Focus Europe Investment gap Deutsche Bank Research

Transcription

Deutsche Bank
Research
Europe
Economics
Date
10 October 2014
Mark Wall
Chief Economist
(+44) 20 754-52087
[email protected]
Focus Europe
Investment gap
After the sharp fall during the Great Recession, investment has recovered in
most advanced countries but has remained anemic in the euro area. In other
words there appears to be an investment gap in the euro area. This week we
examine the causes of this gap and assess the current debate on initiatives for
expanding investment in the EU, the most fleshed out of which is the potential
extension of activities of the European Investment Bank. All in all, we expect
new agreed initiatives to focus more on better deployment of existing
resources and catalysing private investment than on material further increases
in funds for public investment. More flexible instruments for the deployment of
still limited EU resources would be a positive, but it is unlikely that we will see
an investment initiative big enough to become a game changer – neither in
volume nor in terms of sentiment. Investment spending will thus likely
continue to lag crisis resolution rather than lead it.
On 14 October the European Court of Justice (ECJ) will hold a hearing on the
ECB’s OMT programme within a preliminary ruling procedure initiated by the
German Constitutional Court (GCC). The opinion of the ECJ and the GCC’s final
ruling will likely have an impact on the legal feasibility of QE. The provision of
the GCC that acceptance of a debt cut could be avoided could particularly
affect public QE. The market perception of the efficacy and durability of the
public QE may be weakened if the final judgement on OMT is still outstanding.
The Italian parliament cast its first vote in favour of the labour reforms.
Whether the benefits of the reform will be marginal or material will depend on
the final design, implementation and resources. In any case, we do not think
that the labour reform will be enough to turn the economy around without an
overhaul of the public administration and of the tax system.
Research Team
Euroland
Peter Sidorov
[email protected]
Marco Stringa
[email protected]
Mark Wall
[email protected]
UK/Scandinavia
George Buckley
[email protected]
Central Europe
Caroline Grady
[email protected]
Gautam Kalani
[email protected]
Inflation Strategy/Economics
Markus Heider
[email protected]
Politics has taken centre stage in the UK with polls pointing to a hung
parliament in May. There are risks associated with all outcomes – a majority
Conservative government would deliver an EU referendum while a Labour
administration plans a 'mansion tax' and may slow austerity. As a result,
markets may be least concerned by a continuation of the current coalition.
Euro-area investment underperformance
110
Table of contents
European investment initiatives:
disappointing volume and momentum
Investment, pre-crisis peak = 100
105
Page 03
Private/Public QE: Repercussions of the Page 13
OMT case at the ECJ
100
95
Italy: the beginning of labour reform
Page 18
85
Euro Sovereign Events
Page 21
80
UK: A look ahead to May's election
Page 24
75
Rate views
Page 30
90
70
65
2006
Euro area
2007
2008
UK
2009
US
2010
Canada
2011
2012
Japan
2013
2014
Source: Deutsche Bank, Haver
________________________________________________________________________________________________________________
Deutsche Bank AG/London
DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 148/04/2014.
10 October 2014
Focus Europe: Investment gap
Economic Forecasts
Real GDP % growth
b
c
CPI % growth
Current a/c % GDP
d
Fiscal balance % GDP
2014F
2015F
2016F
2014F
2015F
2016F
2014F
2015F
2016F
2014F
2015F
2016F
0.7
1.0
1.4
0.5
1.1
1.5
2.5
2.1
1.6
-2.6
-2.5
-2.1
1.5
1.5
1.4
0.9
1.5
1.8
7.2
6.7
6.6
0.2
-0.1
-0.2
0.4
0.9
1.5
0.6
0.9
1.5
-1.8
-1.8
-1.5
-4.4
-4.3
-3.8
-0.4
0.4
0.7
0.2
0.8
1.2
1.6
1.6
1.5
-3.0
-2.9
-2.7
Spain
1.2
1.9
1.8
-0.1
0.8
1.4
0.4
0.5
0.7
-5.6
-4.6
-3.3
Netherlands
0.7
1.7
1.1
0.5
1.1
1.5
10.9
11.4
11.5
-2.5
-2.0
-1.9
Belgium
1.0
1.0
1.6
0.7
1.3
1.5
-1.0
-0.8
-0.5
-2.5
-2.3
-2.2
Austria
0.8
1.3
1.8
1.5
1.7
1.7
2.7
2.9
3.1
-3.0
-1.8
-1.2
Finland
-0.4
0.6
1.6
1.1
1.2
1.4
-2.0
-1.7
-1.3
-2.4
-1.8
-1.1
Greece
-0.2
2.1
2.7
-1.0
0.4
0.9
1.0
1.5
1.5
-1.8
-0.6
0.1
Portugal
1.0
1.1
1.7
-0.1
0.9
1.3
1.0
1.0
1.0
-4.2
-3.3
-2.7
Ireland
3.7
2.5
3.7
0.4
1.1
1.6
6.5
7.0
7.0
-4.0
-2.7
-2.5
UK
3.1
2.5
2.3
1.7
1.9
2.0
-4.0
-3.2
-3.0
-4.6
-3.5
-2.1
Sweden
2.2
2.6
2.5
0.2
1.5
2.0
6.0
5.5
5.0
-1.5
-1.0
-0.5
Denmark
1.0
2.0
1.8
1.0
1.5
2.0
6.7
6.4
6.0
0.0
-1.0
-2.0
Norway
2.4
2.5
2.5
1.8
2.2
2.0
11.0
10.5
10.0
7.0
6.7
6.5
Switzerland
1.3
1.8
2.0
0.0
0.3
0.6
12.0
11.0
10.5
0.0
0.2
0.5
Poland
3.1
3.5
3.8
0.2
1.1
2.3
-1.8
-2.0
-2.2
4.3
-2.9
-2.8
Hungary
3.4
2.7
3.0
0.2
2.6
3.3
1.6
1.5
1.5
-2.9
-2.7
-2.8
Czech Republic
2.4
2.6
2.8
0.4
1.8
2.0
-1.5
-1.4
-1.5
-2.6
-2.5
-2.4
US
2.4
3.6
3.1
1.8
2.2
2.4
-2.5
-2.5
-2.7
-2.9
-2.5
-2.8
China
7.8
8.0
8.0
2.2
3.0
3.0
2.3
2.5
2.3
-2.1
-1.5
-1.8
Japan
1.0
1.3
1.4
2.9
1.7
1.8
0.2
1.4
2.1
-7.0
-6.1
-4.6
Worldf
3.3
3.9
4.0
3.5
3.8
3.7
Euroland (top-down)
Germany
b
France
Italy
Sources: National statistics, national central banks, DB forecasts
Forecasts: Euroland GDP growth by components and central bank rates
Euroland, % qoq
GDP
Private Consumption
Gov. Consumption
Investment
Stocks (contribution)
Exports
Imports
Net Trade (contribution)
HICP inflation, % yoy
Core inflation, % yoy
EMU4 GDP, % qoq
Germany
France
Italy
Spain
Central Bank Rates (eop)
ECB refi rate
BoE bank rate
US Fed funds target rate
PBOC 1Y deposit rate
BoJ O/N call rate
14-Q1
0.2
0.2
0.7
0.2
0.2
0.1
0.8
-0.3
0.7
0.8
14-Q2
0.0
0.3
0.2
-0.3
-0.2
0.5
0.3
0.1
0.6
0.8
14-Q3F
0.2
0.2
-0.2
0.7
0.0
0.5
0.5
0.0
0.3
0.8
14-Q4F
0.1
0.1
-0.2
0.5
-0.1
1.0
0.8
0.1
0.5
0.9
15-Q1F
0.2
0.2
-0.1
0.2
0.0
1.0
0.8
0.1
0.7
0.9
15-Q2F
0.4
0.2
-0.1
0.5
0.0
1.3
0.9
0.2
0.9
1.0
15-Q3F
0.4
0.2
0.0
0.7
0.0
1.3
1.1
0.1
1.2
1.1
15-Q4F
0.4
0.2
0.0
0.7
0.0
1.3
1.1
0.1
1.4
1.2
2014F
2015F
2016F
0.7
0.7
0.6
1.4
0.0
2.6
2.8
0.0
0.5
0.9
1.0
0.7
-0.4
1.6
-0.1
4.1
3.3
0.5
1.1
1.1
1.4
1.1
-0.2
2.6
0.1
4.4
4.3
0.1
1.5
1.3
0.7
0.0
-0.1
0.4
-0.2
0.0
-0.2
0.6
0.4
0.2
-0.2
0.4
0.2
0.1
-0.1
0.4
0.2
0.2
0.2
0.5
0.4
0.3
0.2
0.5
0.5
0.4
0.3
0.5
0.4
0.4
0.2
0.5
1.5
0.4
-0.4
1.2
1.5
0.9
0.4
1.9
1.4
1.5
0.7
1.8
0.25
0.50
0.125
3.00
0.10
0.15
0.50
0.125
3.00
0.10
0.05
0.50
0.125
3.00
0.10
0.05
0.50
0.125
3.00
0.10
0.05
0.75
0.250
3.00
0.10
0.05
0.75
0.500
3.00
0.10
0.05
1.00
1.000
3.25
0.10
0.05
1.25
1.500
3.50
0.10
Sources: National statistics, national central banks, DB forecasts. (a) Euro Area and the Big 4 forecasts are frozen as of 26/09/14. All smaller euro area country forecasts are as of 26/09/14. Bold figures signal upward
revisions. Bold, underlined figures signal downward revisions. (b) Annual German GDP is not adjusted for working days. (c) HICP figures for euro-area countries/UK (d) Current account figures for euro area countries
include intra regional transactions. (f) As of the week starting 14 July 2014, our global and regional forecast aggregation methodology has changed to dynamic rather than static annual IMF PPP weights. The change
added 0.2pp to global growth in 2014 and 2015 due to rising weight of EM economies.
Page 2
10 October 2014
Eurozone
Economics
Peter Sidorov, CFA
Economist
(+44) 20 754-70132
[email protected]
European investment initiatives:
disappointing volume and momentum

