A member of MUFG, a global financial group

Global Economy – Pausing for Breath or Something more Serious?*

The Bank of Tokyo-Mitsubishi UFJ, Ltd.

Amir Khan

Economic Research | London Desk

The Bank of Tokyo-Mitsubishi UFJ

November 2014

* Data sourced from Macrobond, IMF/IIF unless stated

2

Table of contents

1. Global economy

2. Key risks

3. Country outlooks

4. Concluding thoughts/Q&A

2

3

What’s on our radar?

Moving out: Moving in:

* EMU crisis * Geo-political risk

* US fiscal crisis * Fed rate hikes

* Fed Tapering * China slowdown

*EU bank stress tests * EM/DM growth debateGeo-political risks

Fed Tapering

US fiscal Crisis

EMU criss

EM/DM growth debate

Fed rate hikes

China slowdown

EU bank stress tests

4

Global Economy – Onwards but not upwards

► The global economy has surprised on downside recently, with the latest economic indicators, as measured by

the Citi Economic Surprise Index, languishing in negative territory.

► While this is worrying – spurring the IMF to downgrade its economic forecasts – forward looking surveys paint

a less pessimistic picture, with global growth expected to remain in positive territory (>50 PMI reading) thanks to

the recent revival in DMs.

4

Chart 1: Economic surprise index is laguishing in negative territory

-80

-60

-40

-20

0

20

40

60

Dec

-11

Feb-

12

Apr

-12

Jun-

12

Aug

-12

Oct

-12

Dec

-12

Feb-

13

Apr

-13

Jun-

13

Aug

-13

Oct

-13

Dec

-13

Feb-

14

Apr

-14

Jun-

14

Aug

-14

Developed Markets Emerging Markets

(Index)

Chart 2: But the the picture is not as negative when looking at foward looking surveys such as the PMIs

48

50

52

54

56

58

Jan-

12

Mar

-12

May

-12

Jul-1

2

Sep

-12

Nov

-12

Jan-

13

Mar

-13

May

-13

Jul-1

3

Sep

-13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-1

4

Sep

-14

Developed Markets Emerging Markets World

(Reading >50 indicates expansion)

5

Global Economy - Cross country variations

► With the ongoing slowdown in EMs continuing to play out, the focus of attention has shifted to DMs,

who led by the US & UK, have as a whole continued to do relatively well, though the uneven nature of

the growth among this group has been a key concern.

Chart 3: The PMI readings for the US and the UK, while they have tailed off somewhat recently, continue to outpace their

peers

45474951535557596163

Ja

n-1

2

Ju

l-1

2

Ja

n-1

3

Ju

l-1

3

Ja

n-1

4

Ju

l-1

4

United States United Kingdom Japan Euro Area

(Reading >50 indicates expansion)

6

Global economy – The market view

► Contrary to expectations, demand for safe haven assets has been on the rise. Consequently, the

yields of major countries bonds have been converging towards those of Japan, perhaps signalling that

some of these countries are also headed the way of Japan?

Chart 4: European Benchmak bond yields have been converging towards those of Japan

0

1

2

3

4

5

6

Jan

-07

Jul-

07

Jan

-08

Jul-

08

Jan

-09

Jul-

09

Jan

-10

Jul-

10

Jan

-11

Jul-

11

Jan

-12

Jul-

12

Jan

-13

Jul-

13

Jan

-14

Jul-

14

UK US Germany Switzerland Japan

(10-yr bond yields, %)

7

Growth projections – downward revisions

Average2000

(2000-10)* 2011 2012 2013 2014fUS 2.3 1.8 2.8 1.9 2.2 (2.5)Euroland 2.0 1.6 -0.7 -0.4 0.8 (1.1)Japan 1.6 -0.5 1.5 1.6 1.0 (1.4)China 10.4 9.3 7.7 7.7 7.4 (7.3)Global* 4.2 4.0 3.2 3.0 3.0 (3.6)NB: Figures in brackets denote prior forecasts as at spring. Soure: Bloomberg, *IMF

Table 1: Consenus global GDP forecasts (%, y/y)

8

Key Risks

9

What to watch?

