1 from J.P. Morgan Economics

Central Europe, Middle East, and Africa

United States and Canada

Non-Japan Asia and Pacific

Special Reports and Global Issues

Economic Research Global Data Watch March 18, 2011

Economic Research Note

Oil price and developed market retail sales volume

Offsetting crosscurrents for developed market consumers

Consumer spending fundamentals, developed markets

Fundamentals support modest gains in 2Q

Model of developed market consumer goods spending

Retail sales volume, developed market

Contributions to retal sales volume growth, developed markets

Unemp rate Equities CPI

Alternative simulations, developed markets

Gauging the risks

Economic Research Global Data Watch March 18, 2011

Economic Research Note

Global final goods expenditures (J.P. Morgan proxy) vs. IP

Keep an eye on the global inventory cycle

Developed economiesinventory contribution to GDP growth

Ratio of inventories to shipments

Japan US Taiwan 2007 2008 2009 2010 Korea 2011

Inventory boost will wane by midyear

Global PMI finished goods inventory index (excludes US)