Investment fell across advanced economies following the Great Recession.
However, while it has recovered somewhat in countries such as the US, it
remains weak in the euro area. Some of this may reflect correction of past
overinvestment in the periphery, but factors such as financial
fragmentation and greater policy uncertainty in the EMU suggest that the
fall has been excessive, creating an investment gap.

We believe that supply side measures – reducing financial fragmentation
and improving the investment climate through structural reforms, to
facilitate private investment, are pre-requisites for closing the investment
gap. That said, with a high degree of slack in the economy these should be
complemented by demand side increases in public investment. Risks of
inefficient investment cannot be ignored but should not be used as an
excuse for no action.

Of the measures currently on the table a potential extension of the
activities of the European Investment Bank (EIB) is most fleshed out. The
most important instruments currently are project loans/bonds,
intermediated loans to national development banks and financial
instruments that allow member states to leverage EU structural funds at
national level (ESIFs). Moreover, the European Investment Fund (EIF) as a
branch of the EIB Group can provide venture capital to SMEs.

There is a general consensus in European politics that there should be an
extension of activities of the EIB, which currently disburses EUR 50-70bn
annually in the EU. One option could be to allow more flexible use of EU
structural funds for ESIF instruments. The second option would be for the
EIB to engage in riskier projects. In the absence of a capital increase this
could, however, affect its current AAA rating. The third option would be to
increase the capital base of the European Investment Fund by rededicating
funds coming from either ESM or EFSM. This, however, is currently
rejected by major EMU ‘core’ countries. It is certainly not as foregone a
conclusion as the vivid discussion in the media does currently suggest.

Proposals outside existing instruments have also been brought to the table
in the current debate, ranging from the idea of a mini bond market, such
as the one created in Italy in 2012, to a EUR 700bn 5-year public
investment fund suggested by Poland. That said, we expect new agreed
initiatives to focus more on better deployment of existing resources and
catalyzing private investment than on further contributions of public funds.

Some additional investment in Europe will come – however it is open as to
whether it will be invested in the right projects. Given the risk of repeated
distribution battles and political activism the perspectives of implementing
the most complementary solution to the investment and reform gridlock linking the disbursement of additional funds to the compliance with the
recommendations for structural reforms – are rather weak.

More flexible instruments for the deployment of still limited EU resources
would be a positive, but it is unlikely that we will see an investment
initiative big enough to become a game changer – neither in volume nor in
terms of sentiment. Investment spending will thus likely continue to lag
crisis resolution rather than lead it.
Nicolaus Heinen
Economist
(+49) 69 910-31713
[email protected]
Page 3
10 October 2014
Investment initiatives back on the agenda
Following the recent weakening of the growth trajectory for the Euro area and
the possible threat of economic stagnation and deflation, the recent weeks
have brought a heated debate across EMU countries on how public and private
investment could be reinvigorated. First proposals were discussed at the
Eurogroup Summit in Milan on 12 September and the debate continued at the
special European Council on growth and employment on 7 October.
Two debates – private vs public
The general debate on increasing investment in the Euro area to stimulate the
economy goes along two major strands.

Adjusting austerity efforts in order to foster public investment. Since 2012
there has been a general understanding in the European Council and the
Ecofin that public investment should not be undermined by austerity
efforts (so-called “growth friendly consolidation”). For instance, national
public spending which is used to finance projects that are co-funded by
European Structural and Cohesion Funds can be excluded from the
measurement of the Maastricht deficit threshold. The Stability and Growth
Pact provides for some flexibility as exemption clauses allow to refrain
from an Excessive Deficit Procedure for those countries suffering from
weak economic conditions.

Leveraging public funds in order to activate private investment. The other
strand of the debate aims to enhance the cooperation between private and
public investors using public funds as an incentive or as a means of risk
sharing to motivate companies and households to invest.
While a less ambitious austerity stance seems to already be the pragmatic
consensus in Europe, politics is currently focusing on the second option.
Is there an investment gap in the euro area?
Before we begin to examine the details of the existing and proposed
investment initiatives as well as the likelihood of and any potential problems in
their implementation it is worth briefly examining the underlying
macroeconomic issues. Is investment at a sub-optimal level in the euro area
creating an ‘investment gap’? If so, what have been the causes?
Calls for a need for greater investment have been near the front line of
economic discussion across the advanced economies, most recently by the
IMF in its latest World Economic Outlook in which it claims that the time is
right for a push in public infrastructure. Since the financial crisis investment as
a percentage of output has declined across the G7 economies (Figure 1).
While the decline in investment has been seen across most advanced
economies during and in the aftermath of the Great Recession – to be
expected as investment is cut in an environment of economic weakness and
increased uncertainty – the decline in the euro area has been more persistent
than that in, for instance, the US, with the sharpest decline in the peripheral
countries (Figure 2)1. This further raises concerns as to whether the euro area
is currently stuck in a situation of excessively low investment.
1
A point of note is that while the UK has seen a prolonged decline in investment following the Great
Recession similar to the euro area, investment is currently growing at +9.1% yoy in the UK (as of Q2)
versus a paltry +1.3% yoy in the EMU.
Page 4
10 October 2014
Figure 1: Investment declined across
Figure 2: But in Europe the decline
G7 during Great Recession
has continued
35
35
Investment as %
of GDP
EA
UK
US
CA
JP
30
Investment as %
of GDP
EA
ES
FR
IT
DE
30
25
25
20
20
15
15
2008-2010 Great
Recession
10
1980
1985
1990
1995
2000
Source: Deutsche Bank, AMECO, Haver
2005
2008-2010 Great
Recession
2010
10
1980
1985
1990
1995
2000
2005
2010
Falling investment ratios do not necessarily imply an investment gap
We should point out, that the above comparison of the headline investment
ratios across countries and time periods does not in itself automatically imply
the existence of an investment gap. There are a number of reasons why the
efficient investment ratio could now be lower than before the crisis:

Adjusting for past overinvestment. This in particular relates to the
construction-focused investment booms before the Great Recession in the
peripheral economies. The share of construction investment in GDP
reached 22% in Spain and Ireland in 2007, double that in the ‘core’
countries (Figure 3).

Efficiency of investment The above construction overinvestment in the
periphery is an example of relatively inefficient investment. More broadly,
investment will have limited benefits if it is focused on ”white elephants”
and other unproductive projects. On this note, in 2 September Focus
Germany our colleagues find that German investment is relatively efficient
compared to most euro area countries, especially in the periphery, one the
potential reasons for this being the higher propensity in Germany for more
productive investment in machinery & equipment versus less productive
construction investment.