In light of the downward revision to growth & the recent market sell-off, risks has returned to the forefront of investors attention:

► Geopolitical risks

►“Sudden stop” of capital flows to EMs

►Premature withdrawal of stimulus

►Dangers of a “hard landing” for the Chinese economy

►Deflationary pressures

10

Geopolitics - Should we be worried about the rise of geopolitical tensions?

►Besides the fallout from the Ukraine conflict – which highlight the dependence of Europe on Russian

gas – the world is also having to contend with the recent intervention by the west against ISIS in the

MENA region .

► While the direct impact of these events, beyond the markets immediately affected, has been limited

so far, the spill-over effects on other countries is becoming more visible.

Chart 6: Europe has an unhealthy addiction to Russian gas

0

10

20

30

40

50

60

70

80

90

100

CZE BGR UKR POL TUR AUT HUN DEU ITA ROU

Energy imports from Russia Gas imports as share total energy imports

(% )

11

Geopolitics – Sanctions & their S/T impact

► Four rounds of sanctions have been slapped on Russia since the outbreak of the Ukraine conflict.

► The initial round of sanctions, largely targeted key individuals/companies linked to Putin’s regime, so

on the whole their impact was rather limited. The more recent set of sanctions with their focus on key

sectors & the imposition of limits on financing of Russian companies is more harmful, with their impact

being felt beyond Russia itself.

Chart 7: The Ukraine conflict has had a major impact on both Russia & ukraine's economic output...

-20

-15

-10

-5

0

5

10

15

12Q

1

12Q

2

12Q

3

12Q

4

13Q

1

13Q

2

13Q

3

13Q

4

14Q

1

14Q

2

14Q

3f

14Q

4fRussia Ukraine

(%, y/y)

Chart 8:...And through the confidence channel is also impacting the German economy

-3

-2

-1

0

1

2

3

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Jul-1

0

Jan-

11

Jul-1

1

Jan-

12

Jul-1

2

Jan-

13

Jul-1

3

Jan-

14

Jul-1

4

80

85

90

95

100

105

110

115

120

Business investment (LHS) Ifo Business confidence Index (RHS)

(%, y/y) (Index)

12

Geopolitics – Sanctions & their L/T impact

► Given Russia’s heavy reliance on overseas companies for the future development of its oil & gas

sector, the current sanctions if they prove to be protracted could compromise Russia’s future oil

production.

► Additionally, while in the immediate term, Russia companies are managing to live with reduced

availability of financing at the international level by leaning on domestic state owned banks, the dangers

of a more serious credit crunch developing cannot be ruled out over a longer-term time horizon.

Chart 9: The Russian oilfield services sector is fairly dependant on western companies

In-house divisions34%

Others6%Western

companies23%

Russian private companies

37%

Market Share 2013 (%)

13

Capital outflows – Is a taper tantrum 2.0 in the offing?

► Events last & earlier this year serve to highlight that a number large EMs are susceptible to sudden

withdrawal of capital, particularly those termed the “fragile five” that are running “twin deficits”.

►While the recent focus on these EMs is likely to continue for the time being, the fact that policymakers

in these countries have been willing to raise rates has helped to reassure markets somewhat.

Chart 11:…And as result policymakers in these countries have had to hike their policy rates upwards to guard against capital

outflows

-3

-2

-1

0

1

2

3

4

5

Braz

il

Turk

ey

Indo

nesi

a

Sout

hAf

rica

Indi

a

Philip

pine

s

Mal

aysi

a

Rus

sia

Thai

land Pe

ru

Mex

ico

Pola

nd

Chi

le

Rom

ania

Hun

gary

(Change in policy rates since May'13)

Chart 10: The Fed's hint that it will commence its tapering programme caused a sharp fall in the currencies of the

"fragile five" economies...

70

75

80

85

90

95

100

105

110

Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14

Brazil India Indonesia Turkey South Africa

Fed hints at tapering its asset purchases

(Index, Jan '13=100)

14

Country Outlooks

15

US – The “comeback kid”

► After a dismal Q1, the US economy rebounded strongly in the last two quarters. While this confirms our view

that the Q1 contraction was largely weather induced, at around 2-2.5%, growth for the full year is again likely to

disappoint somewhat.

