1

Economic overview– moving from

“less worse” to “better”

9 June 2009

2

Global downturn continued to ease in May

The Global PMI – covering manufacturing and services – rose in May to its highest since last September, suggesting the annual rate of worldwide GDP contraction has eased from a post-war record of -3.5% in Q1 to perhaps “just” -1% in Q2. Job losses have also moderated, with employment falling in May at its slowest rate since last October.

Global GDP Global Employment

34

38

42

46

50

54

58

Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09

-2.0%

-1.0%

0.0%

1.0%

2.0%

Global PMI Employment

Global Employment

PMI Employment , yr/yr

35

40

45

50

55

60

65

Q1 1999 Q1 2001 Q1 2003 Q1 2005 Q1 2007 Q1 2009-4%

-2%

0%

2%

4%

6%

Global PMI Output

Global GDP

PMI GDP, yr/yr

3

Improvement led by Asia, then Anglo-Saxons

Developed Emerging

PMIs indicate that the improvement has been led by Asia – notably China and India, where manufacturing output has now risen for two months – followed by the US and UK. The Eurozone and much of Central and Eastern Europe are lagging, but have nevertheless seen rates of decline moderate considerably in recent months.

15

20

25

30

35

40

45

50

55

60

65

70

2007 2008 2009

Russia

China

India

Brazil

Manufacturing PMI output index

15

20

25

30

35

40

45

50

55

60

65

70

2007 2008 2009

UK

Eurozone

US

Japan

Manufacturing PMI output index

4

From Japanese exports to UK services, business trends have rebounded

Japanese exports UK services activity

20

30

40

50

60

Jan-01 Jan-03 Jan-05 Jan-07 Jan-09

-50%

-25%

0%

25%

Japan PMIManufacturing NewExport Orders

Official Japaneseexports

PMI Exports Index Exports, yr/yr %

38

42

46

50

54

58

62

2005 2006 2007 2008 2009

-2%

-1%

-1%

0%

1%

1%

2%

UK PMI ServicesActivity Index

Official UK servicesgrowth

PMI Services Activity Index Q/Q grow th

The recession has been characterised by a sharp retrenchment of global trade in response to the financial crises in the west. It’s therefore interesting to see key two indicators, of Japanese exports and UK services activity (which includes banking), swing back far faster than anticipated to pre-Lehman levels.

5

“V” or “W”? Does the recovery have legs?

Orders-to-inventory ratios point to further production growth in coming months. There is a concern that the current improvement could be short-lived once stocks are rebuilt and high unemployment chokes growth momentum (meaning a “W” shaped GDP trend in 2009-10 rather than a “V” shape).

But other PMI data suggest we are seeing something more sustainable:

– Stocks are still falling at a near-record rate, so current improved trends are not just based on inventory building in manufacturing.

– Underlying confidence in services (as well as manufacturing) rose again in May.

Financial conditions also continued to improve as fears of corporate default eased ….

40

50

60

70

2007 2008 2009

37

42

47

52

EU services outlook

Global manufacturingstocks

PMI services outlook (50 = no change in activityin 12 month's time)

PMI manufacturing stocks(50 = no change on

previous month)

6

Inter-bank markets are functioning more normally, and credit default fears have eased.

The narrowing of the LIBOR-OIS spread indicates that banks have become more willing to lend to each other. At the same time, credit spreads have narrowed due to reduced fears of corporate default, helping boost economic activity. Though in both cases we are not yet back to pre-crisis levels.

35

40

45

50

55

60

2005 2006 2007 2008 2009

0.0%

0.4%

0.8%

1.2%

1.6%

2.0%

Markit European UnionPMI Output Index

Markit iTraxx EuropeIndex (inverted)

iTraxx Europe Index (spread - inverted)

PMI Output Index(50 = no change)

Credit markets and economic growth

-0.5

0.5

1.5

2.5

2005 2006 2007 2008 2009

LIBOR-OIS (US)

LIBOR-OIS (UK)

LIBOR-OIS spreads3-month LIBOR minus 3-month overnight interest rate sw aps (monthly ave.)

7

Equities have followed macroeconomic trends

Stock markets have rebounded around the World, in line with signs of a bottoming out of the recession.

Following the macroeconomic trends, as described by the PMIs, emerging markets have been favoured over the developed world.

From their lows in March, the FTSE indices for the emerging and developed worlds have risen 71% and 43% respectively*.

This probably reflects a cyclical return of risk appetite – but also follows the suggestion that China and India may have decoupled from the US, as PMIs show that domestic demand in these countries has helped drive their recoveries.

* as of 3 June.

200

250

300

350

400

450

500

550

600

Sep

-08

Oct

-08

Nov

-08

Dec

-08

Jan-

09

Feb

-09

Mar

-09

Apr

-09

May

-09

Jun-

09

100

120

140

160

180

200

220

Emerging

Developed

FTSE Developed (US $) FTSE Emerging (US $)

8

US$ shunned as FX markets show a return of risk appetite, especially for commodity currencies

% gain on US$(2009 low to 4 June):

Euro

11.6

GB£

15.0

Yen

4.4

Aus$

21.6

NZ$

22.4

Ca$

15.6

SA Rand

24.7

Bra R

20.9

The US dollar fell in May as the brighter outlook for the world’s economy caused a shift to increased risk appetite, especially against commodity-based currencies. Traders noted that demand for raw materials will rise as the manufacturing upturn gains traction. The euro and sterling also gained, reflecting the better-than-expected economic data.

0.5

0.6

0.7

0.8

May-08

Jul-08

Sep-08

Nov-08

Jan-09

Mar-09

May-09

85

90

95

100

105

110

115EUR

GBP

JPY

Yen / US$Sterling, Euro / US$

0.6

1.1

1.6

2.1

May-08

Jul-08

Sep-08

Nov-08

Jan-09

Mar-09

May-09

6

8

10

12

AUD

NZD

CAD

SAR

SA Rand / US$Aus, NZ, Can $ / US$

9

Focus shifts from recession to funding the recovery

The month of May has seen shifts in many key indicators, which are now showing actual increases rather than just the rate of decline getting less worse. Forecasters & policymakers are therefore increasingly revising up their growth predictions, many for the first time in the downturn.

But many also remain very nervous about longer-term prospects and the possibility of a bumpy or “W” shaped recovery path.

Notably, consumer spending and public sector restraint will subdue growth next year. Anaemic growth means governments may struggle to fund rising deficits, most neatly illustrated by a widening of sovereign CDS spreads (see chart).

Policymakers may at last be re-entering charted waters as far as growth and inflation are concerned, but their job is far from over.

0

50

100

150

200

250

May

-08

Jun-

08

Jul-0

8

Aug

-08

Sep

-08

Oct

-08

Nov

-08

Dec

-08

Jan-

09

Feb

-09

Mar

-09

Apr

-09

May

-09

US

UK

Germany

Italy

Japan

Markit Sovereign 5-yr CDS spreads