Catch up over time. Investment ratios may be temporarily (even if for a
rather prolonged period) boosted by an economy catching up from a lower
starting level of capital stock. The high investment in Japan in 1960s-70s
and the 1990s post-reunification investment boom in Germany are
examples.
Structural shifts. These can happen both across countries and over time.
For instance, movement in value added over time away from
manufacturing towards knowledge-based services industries may lower
the investment ratio, as replacing and increasing capital stock becomes
relatively less important. That said, the inclusion of R&D in investment that
is taking place in European national accounts this year may somewhat
offset this.
Figure 3: Construction– adjustment
still ongoing in Spain and Portugal
25
Construction as % of GDP
20
15
10
5
0
1995
1998
FR
DE
IT
IE
PT
ES
2001
2004
2007
2010
2013
…but there are enough factors to suggest that it does exist
While we should undoubtedly consider the above caveats when making our
conclusions on the need for greater investment in Europe, there are a number
of factors which continue to weigh down investment in the euro area beyond
what can be justified by the above considerations.
Page 5
10 October 2014
First, the dearth of public investment. True, this in part reflects a similar
correction of past overinvestment, which was seen both in the public and
private sector. The decline in public investment in the euro area periphery, has
been at least as sharp as that in private investment (Figures 4 and 5) and unlike
private investment which fell across the euro area, the public investment
contraction has been limited to the periphery. This is as it has been the biggest
victim of euro area austerity as budgetary pressures resulted in cuts focused
away from the more politically sensitive areas of public consumption, which
has remained relatively resilient (Figure 6). The need to prioritize public
spending towards growth-friendly measures has been highlighted by both the
European Commission and the ECB. Re-prioritizing public investment should
be part of this.
Figure 4: Private investment has
Figure 5: Public investment decline
Figure 6: …in contrast to relatively
declined in ‘core’ and ‘periphery’
has been sharp in the periphery…
resilient public consumption there
28
26
Private investment as
% of GDP
24
22
6
EA
ES
FR
IT
DE
Public investment
as % of GDP
Public consumption
% of GDP
25
EA
ES
FR
IT
DE
5
4
IE
ES
IT
GR
PT
20
15
20
3
18
10
16
2
14
10
1980
1985
1990
1995
2000
5
1
2008-2010 Great
Recession
12
2005
2010
0
1980
2008-2010 Great
Recession
2008-2010 Great
Recession
1985
1990
1995
2000
2005
2010
0
1980
1985
1990
1995
2000
2005
2010
Another factor suggesting the existence of an investment gap is the financial
fragmentation in the euro area. While the ECB’s easing policies have fed
through into borrowing costs in the core countries – firms’ borrowing costs in
Germany and France have been on a downward path since late 2011 (Figure 7),
in Spain and Italy they have remained resiliently high. At the peak of the euro
crisis these largely reflected the high sovereign risk associated with the
periphery. However, the reduction in sovereign yields to record lows over the
past two years have not been reflected in bank lending rates (Figure 8).
Figure 7: Borrowing rates in the
periphery have remained high
Figure 8: Even as sovereign yields
have plummeted
Figure 9: Borrowing rates must be
viewed in the context of the growth
outlook
7
6
7
Interest rate on new
NFC borrowing, 1-5
year maturity, %
% interest rate
7
6
5
5
5
4
4
4
3
3
3
1
0
2003
2005
France
Germany
Italy
Spain
2007
2009
Source: Deutsche Bank, ECB, Haver
Page 6
2011
2013
2
2005
2007
2009
2011
Italy
Spain
2
1-5 year NFC banks loans
1-5 year NFC banks loans
Italy 5-year sov yield
Spain 5-year sov yield
1
0
2003
France
Germany
6
2
Two-year ahead potential
nominal GDP forecast, % yoy
1
0
2013
Year
2005
F'cst date Dec-03
2007
Dec-05
2009
Dec-07
2011
Dec-09
2013
Dec-11
2015
Nov-13
Due to data availability we calculate the ‘potential nominal GDP
forecast’ by summing the potential real GDP forecast from the
Nov/Dec editions of the OECD Economic Outlook and the inflation
forecast from the November European Commission forecast e.g.
forecasts for 2013 made in autumn 2011.
10 October 2014
It could be argued that thanks to the loose monetary policy the lending rates in
the periphery are now lower than before the Great Recession i.e. that there is
no problem of rates being too high and the higher peripheral borrowing rates
simply reflect a risk premium given the greater economic uncertainty there.
However, we feel that the borrowing costs have to be viewed in the context of
lower growth prospects.
We can indicatively demonstrate this point by a comparison of corporate
borrowing rates and expected nominal GDP growth. We use the two year
ahead potential nominal GDP growth rate as an indicative proxy for short-tomedium term investment opportunities. This has fallen across the EMU4 with
the exception of Germany, with the fall most dramatic in Spain (Figure 9).
Hence, although borrowing rates in Spain in 2013 were broadly in line with
2006-07, they were well above expected nominal growth unlike the pre-crisis
period when interest rates were too low encouraging excessive leveraging.
Nominal borrowing rates may be cheap at the moment, but the weaker
inflation outlook real rates have adjusted as far, and when compared to the
growth outlook they remain expensive.
What does this mean for policy?
So what does the above discussion imply for European policy choices?
First and foremost, measures addressing the structural impediments to
investment are needed. On financial fragmentation, banking union should take
us some way towards solving the problem, but it is not, by itself, sufficient.
Even if the transmission problems in the bank funding channel are resolved,
the euro area economy will remain vulnerable from its overreliance on the
banking channel to finance investment. Work on developing new channels
facilitating the financing of investment are needed, including the potential
expansion of EIB facilities to encourage private investment that are currently
under discussion as well as broader work to expand the role of capital markets.
The creation of a ‘Capital Markets Union’ is a new buzzword in EU circles and
would be complementary to the ECB’s desire to expand the ABS market in
Europe.
Further on the supply side, broader measures to improve the investment
climate and potential growth and reduce the impact of economic and policy
uncertainty are needed. Structural reform progress has unfortunately slowed
since the peak of the euro crisis in 2012.
While we view the above supply side measures as a pre-requisite for a strong
sustainable recovery in investment, given the high level of slack and the limits
being reached on monetary policy, action on the demand side, via increased
public investment, is also warranted. As highlighted by the IMF in its latest
WEO2, in situation of high economic slack3 public investment can boost output
and even lower public debt/GDP ratios in both the short-term and long-term –
provided that the investment is efficient. Given the limited fiscal room, such
measures may need to be budget neutral, as part of the reorientation of fiscal
policy towards a more growth-friendly stance. And importantly, to reduce the
credibility risks and potential moral hazard concerns from increased spending,
higher public investment should be used to complement, not replace, the
above structural measures.
We next look at the existing and potential investment initiatives in the euro
area and assess how they measure up against the points raised above.
2
See Chapter 3 of the October 2014 IMF World Economic Outlook, available at
http://www.imf.org/external/pubs/ft/weo/2014/02/pdf/c3.pdf.
3
Higher multipliers on public investment are likely when the output gap is large as there is little risk
crowding out private investment.
Page 7
10 October 2014
First initiatives in 2012
Back in June 2012 EU heads of state and government signed the so-called
Compact for Jobs and Growth. Apart from being a political commitment to
structural reforms in order to improve the conditions for private investment the
Compact provided for a collection of new hybrid financing mechanisms to
leverage the impact of public funds with private financial resources.
In a nutshell the compact provided for EUR 120bn of public funds – with a big
share of these funds redirected from existing sources:

The capital of the European Investment Bank (EIB) was increased by EUR
10bn in order to increase the lending capacity of the Bank by EUR 60bn so
that commercial banks could pass on these loans to client SMEs. In case
of a strong demand for these loans it was estimated this could have
activated up to EUR 180bn of additional investment. However, as the
general investment climate did not turn positive, the demand for credit
remained rather low. Also the eligibility of creditors was not sufficient in
peripheral countries. Meanwhile in the economically strong countries of
the EMU ‘core’ the EIB resources crowded out the credit supply of
commercial banks4.

It was also decided to reallocate EUR 55bn of undrawn Structural Funds
from the EU budget to finance measures for SMEs and youth employment.
However, particularly those member states which needed these financial
resources most had difficulties to identify projects as they had only narrow
room for maneuver due to fiscal policy constraints and/or political gridlock.

Moreover, EUR 5bn were made available for so-called project bonds. This
new asset class provides that project companies – i.e. special purpose
vehicles for public-private partnership which invest in large scale projects
in the field of energy, transport and broadband infrastructure – could
benefit from a credit enhancement by the European Investment Bank in
order to increase their appeal to institutional investors. We will elaborate
more on the project bonds below. Also project bonds were only scarcely
used by member states as they had to save money themselves and could
not pay for the necessary co-financing tranches.
Looking back at this initiative it can be concluded that the financial resources
were not drawn as expected – and if they were they did not unfold the
investment dynamics and second and third round effects that had been
intended. In fact the following year the Commission remarked in an interim
evaluation report that the Compact had “not yet been used to its full potential.”
While commitments under the cohesion policy budget and structural funds
were reprogrammed and co-financing requirements were reduced the
Commission remarked that the Member States should focus on the
implementation of projects. At the same time, the pace of structural reforms –
which were another integral part of the compact – has slowed down. As recent
as on 1 October the European Commission admitted that only 10 percent of
the measures that were proposed within the annual cycle of economic policy
surveillance (“European Semester”) had been fully implemented or made
“substantial progress”.
Looking at the current debate it remains to be seen whether the instruments
that are currently being discussed will increase the propensity of the private
sector to invest. Certainly the pressure is not as high as back in the year 2012
4
Cf. Dullien, S. (2013). Ein Jahr EU-Wachstumspakt: Die Enttäuschung war abzusehen. Wirtschaftsdienst
2013 (6). pp. 354–355.
Page 8
10 October 2014
with capital markets having calmed down due to pragmatic ECB action. After
all, it depends on the willingness of Euro area countries to implement
structural reforms in order to enhance the investment climate.
Most prominent initiative: Enhancing the role of the EIB
Of the measures currently on the table a potential extension of the activities of
the EIB is most fleshed out. The EIB is owned by the 28 EU Member states. It
is currently vested with subscribed capital of EUR 243bn and works with
different instruments5.
The most important instruments of the EIB are:

Project loans for individual projects for which total investment cost
exceeds EUR 25m. The lending sum of the loans can cover up to 50% of
the total cost. The current average share of the EIB is about one third as
the activities of the EIB attract investors from the private sector.