► The healing of the labour market, meanwhile, has continued apace, making eventual interest rate rises more

likely in 2015, though we expect the Fed to “soft pedal” towards this goal.

a breather in Q1…Chart 12: The US economy bounces back strongly after taking Chart 13:…On the back of the strong growth in the private sector

-20

-15

-10

-5

0

5

10

Q1-

2007

Q1-

2008

Q1-

2009

Q1-

2010

Q1-

2011

Q1-

2012

Q1-

2013

Q1-

2014

Leading Economic Index (%, y/y) GDP (AR)

(%

-1

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

Consumer spending Investment Govt. spending Net trade

(% Contribution to overall growth in Q2)

16

3. China – Reforms take centre stage...

►Policymakers continue to grapple with the slowdown of the economy, but they have refrained from embarking on

a large stimulus programme, as in 2009.

►While we welcome this shift in emphasis, we think that policymakers will remain eager to ensure that growth

continues to come in at least 7%, on grounds of ensuring social stability.

Chart 14: China's actual GDP growth has consistently exceeded Chart 15:…While at the same time the gap between fixed investment its target... & private consumption has continued to grow larger

8.39.1

10 10.111.3

12.7

14.2

9.6 9.210.4

9.3

7.7 7.7

0

2

4

6

8

10

12

14

16

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

(%, y/y)

7% growth target under 10th 5-yr plan

7.5% growth target under11th 5-yr plan

7% growth target under 12th 5-yr plan

25

30

35

40

45

50

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Gross fixed Investment Private consumption

(% of

17

China: ...But implementation is likely to prove challenging

18

Euro Area – The “new Japan”?

► With an economy that is struggling to regain its pre-crisis level of output & inflation well below the 2%

target, the Eurozone has increasingly been labelled the “new Japan”.

Chart 16: GDP relative to pre-crisis period & current inflation dynamics

-30

-25

-20

-15

-10

-5

0

5

10

Eu

rozo

ne

Sp

ain

Ita

ly

Gre

ece

Ire

lan

d

Ge

rman

y

Fra

nce

Ne

the

rlan

ds -0.4

-0.2

0

0.2

0.4

0.6

0.8

1

1.2

GDP (LHS) Inflation (RHS)

(% deviation of GDP from Q1-2008) (%, y/y)

19

Euro Area – Can Germany still lead the region’s recovery?

► The German economy unexpectedly contracted in Q2, raising doubts about its staying power.

► Our sense is that the recent weakness experienced by Germany has essentially been due to cyclical

&/or temporary factors (slowdown of key trading partners, impact of sanctions on Russia etc). As such,

we’re still expecting it to outperform its Eurozone peers.

Chart 17: Despite taking a knock recently we still expect Germany to lead the recovery

60

70

80

90

100

110

120

Ja

n-0

7

Ju

l-0

7

Ja

n-0

8

Ju

l-0

8

Ja

n-0

9

Ju

l-0

9

Ja

n-1

0

Ju

l-1

0

Ja

n-1

1

Ju

l-1

1

Ja

n-1

2

Ju

l-1

2

Ja

n-1

3

Ju

l-1

3

Ja

n-1

4

Ju

l-1

4

Germany Euro Area

(EC economic sentiment Index, balance)

20

Euro Area – Can EU stress tests serve as a “game changer”?

► The Eurozone stress tests, while eagerly awaited, passed without any surprises, with just 25 banks

failing to pass the tests.

► While we welcome this exercise, it will not be a “game changer” for lending to the real economy, as

there are questions not just about the supply of credit but also its demand.

Chart 18: ECB bank lending survey points to little improvement in lending conditions thus far

-10

-5

0

5

10

15

20

25

30

35

40

Jan

-08

Ap

r-0

8

Jul-

08

Oct

-08

Jan

-09

Ap

r-0

9

Jul-

09

Oct

-09

Jan

-10

Ap

r-1

0

Jul-

10

Oct

-10

Jan

-11

Ap

r-1

1

Jul-

11

Oct

-11

Jan

-12

Ap

r-1

2

Jul-

12

Oct

-12

Jan

-13

Ap

r-1

3

Jul-

13

Oct

-13

Jan

-14

Ap

r-1

4

Jul-

14

Oct

-14

Large Enterprises All Enterprises Small & Medium Enterprises Households

(Net % of respondents)

Loosening

Tightening

21

Euro Area – ECB goes all out

The ECB has gone much further than expected, but will its latest measures be enough?

