UniCredit Group

• The G-8 meeting hosted in Italy has, unfortunately, evidenced again divides on stimulus measures and on possible exit strategies to be implemented once the crisis is over. Especially, disagreement among European countries is particularly worrisome: further lack of coordination on exit strategies would be particularly harmful and may sow the seeds of future imbalances and of a sizeable drop in eurozone potential growth.

• Evidence that the eurozone supply-side of the economy has strongly deteriorated in response to the crisis suggests a possible decline in potential growth. Recently-published numbers by the European Commission go so far as to estimate a plunge in growth potential to only 0.7% for 2009-2010. Taking stock of the significant degree of uncertainty that surrounds any estimate and usually-large ex-post revisions, we carry out a scenario analysis by adjusting our survey-based Taylor rule to different assumptions on the potential growth rate. Finally, we identify some indicators, available in a more timely fashion, which could help us spot virtually in real time a possible decrease in the potential growth rate.

• The credit outlook is the main threat that may yet turn the scant recovery we expect into a worst-case credit crunch nightmare. We anticipated with a good lead the ongoing credit downturn, but we remain constructive on perspectives. True, lending to both households and non-financials will slow down further and negative growth rates for loans to private sector may soon become reality. However, ECB’s efforts have been huge; they will prove to be successful on short-term lending and are only just starting to target long-term credit. The recent step up in moral suasion on banks to pass on credit to the real economy is certainly a sign of worry but also an indication that in Frankfurt everything will be done to avoid a credit crunch.

• In the meantime, inflation has turned negative, it will stay negative until September, and promises to remain well below 2% throughout the forecast horizon (thanks to plunging core prices). We take a look at price expectations as they are measured in the EC survey and find that while selling price expectations have bottomed, consumers’ expectations have not. This doesn’t imply any genuine deflationary signal, but doesn’t bode well for private consumption in the short run.

• Looking at the curve, yields should remain in trading range, displaying a lot of volatility as mood swings back and forth from optimism to pessimism. With no rate hikes in sight and decreasing Libor fixings, we see value in 3M futures (GBP especially) with delivery Jun/Sep10.

• In the FX space, we find that the recent debate over the decline of the USD leadership as global reserve unit is a bit exaggerated. This may offer “noise traders” an excuse to amplify EUR-USD volatility, but neither the euro, nor the renminbi nor the IMF’s SDR will challenge the USD supremacy in the foreseeable future.