Intermediated loans are loans which are passed to local banks and which
are then “lent-on” to SMEs, Mid-Cap businesses but also public sector
bodies – as long as the financial resources are deployed for objectives that
are in line with the EIB’s policies – for instance economic and social
cohesion.

ESIF Financial Instruments transform national financial resources coming
from the EU budget into financial products such as loans, guarantees and
equity. The management of the placement is made by the national
authorities. These financial instruments have been used so far for
Structural Fund investments.

Project bonds are the most recent product of the EIB. As outlined above
private/public project companies investing into large scale projects in the
field of energy, transport and broad-band infrastructure could benefit from
a credit enhancement: The EIB guarantees a tranche of subordinated debt
so that the credit standing of the senior debt (project bonds) is enhanced
and becomes more attractive for institutional investors6. Eligible Projects
are selected by the EIB. The approval of each project is up for decision by
the board of directors.
Apart from these the EIB holds a 62% share of the European Investment Fund
(EIF) which provides venture capital to small and medium size enterprises. The
success of the measures of the EIB and the EIF with regard to public and
private investment in the Euro crisis has not yet been fully assessed.
Nevertheless, there is a general agreement in European politics that the
activities of the EIB should be extended. In this context there are several
options that are currently discussed.
First option: Increase the flexibility of ESIF Financial instruments. A relatively
easy way to make more funds available for investment projects would be to
make the use of financial resources coming from the EU budget more flexible
in order to leverage them in national ESIF financial instruments.
Second option: Increase special activities. Investment activities which carry a
higher risk are normally backed up by a “special activities reserve” which
currently amounts up to EUR 6.1bn. One possibility would be to increase the
5
The subsequent description of projects and programmes refers to information given on the EIB’s
website.
6
Cf. Heymann, E. (2013). Project Bond Initiative: Project selection the key to success. EU Monitor.
Frankfurt: Deutsche Bank Research
Page 9
10 October 2014
EIB’s special activity reserve. In this context, however, the EIB and its
shareholders are currently facing a dilemma. If the EIB wants to extend its
special activities but keep its AAA rating in order to further take advantage of
low funding costs it needs an increase of subscribed capital. This capital
increase, however, would have to be financed by the EU member states and
would run contrary to their austerity efforts.
Third option: Strengthen the capital base of the European Investment Fund.
The third option would also require additional resources coming from the EU
member states. In this context the rededication of financial resources coming
from the ESM (either guarantees or parts of the cash reserve) is currently
discussed in order to recapitalize the European Investment Fund (EIF).
However, this would be certainly objected by some Euro area countries – and
unanimity is required in order to redefine the purpose of ESM guarantees.
Politically more feasible would be the rededication of financial means coming
from the small European Financial Stability Mechanism (EFSM), a EUR 60bn
facility which is attached to the European Commission and which
complemented the EFSF in its financial aid to Ireland (EUR 22.5bn) and
Portugal (EUR 26bn) back in 2010 and 2011. Currently a sum of about EUR
11.5bn would still be available. However, there are also plans to rededicate
these financial means to the balance of payments facility – a rescue
mechanism of Non-EMU countries. To conclude, the rededication of funds
coming from either ESM or EFSM is certainly not as foregone a conclusion as
the vivid discussion in the media currently suggests.
While there is a general understanding among most heads of state and
governments in the Euro area, the President of the EIB (Werner Hoyer) has
recently underlined in various press statements and interviews that he would
not be willing to exchange the triple-A rating for a higher lending capacity. Any
change in the lending policy of the EIB would require a qualified majority in the
Board of Governors – the most important decision making body of the EIB
which determines the guiding principles of the EIB’s policies, including credit
policy guidelines. That means that it would need at least 18 out of 28 votes
and represent at least 68% of the subscribed capital. In any case, any change
in the investment policies by the EIB would have to follow the agreement by
the European Council – and this will be agreed on unanimously. President
Hoyer’s resistance could therefore be regarded as a mere political statement –
but not as a real threat of vetoing.
Other investment proposals
That said, expansion of the EIB resources and scope is not the only set of
measures potentially on the table. Two other ideas were reportedly discussed
at the EU finance ministers meeting in September:
Poland’s ’European Fund for Investments’ (EFI) idea
Based on a presentation at the Bruegel Institute on 4 September (and an
accompanying VoxEU post) by the Polish Finance Minister this calls for a
public investment programme to invest EUR 700bn over 5 years. Under the
proposal it is suggested that this EFI could be funded with paid-in capital from
the EU states, leveraging this on the capital markets, similar to the ESM.
A number of features appear quite similar to existing institutions including the
EIB and the European Investment Fund (EIF). However, some of the details are
considerably different:
Page 10
10 October 2014

The size is much greater – at an average of EUR 140bn of investment
annually over 5 years it is more than double the EUR 60bn annual lending
programme of the EIB in the EU.

The fund would invest directly into infrastructure projects taking direct
equity stakes which can be privatized in the future, rather than providing
debt funding.
The proposal is commendable for its boldness, both in terms of size and the
concept of having a coordinated scheme for direct investment. However, given
its large, somewhat arbitrary size it raises more questions than it answers on
how efficiency of investments would be reached – the choice and availability
of suitable projects to meet the ambitious size is unclear. The size of the
suggested borrowing in the capital markets, at over EUR 100bn annually on
average if completed over 5 years, would have an substantial impact on the
market, which would need to be considered.
Italian mini bonds plan
We did not get any detail on the discussion on this but we would expect it to
involve the possibility of expansion to EU level of a programme launched in
Italy in 2012. Changes to legislation allowed SMEs to issue debt securities,
facilitating the creation minibond market in Italy. Under the scheme SMEs with
audited financial statements can issue bonds, with credit classification of the
issuer performed by a sponsor (usually a local bank). The minibonds can be
invested into directly but have often been packaged into asset-backed
securities.
The mini bonds scheme is novel in its attempt to address a key financing
problem in the euro area – the severe impact of financial fragmentation on
SMEs, which represent a large portion in the economy. However, it is not a
magic solution – although promising, the minibond market in Italy has been
limited in size so far and most of the issues have been by relatively large
companies.
For such type of scheme to be genuinely successful at European level we
would likely require a bolder move towards an EU capital markets union. JeanClaude Juncker pledged that the creation of a ‘capital markets union’ was one
of the goals of his mandate. However, as far as we are aware there are no
official details beyond this ‘buzz phrase’ and the challenges to creating a true
single capital market in Europe are arguably even more onerous than those for
banking union.
Conclusion
The coming months should bring an intense political discussion on how to
increase both private and public investment in the Euro area. For economists it
will be a particular challenge to distinguish those initiatives that are rather
driven by political activism and those that are economically well grounded. In
any case, there is a need to act. Our evidence suggests that both aggregate
public and private investment in Europe are too low. The underlying reasons of
the fall in investment are partly due to downward adjustment for past
overinvestment but there are reasons to believe that the fall in investment has
been excessive. Country differences do apply. This in turn could imply some
downside risks for potential growth in Europe.
Therefore, the potential effects of investment measures on potential growth
and the potential synergies between public funding and private investment
should be better explored. In this context the major risk is that political
activism can overlook potential moral hazard risks and possible inefficiencies
Page 11
10 October 2014
of investment. Spending additional financial resources is tempting - and in the
current low interest environment it is tempting as well to disregard efficiency
requirements. In this context, the special European Council on growth on
employment last Wednesday in Milan was quite telling: Among the heads of
state and government of the EU no general agreement could be achieved on
which projects additional funds should be invested. Nevertheless, the caveats
on efficiency of investment and potential moral hazard should not be referred
to as reasons not to act.
To conclude, the overall outlook on investment in Europe is rather mixed.
Some additional investment in Europe will come - however it is open as to
whether it will be invested in the right projects. Given the risk of repeated
distribution battles and political activism the perspectives of implementing the
most complementary solution to the investment and reform gridlock - linking
the disbursement of additional funds to the compliance with the
recommendations for structural reforms – are rather weak.
More flexible instruments for the deployment of still limited EU resources
would be a positive, but it is unlikely that we will see an investment initiative
big enough to become a game changer – neither in volume nor in terms of
sentiment. Investment spending will thus likely continue to lag crisis resolution
rather than lead it.
Page 12
10 October 2014
Europe
Economics
Nicolaus Heinen
Economist
(+49) 69 910-31713
[email protected]
Private/Public QE: Repercussions of the
OMT case at the ECJ

On Oct 14 the European Court of Justice (ECJ) will hold a hearing on the
ECB’s OMT programme. It will be an official exchange of views between
the plaintiffs and the ECB. Neither the statements nor the hearing will be
public, and also the composition of the jury is secret until 14 October.
There will be no judgment, and similar proceedings have taken up to 15
months on average in the past.