► Further cuts to the policy rate

► Implementing a negative deposit rate

► Boost baking system liquidity via further LTROs

► ABS & covered bond purchases

22

UK – Outpacing its peers

► The UK economy continues to surprise on the upside. After a strong H1 performance, the economy is set to continue to grow at a healthy pace as we head towards 2015.

► Notwithstanding the strong pace of the recovery, the unbalanced nature of the recovery is still of some concern, as well as the fact that wages in real terms remain in negative territory.

wages are failing to keep pace with pricesChart 19: UK has re-gained its pre-crisis level of output… Chart 20:…But peoples living standards remain squeezed because

90

92

94

96

98

100

102

104

Jan-

08

Jan-

09

Jan-

10

Jan-

11

Jan-

12

Jan-

13

Jan-

14

UK Euro Area

(Index, Jan '08=100)

-6

-4

-2

0

2

4

6

8

10

Jan-

07

May

-07

Sep-

07

Jan-

08

May

-08

Sep-

08

Jan-

09

May

-09

Sep-

09

Jan-

10

May

-10

Sep-

10

Jan-

11

May

-11

Sep-

11

Jan-

12

May

-12

Sep-

12

Jan-

13

May

-13

Sep-

13

Jan-

14

May

-14

Sep-

14

Change in weekly earnings CPI

(%, y/y)

23

Emerging Markets Focus - Russia

► The Russian economy has been buffeted by the imposition of western sanctions, but of note is that

sentiment towards the country has been falling since the recent easing of oil prices.

► While we do not expect a repeat crisis on lines of 1998, at current oil prices, the Russian authorities

will have to contemplate spending cuts, which will add further pressure on the economy.

Chart 21: The rouble has fallen in line with the softening in oil prices...

0

5

10

15

20

25

30

35

40

45

50

Nov

-14

Aug

-14

Jun-

14M

ar-1

4Ja

n-14

Oct

-13

Jul-1

3M

ay-1

3Fe

b-13

Dec

-12

Sep

-12

Jul-1

2A

pr-1

2Fe

b-12

Nov

-11

Sep

-11

Jun-

11A

pr-1

1Ja

n-11

Nov

-10

Aug

-10

Jun-

10M

ar-1

0

60

70

80

90

100

110

120

130

Rouble vs USD (Inverted scale, RHS) Brent (US$/b, LHS)

Chart 22:...But the overall vulnerability of Russia compared to the 1990s is much less

0

50

100

150

200

250

300

350

400

450

500

1995 2013

0

1

2

3

4

5

6

7

8

9

10

Reserves (LHS, US$bn) Months import cover (RHS)

24

Q&A

25

25

The Bank of Tokyo-Mitsubishi UFJ, Ltd. is authorised and regulated by the Prudential Regulatory Authority (PRA) & Financial conduct Authority (FCA).

This report is a marketing communication which has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of the investment research.

This report does not attempt to address the specific needs, or investment objectives of any specific recipient. This report is based on information from sources deemed to be reliable but is not guaranteed to be accurate and should not be regarded as a substitute for the exercise of the recipient’s own judgment. Unless otherwise stated, all views herein (including any statements and forecasts) are solely those of The Bank of Tokyo-Mitsubishi UFJ, Ltd., its subsidiaries and affiliates each of whom are under no obligation whatsoever to update this report. The Bank of Tokyo-Mitsubishi UFJ, Ltd., its subsidiaries and affiliates accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this report.

The Bank of Tokyo-Mitsubishi UFJ, Ltd. retains copyright to this report and no part of this report may be reproduced or re-distributed without the written permission of The Bank of Tokyo-Mitsubishi UFJ, Ltd. The Bank of Tokyo-Mitsubishi UFJ, Ltd. expressly prohibits the re-distribution of this report to Retail Customers, via the internet or otherwise and The Bank of Tokyo-Mitsubishi UFJ, Ltd., its subsidiaries or affiliates accept no liability whatsoever to any third parties resulting from such re-distribution.