The legal proceedings go back to constitutional complaints that were filed
at the German Constitutional Court (GCC) in the year 2011 and 2012
questioning Germany’s involvement with the ESM and the ECB’s sovereign
bond purchases on secondary markets. On 7 February 2014 the GCC
passed the case against the OMT to the ECJ sending a list of specific
questions regarding the legality of OMT and stayed the proceedings.

While the ECJ will take its own approach towards this case, its opinion
(and the GCC’s final ruling) will likely have an impact on the legal feasibility
of any future private and public QE by the ECB. The GCC formulated four
conditions which it considers relevant to make OMT compliant with the
ECB’s mandate and the EU treaty.

The most critical condition is that any acceptance of a debt cut must be
excluded for the ECB. Looking forward this could become a limiting factor
for public QE as any acceptance of a debt cut could be regarded as direct
monetary state financing. As purchasing non-CAC bonds only would
distort markets the ECB could aim to seek a weighted approach: it may
buy both CAC and non-CAC bonds but no more than 25% of any individual
CAC bond issue. Alternatively it could consider demanding guarantees for
possible losses as discussed in the context of ABS already.

We think it is quite likely that the ECJ and subsequently the GCC will come
to a favourable ruling on the subject of OMT. However, proceedings and
timeline are still unclear. We expect economic conditions to force the ECB
into public QE within the next 6 months. The market perception of the
efficacy and durability of the public QE may be wakened if the final
judgement on OMT is still outstanding
Barbara Boettcher
Economist
(+49) 69 910-31787
[email protected]
Recap: What happened?
There will be a hearing in the European Court of Justice (ECJ) on the ECB’s
OMT programme on 14 October. These legal proceedings go back to various
constitutional complaints that were filed at the German Constitutional Court
(GCC) in 2011 and 2012. They questioned Germany’s involvement with the
ESM and the ECB’s sovereign bond purchases on secondary markets. While
the GCC had deemed Germany’s participation in ESM as being constitutional
already in late summer 2012, it separated the aspect of the ECB’s sovereign
bond purchases on secondary markets from the proceedings and examined it
separately. Meanwhile, the plaintiffs extended their constitutional complaints
upon the ECB’s OMT announcement – although the programme had never
been activated.
Page 13
10 October 2014
On 7 February 2014 the GCC passed the case against the OMT to the ECJ and
stayed the proceedings. For the first time in history the GCC involved the ECJ
in a preliminary ruling on constitutional issues. The proceedings in Germany
itself were highly controversial which was expressed by the fact that two of
the judges explicitly mentioned their dissenting opinions. The Court sent a list
of specific questions regarding the legality of OMT to the ECJ. The GCC has so
far put on hold its inquiry on OMT until it gets the legal opinion from the ECJ.
But in the end, it will be the GCC that gives the final ruling on the complaints –
only taking into account the legal opinion of the ECJ.
The hearing on 14 October will be an official exchange of views at the ECJ
between the plaintiffs and the ECB. Several Euro area countries such as Spain
and Italy have lodged their statements as well. Neither the statements nor the
hearing will be public, and also the composition of the jury is secret until 14
October. There will be no judgment, and similar proceedings have taken up to
15 months on average in the past (the GCC did not apply for a fast-track
procedure).
When the GCC forwarded the case to the ECJ it stated in its declaration that it
regarded the OMT decision as exceeding the competences that were given to
the ECB through the European Treaties. The GCC considered OMT as not being
covered by the mandate of the ECB on monetary policy (Art. 119 and 127
TFEU) and in violation with the prohibition of monetary financing of the budget
(Art. 123 TFEU). Acting as a monetary "bypass" if politics impede decisions
was not the mandate of the ECB. The Court criticized that this would lead to a
structural shift in the competences and the burden sharing between member
states. In the opinion of the German judges, the only possibility to render OMT
compliant with EU Treaties would be the following four-fold specification of
the – never spelled out - OMT programme:
1.
OMT should not undermine the conditionality of the assistance
programmes of the EFSF and the ESM,
2.
The acceptance of a debt cut must be excluded (which would imply
that the ECB should be cautious when purchasing bonds that include
CACs, and would by construction go against the ECB's intention to be
"pari passu")
3.
government bonds of selected Member States should not be
purchased up to unlimited amounts, and
4.
interference with price formation on the market is to be avoided
where possible.
While this seemed to be addressed towards the ECJ as "guidelines" or even
“criteria” on how to make OMT compliant with EU Treaties, the ECJ will
doubtlessly take its own approach towards this case. It could back the ECB,
which might end up in a constitutional stalemate with the German
constitutional law being seen in contradiction with the EU primary law. This
could become problematic as there is still a largely undefined relationship
between the German Court and its European counterpart.

On the one hand, even after referring on the case to the ECJ, the GCC
considers itself principally entitled to reject the decisions or opinions of the
ECJ if it still considers actions taken to be “manifestly in violation of
powers, and that the challenged act entails a structurally significant shift in
the allocation of powers to the detriment of the Member States”. This
entitlement of the Court was originally set up by the so-called Honeywell
decision of 2010, and the Court has explicitly referred to this judgment in
its latest declaration.
Page 14
10 October 2014

On the other hand, the Court has bound the most important part of its
assessment to the judgment of the ECJ. When the GCC forwarded the
case to the ECJ the pronouncement read “Subject to the interpretation by
the Court of Justice of the European Union, the Federal Constitutional
Court considers the OMT Decision incompatible with primary law; another
assessment could, however, be warranted if the OMT Decision could be
interpreted in conformity with primary law.” That transfers the power of
interpretation on the OMT decision to the ECJ.
Therefore, we consider it likely that the ECJ will issue a positive vote on the
role of the ECB. Given the ex-ante commitment of the GCC to the ECB’s
assessment, the GCC will likely take the vote of the ECJ as a foundation for its
judgment. Nevertheless, the strong wording in the Court's declaration that it
regards OMT as not compliant with the constitution is an important signal to
the German political decision-makers in the government and the parliament.
Thus, OMT could lose its character as an insurance "in case of turmoil" in the
market, at least until the two Courts have come to a decision.
Looking forward: Implications for private and public QE
The general view is that the GCC, in asking the four questions, has limited the
intervention power of the OMT. However, this is only one part of the story as
the four criteria might also have their implications on the legal feasibility of any
future private and public quantitative easing by the ECB.
On 2 October the European Central Bank further outlined the details of the
asset backed securities (ABS) and covered bond (CB) purchasing programmes
– also known as private Quantitative Easing (private QE). The purchases will be
confined to assets which are currently ECB repo eligible and done via both
primary and secondary markets. However, in our view the ECB will find it
challenging to meet even half of its net E1tr balance sheet expansion via
private QE and TLTROs. Particularly the ECB’s confirmed demand for a
guarantee to buy mezzanine ABS suggests an unwillingness to take on a large
amount of credit risk. Against that background we remain of the opinion that
the ECB will move to broad-based asset purchases including public QE within
the next 6 months (see Focus Europe of 26 September).
The ongoing procedures at the ECJ will have their implications on the legal
compatibility of both private and public QE. As the ECJ will structure its
assessment of the OMT case along the four conditions that were set up by the
GCC we will refer to these four conditions in the remainder of this article. Note
that our analysis below is highly speculative as we do not know the outcome
of the hearings at the ECJ and we do not know what line of arguments
plaintiffs of future constitutional complaints will follow.
Criterion 1: No undermining of economic conditionality
A first condition that the GCC set up is that OMT should not undermine the
economic conditionality of the macroeconomic adjustment programmes for
countries that are currently subject to financial support by either ESM or EFSF.
This condition reflects the reasoning of the claimants when they filed their
cases back in 2011 and 2012 when the activity of EFSF and ESM had reached
its peak. Currently, Greece and Cyprus are the only countries left under a
macroeconomic adjustment programme as Portugal, Ireland and Spain have
left their respective programmes behind – in the current low interest
environment they can easily refinance themselves on the markets.

The programme of Greece expires at the end of this year. Current political
rhetoric suggests the country could have left its macroeconomic
Page 15
10 October 2014
adjustment programme by the end of this year – though under substantial
concessions of its Euro area peers, e.g. another cut in interest rates on
support credit lines.

The programme of Cyprus will expire in March 2016. Conditionality for
Cyprus mainly refers to adjusting public revenues and expenditures, as
well as pension and health care reforms and a restructuring of the financial
system.
Looking forward, the issue of conditionality under macroeconomic adjustment
programmes will therefore play only a minor role compared to conditionality
efforts in the past. Nevertheless, Mario Draghi also stressed in his comments
that private QE for Greece and Cyprus were linked to complying with the
programmes. He did so with good reason as ABS purchases will most likely
affect the pressure on banks for balance sheet consolidations – also in the case
of Greece as the effects could materialize even before the country leaves its
current macroeconomic adjustment programme at the end of this year.
Given the longer time horizon for the adjustment programme of Cyprus, these
considerations do also apply to Cyprus – and in addition, also with regard to
public QE. It could well limit the market pressure for economic reforms for
national politics. However, given the small economic size of Cyprus and the
fact that the economy of the island mainly depends on the economic situation
in Greece one could argue as well that conditionality was anyhow limited due
to the gravity of external influences.
To conclude, if the first criterion of the current proceedings at the ECJ were
applied as a reference upon public and private QE any possible influence on
the conditionality of future programs would most likely be considered as not
being problematic.
Criterion 2: No acceptance of a debt cut
Things could turn out to be different with the second criterion. In the current
proceedings the GCC requires that the acceptance of a debt cut must be
excluded. This would imply that the ECB must refrain from purchases of bonds
that include CACs. Moreover, it would go by construction against the ECB's
intention to be "pari passu”. The intention behind this requirement is that the
budgetary authority of national parliaments in the Euro area could be violated if
the ECB – or the national central banks – had to account for losses in case of a
debt cut on those papers in their portfolio and would forward lower central
bank revenues to the national budgets.
This could become quite a challenge regarding private and public QE.
Moreover, in case of any public QE, there would be another challenge as any
acceptance of a debt cut could be regarded as direct monetary financing of the
state - and therefore a clear breach of the EU Treaty provision.
One option for the ECB could be to discriminate between CAC/non-CAC bonds
as a strategy to minimize the debt restructuring risks. Limiting the purchases
to non-CAC sovereign bonds could take care of the sovereign restructuring
concern, but would distort the market. In our understanding, limiting
purchases of CAC bonds to no more than 25% of an issue allows the private
market to decide on an orderly debt restructuring should it be necessary in the
future without the agreement of the ECB. This would at least avoid the ECB
voluntarily accepting losses — though that still might not be sufficient for the
GCC. Still, it is possible the ECB uses a weighting of purchases between CACs
(below 25%) and non-CACs as a middle way through the problem.
Page 16
10 October 2014
Alternatively, separate guarantees could be one possibility to hedge the ECB’s
risk of losses in case of a debt cut in private QE. A first indication could be the
ECB’s recent insistence that EMU countries will have to provide additional
guarantees for mezzanine ABS tranches to be bought by the ECB. It remains to
be seen where this additional money could come from. In the case of public
QE the discussion could quickly turn to a reorientation of the ESM’s mandate.
Apart from that, the option of running the ECB with negative equity has often
been discussed in the context of possible larges losses in its portfolio.
However, any attempt to compensate for the negative equity would result in
lower central bank profits being forwarded to the national budgets.
Criterion 3: No purchases up to unlimited amounts
The third criterion should be less problematic to comply with. Already in the
hearings on the current OMT case back at the GCC in Germany last year the
impact of the OMT was implicitly limited – e.g. by limiting the possible area of
intervention to certain maturities.
The desired impact of the current private QE programme has been defined as
an extension of the ECB’s balance sheet to about EUR 1tr in order to put the
balance sheet back to the levels of mid-2012. This target should also apply to
any kind of public QE which would only be triggered if the EUR 1tr balance
sheet extension could not be reached by private QE alone.
Criterion 4: No interference with the market price formation
The fourth criterion could be again tricky. However, the provision has a rather
weak wording in the preliminary ruling (“to be avoided where possible“) and it
can thus be doubted whether price formation will remain a critical part in
future GCC cases. All the more so, as in contrast to OMT, QE is not about the
price of debt but about the size of the ECB’s balance sheet. Moreover, as the
ECB’s target of both private and public QE is to get inflation closer to its target
in the Euro area, this move should still be backed by the explicit mandate of
the European Central Bank. This is not to deny that both private and public QE
are a considerable market intervention and will have their interferences with
market price formation for ABS, covered bonds, and sovereign bonds and their
yields, respectively. The ECB estimates that out of the 1.2tr covered bonds
market roughly EUR 600 bn would be eligible for purchase given the ECB’s
own requirements and out of the ABS market volume of EUR 690bn app. EUR
400bn.
Outlook
This article has reviewed the ongoing proceedings on the OMT that will be
dealt with in the hearing at the ECJ on 14 October. The outcome of the
proceedings, but also the reference that the GCC has already made by defining
the four criteria for ECB action to be compatible with both European Law and
the German constitution are framing the ECB’s future action. We have seen
that particularly the issue of a debt cut will remain critical and cannot easily be
solved.
Last, not least, the creativity of future plaintiffs at the GCC and the ECJ should
not be underestimated. It can almost be taken for granted that plaintiffs will
take the opinion by the ECJ and the subsequent judgment by the GCC as an
incident to formulate new constitutional complaints. They will address the
alleged legal inconsistencies within the judgment but also the implications that
we discussed with regard to private and public QE. The judgment by the GCC
on the current OMT case – for which no timeline is available - could therefore
create more uncertainty around any nonconventional action by the ECB in the
future than politics, markets and central banks across Europe would like to see.
Page 17
10 October 2014
Italy
Economics
Marco Stringa, CFA
Economist
(+44) 20 754-74900
[email protected]
Italy: the beginning of labour reform

The Italian Parliament’s Upper House has voted in favour of labour reforms.
This is the beginning of the labour reform process, which should be
completed towards mid-2015. Note that the vote was on a "delegation
law". The perimeter defined by the delegation is very wide; hence,
uncertainty about the final form of labour reform will remain until the
government approves the legislative decrees.

We are confident that the labour market reform, when completed, will
bring benefits. However, whether the benefits are marginal or consistent
will depend on three elements: (i) the detailed design; (ii) implementation;
(iii) the resources allocated to it and whether these are permanently funded
via equivalent cuts in current expenditure.

That said, we do not think that labour market reform will be enough to turn
the Italian economy around. Labour reform needs to be planted in more
fertile soil for growth. In our view, this requires an overhaul of the public
administration and the tax system in favour of productive factors. The
government has committed to tackling these key two issues, but so far we
find the proposed measures unconvincing.
Italian government won confidence vote on labour reform
On 8 October the Italian Parliament’s Upper House voted in favour of labour
reform. The government won the confidence vote by 165 to 113.7 The next
step is the vote by the Lower House; even in this case, PM Renzi stated that he
will impose a confidence vote on labour reform if parliamentary discussion is
not swift. However, uncertainty about the final form of labour market reform is
high; hence, here we provide a brief summary of the key themes to monitor.
An important vote, but it is the beginning of the reform process
This is the beginning of the labour reform process, which should be completed
towards mid-2015. Indeed, the Upper House did not vote on the final labour
reform but on a so-called delegation law. Such a law will delegate to the
government the power of writing the detailed labour reform with the ex-ante
approval of parliament as long as the government moves within the perimeter
established by the delegation law itself. The perimeter defined by the
delegation is very wide; hence, uncertainty about the final form and benefits of
labour reform will remain until the government approves the legislative
decrees.
It is unusual to impose a confidence vote on a delegation law. Some might
question whether it is fully in line with the Constitution. The government
imposed the confidence vote given the divisions within Renzi’s PD party. With
six months having passed since the initial proposal, Renzi probably also
wanted to show some progress ahead the special European Council on growth
and employment on 7 October in Milan.
7
There were 111 no votes and 2 abstentions, the latter count as no votes in the Upper House.
Page 18
10 October 2014
Key objectives of the reform
Last week in Focus Europe we took a look at the performance of the Italian
economy and the state of structural reforms. 8 Here we provide a brief
summary of the key objectives of labour reform.
A toxic combination for young generations
Italy’s labour market manages to combine too much flexibility for temporary
contracts, which deters human capital investment, with too much rigidity for
permanent employees, which discourages investment in productive capacity.
This is topped up with ineffective active employment policies for the
unemployed, uneven and inefficient unemployment benefit schemes and a civil
justice system that is painfully slow. Finally, the wage bargaining process is
too centralized given Italy’s deep regional differences. It is no surprise that this
toxic mix is detrimental to productivity.
The government’s objectives and an uncertain outcome
The government’s aim is to introduce comprehensive reform that (i) decreases
the above duality of the labour market by easing individual redundancy rules
(Article 18); (ii) decreases the fragmentation of unemployment benefits; (iii)
improves active employment policies and (iv) simplifies the byzantine labour
regulation code. A minimum wage could also be introduced.
The most contentious element is, as usual, the first point above – Article 18.
Article 18 applies to firms with more than 15 employees. In its original
formulation of more than 40 years ago, Article 18 gave employees the right to
be reinstated if a judge declares a dismissal as unfair. The key problem here is
that because of the slowness of the civil justice system, a final judgment can
take up to four years, if not more (depending on geographical location, the
time can vary from one to six years). This introduces a high degree of
uncertainty in the form of contingent liabilities for the employer, potentially
stifling economic activity and introducing a disincentive to offer permanent
positions.
Unfair dismissal decisions can be due to (i) economic, (ii) disciplinary or (iii)
discriminatory factors. In case of unfair dismissal, the right to reinstatement
automatically applies if the cause is discrimination as dictated by the
Constitution. After the labour reform of Monti’s government, it is the judge
who decides whether an unfair dismissal for disciplinary or economic reasons
requires a reinstatement or a pecuniary compensation of between 12 and 24
months’ salary. This, however, does not remove the uncertainty that could
follow a long legal process.
Initially, it appeared that PM Renzi was aiming to remove the reinstatement
options for unfair dismissal for both economic and disciplinary reasons. The
government, however, as confirmed this week by the Labour Minister, has
partially softened its position in response to pressure from the left of his party
(PD). The reinstatement option will remain for some serious cases of unfair
dismissals for disciplinary reasons. But no details were provided ahead of the
vote in Parliament.
We will need to see the final formulation of labour market reform before
assessing its potential benefits:
8
See “Italy: internally and externally constrained”, http://pull.db-gmresearch.com/p/30070CA6/65867619/DB_FocusEurope_2014-10-03_0900b8c088cebada.pdf
Page 19
10 October 2014

First, there is the possibility that an employee appeals to a judge arguing
that her/his dismissal for economic reasons actually masks a disciplinary
motivation. In that case, legal uncertainty could return. Our understanding
is that the above modifications of Article 18 will not apply to existing
contracts but only to new ones.

Second, besides simplifying the labour regulation code, the government
aims to introduce a new form of permanent contract that would
progressively increase the level of protection. It is unclear whether Article
18 will be temporarily or permanently suspended for these contracts. In
the latter case, progressive protection would take the form of increasing
compensation.

Third, for this new form of permanent contract with increasing protection,
the most important element is not necessarily the debate around Article 18.
It is crucial that the new proposed permanent contract with progressively
increasing protection is incentivized by significant tax savings for firms
with respect to temporary contracts. In this case, the new contract could
significantly decrease the above-described duality of the labour market.
This should benefit productivity in the medium term. The key question is
whether the government can identify enough resources. At the moment,
we find it difficult to be very optimistic.

The fourth element is the gap between available and necessary resources
to decrease the fragmentation of unemployment benefits and improve
active employment policies. In February 2014, key members of Renzi’s
current economic team estimated the cost at around EUR 7-8bn (c0.5% of
GDP). Now it seems that the estimated cost has been lowered to about
EUR 2bn.

The fifth element is whether labour market reform will also encompass the
public sector.
Will labour reform bring material benefits?
The answer will depend on two broad developments:

First, we are confident that labour market reform, when completed, will
bring benefits. However, whether the benefits are marginal or consistent
will depend on three elements: (i) the detailed design; (ii) implementation;
and (iii) the resources allocated to it and whether these are permanently
funded via equivalent cuts in current expenditure.

Second, we do not think that labour market reform will be enough to turn
the economy around, as has happened in Spain. Labour reform needs to
be planted in more fertile soil for growth. In our view, this requires an
overhaul of the public administration – justice system included – and of the
tax system in favour of productive factors. The government committed to
tackling these key issues, but so far we find the proposed measures
unconvincing.
Page 20
10 October 2014
Eurozone
Economics
Euro Sovereign Events
Mark Wall
Marco Stringa, CFA
Chief Economist
(+44) 20 754-52087
[email protected]
Economist
(+44) 20 754-74900
[email protected]
Peter Sidorov, CFA
Economist
(+44) 20 754-70132
[email protected]
The following is a list of key events to watch in the coming weeks and months
– events that could have bearing on how the euro sovereign debt crisis evolves.
2014
October

October (ongoing): Troika mission to Greece. The fifth, and what should
final, review of the current Greece assistance programme started in the
last week of September, expected to complete over the course of October,
with the later stage likely to come around the time of publication of ECB’s
AQR/stress test exercise on 26 October. The review was proceeded by
talks between the Troika and Greek officials, ostensibly on how the exit
from the current programme will be structured. The Greek government
called a confidence vote for 10 October to dispel speculation about a
possible early election next year and improve its political standing on
reform implementation. For our latest update on Greece see 26 September
Focus Europe.

13/14 October: Eurogroup/ECOFIN finance ministers’ meeting The agenda
on financial and macro stability developments in the euro area will include
the review of Greece’s adjustment programme, preparation for the October
European Council and discussion on the draft of budgetary plans and
banking union.

14 October: ECJ public hearing on GCC OMT referral The European Court
of Justice is due to hold a public hearing to consider arguments on the
legal challenge to the ECB’s OMT programme that was referred to the ECJ
by the German Constitutional Court.

15 October: Eurozone countries’ draft 2015 budget submission deadline
Euro area member states are due to submit their draft budgetary plans to
the European Commission under the Two Pack regime. The Commission
then issues its opinion on the submitted plans on 15 November.

October (second half): ECB launches asset purchase programmes The ECB
is set to begin its private asset purchase programmes, starting with the
Covered Bond Purchase Programme (CBPP3) in the second half of October.
The ABS Purchase Programme (ABSPP) is due to follow later in Q4, with
both programmes to last at least two years. See ECB reaction article in this
issue of Focus Europe for more details.

17 October: Moody’s credit rating review for Spain

23-24 October: European Council – EU leaders’ summit

24 October: Fitch’s credit rating review for Italy

24 October: Fitch’s credit rating review for Spain

24 October: Moody’s credit rating review for Germany

26 October: Ukraine parliamentary elections Fresh elections, which had
been on the cards since the presidential elections in May, won by Petro
Page 21
10 October 2014
Poroshenko, were called on 25 August. The elections are likely to generate
noise and add to uncertainty around the conflict in Eastern Ukraine.

31 October: Moody’s credit rating review for the Netherlands

October (second half): ECB comprehensive bank assessment results. ECB
due to publish the results of the comprehensive assessment of around 130
largest euro area banks, comprising an asset quality review and stress test.
Banks facing a shortfall will be requested to submit capital plans within
two weeks, which will then be evaluated by the SSM. The assessment
exercise began in November 2013 and will take 12 months to complete
with the results published prior to the ECB taking on its role as the single
supervisor in November 2014.
November

4 November: ECB assumes Single Supervisor role. Following the
publication of the results of comprehensive assessment exercise and 12
months after the SSM regulation came into force the ECB will assume its
full supervisory tasks.

4 November: US mid-term elections All 435 seats will be up for election in
the House of Representatives, which the Republicans currently control
with 234 seats (16 above majority threshold). The Democrats control the
Senate with 53 of the 100 seats (55 including two Democrat leaning
independents). 36 Senate seats will be up for election in 2014, 21 of these
currently Democrat and 15 Republican.

6 November: ECB Governing Council meeting in Frankfurt

6 November: Eurogroup/ECOFIN finance ministers’ meeting

7 November: Standard and Poor’s credit rating review for Portugal

9 November (tentative): Proposed Catalan independence referendum
(Spain) Leaders of Catalonia’s secessionist parties that control the Catalan
parliament have proposed a consultation vote on Catalonia’s
independence. The planned vote would ask two questions: “Do you want
Catalonia to be a state?” and, if answered ‘yes’ to the first, “Do you want
that state to be independent?” The Spanish government has repeatedly
rejected the plans as illegal. Although it appears highly likely that the
Spanish Constitutional Court will reject Catalonia's request for a selfdetermination referendum, the situation remains uncertain. For example,
we would still see a non-negligible possibility that some sort of nonbinding referendum will take place in November. In any case, a permanent
solution does not look forthcoming. See article in 12 September issue of
Focus Europe for more details.

12 November: New forecasts by the European Commission. The European
Commission will outline the economic reform priorities for the EU for 2015
in the light of its growth forecasts. Given the weak economic outlook we
expect that the Commission will signal some flexibility with regard to
austerity targets. The Commission will also publish its assessment on
macroeconomic imbalances (alert mechanism report) in EU and EMU on
the same day.

14 November (tbc): Commission comments on draft budgetary plans of
EMU countries. If the draft budgetary plans are not in line with the fiscal
policy recommendations of the Commission, the Commission can require
the budgetary drafts to be readjusted already by the end of October. The
assessment of the budgetary draft will also be taken into consideration
when the Commission assesses the countries' compliance with the
country-specific provisions set out under the Excessive Deficit Procedure in
April.
Page 22
10 October 2014

14 November: Standard and Poor’s credit rating review for Spain

15-16 November: G20 leaders’ summit in Brisbane, Australia

21 November: Fitch’s credit rating review for Greece

21 November: Standard and Poor’s credit rating review for the Netherlands

21. November (tbc): Eurogroup on draft budgetary plans. The Eurogroup
will review the Commission's assessment on draft budgetary plans and the
fiscal stance across the euro area.

28 November: Moody’s credit rating review for Greece

November/December: French Budget vote French National Assembly votes
on 2015 budget draft. After the recent cabinet reshuffle (in August Prime
Minister Valls replaced three ministers who openly opposed his reform
course) tensions within the Socialist party have increased. An even larger
number of dissenters than in the confidence vote for Valls' new team on
September 16, when more than 30 out of 290 Socialist MPs did not vote in
favour of the cabinet, would put a majority for the government's budget
proposal at risk.
December

4 December: ECB Governing Council meeting in Frankfurt

5 December: Standard and Poor’s credit rating review for Ireland

5 December: Standard and Poor’s credit rating review for Italy

8 December: Eurogroup/ECOFIN finance ministers’ meeting

11 December: 2nd TLTRO The ECB is due to allot the second round of its
targeted long-term refinancing operations. A total of EUR 83bn was taken
up under the first operation in September, a disappointment relative to our
projection for around EUR 100bn take up and even higher market
expectations. We do expect higher take up in the second operation but the
total in the first two TLTROs is likely to fall well short of the EUR 400bn
total allowance (DB exp EUR ~250bn), making the ECB’s aim of expanding
the size of its balance sheet more challenging.

12 December: Fitch’s credit rating review for France

18-19 December: European Council – EU leaders’ summit

December (end): End of second adjustment programme in Greece
2015
1 January: Lithuania due to join the euro area Lithuania will adopt the euro in
2015 (on 23 July the European Council approved Lithuania’s requires to join
the euro are at of 1 January 2015 at a conversion rate of €1=LTL3.45280). The
country becomes the last of the Baltic States to join the euro after Estonia
(2011) and Latvia (2014). Lithuania’s entry into the euro area will trigger a
change in the ECB voting structure that was planned for when the 19th
member joins. The number of voting members on the council will be limited to
21 at any one meeting (currently 23 – 6 executive board members and 17
national central bank governors), with a rotation process among NCB
governors that should marginally favour the largest countries compared to the
current system where each member has one vote at every meeting.
Page 23
10 October 2014
Europe
George Buckley
Economics
Chief Economist
(+44) 20 754-51372
[email protected]
UK: A look ahead to May's election

Party conference season and by-elections have put politics firmly back on
the agenda in the UK in the run up to the next general election – scheduled
for a little over six months’ time (May 7). The polls have moved in favour
of the Conservatives in recent weeks with the latest giving a small lead for
the incumbent senior coalition partner. Such a small lead is unlikely to be
sufficient to produce a majority government, however.

Indeed, our rules of thumb suggest that the Conservatives need to be 5%
or more ahead of the opposition Labour party to be sure of forming a
majority government next May. Because of the nature of the UK’s political
system (first-past-the-post), however, even if the two parties are neck and
neck in the polls, this could be enough to produce a Labour majority.

We take a look at what various political configurations next May could
mean for the economy and the markets. Unlike the 2010 general election,
financial markets may be happier with the certainty of the current coalition
being returned to power. After all, a majority for one of the two major
political parties comes with important risks: EU exit in the event of a
Conservative victory, and a mansion tax/higher top-rate income tax/slower
austerity in the event of a Labour win.
Introduction
With the Party Conference season now over, UKIP having claimed their first
seat in the House of Commons following this week’s Clacton by-election (and
coming close to securing a second win in Heywood & Middleton), and a
general election only a little over six months away, we review in this week’s
article the political landscape and how it might affect economic policy going
forward.
Figure 1: Polls have tightened
50
Figure 2: How polls translate into seats
10
Opinon polls, % (5 poll moving average)
All polls since GE 2010
45
5
40
35
0
30
-5
Conservative
Labour
Lib Dem
UKIP
25
20
15
Cons
-10 lead
over
Lab, %
-15
10
5
2010
-20
2011
2012
Source: Deutsche Bank, UK Polling Report
Page 24
2013
2014
-50
-25
Number of seats: Con (blue dots)
or Lab (red dots) majority
0
25
50
75 100 125
150
175
Source: Deutsche Bank, UK Polling Report, Electoral Calculus
10 October 2014
Where the polls currently stand
Last month (September), opinion polls had been showing a Labour lead over
the Conservatives of around 4pp on average. This is illustrated in Figure 1
above. Over the past two years this chart shows the polls tightening
significantly, with Labour’s lead having averaged a far more comfortable 10pp
between spring 2012 and mid-2013.
A number of recent YouGov polls conducted since the start of this month (i.e.
after the Conservative Party Conference) have begun to show the
Conservatives ahead of Labour – by one or two points. Whether the Prime
Minister’s better performance than the opposition leader at their respective
Conferences (this is the view of some of the – even left-of-centre – press
coverage) will mean this is a permanent or temporary shift in the polls of
course remains to be seen.
Figure 3: UK election results since 1945
200
Figure 4: Breakdown of Scottish MPs in Westminster
Parliamentary majorities (seats)
Blue Conservative, red
Labour governments
150
6
1
Scottish MPs
in Westminster
Majority
100
11
Con
Lab
50
Lib
Other
0
Minority
41
1966
1970
1974
1974
1979
1983
1987
1992
1997
2001
2005
2010
1964
1959
1955
1951
1950
1945
-50
Source: Deutsche Bank, UK Parliament
Source: Deutsche Bank, UK Parliament
How do the polls translate into seats in parliament? We have developed simple
rules of thumb based on the results of all the main opinion polls published
since the last election in 2010 (of which there have been more than 1,500).
We use each of these polls to work out the number of seats majority/minority
(of the 650 MPs in the House of Commons) using electoralcalculus.co.uk. This
is shown in Figure 2 above. By adding lines of best fit to the scatter chart we
can work out roughly what election results would be generated by various
percentage-point polling differences between Labour and the Conservatives:

Conservative lead of over 5%: CON MAJORITY

Conservative lead of 2-5%: CON MINORITY

Conservative lead of 0-2%: LAB MINORITY

Labour lead of 0% or better: LAB MAJORITY
Taking an average of the latest polls published since the start of October (CON
33%, LAB 35%, LIB 7%) would, according to electoralcalculus.co.uk, give
Labour a majority of just 14 seats. This is small relative to history, as Figure 3
above left shows. Importantly, if there is pressure to resolve the West Lothian
question in the next parliament (i.e. in return for fuller devolution for Scotland,
Page 25
10 October 2014
removing the ability of Scottish MPs in Westminster to vote on English-only
matters) then this would mean an effective Labour minority in the House of
Commons when voting on English-only affairs. Assuming Labour were to
achieve the same number of seats in Scotland as is currently the case (i.e. 41 –
see Figure 4 above right) then they would need a majority of 24 seats in the
House of Commons to be sure of also having an effective majority for Englishonly legislation post the West Lothian question being resolved. As highlighted
above, current polling puts them short of this.
But polls can, of course, change quickly. Electoralcalculus.co.uk notes that,
“In every election since 1983, the Labour party has lost ground over the two
years before the election”. The economic situation could have an important
bearing on the election result too. For example, while economic output is now
over 2.5% above its previous peak, the same cannot be said for real wages,
which remain particularly weak (Figure 5). Should household finances recover
more quickly in the months leading up to the election, this may support the
incumbent government. In this respect, the ONS announcement this week of
its intention to publish “economic wellbeing” figures from the end of this year
could be useful in judging how important the economy is to voters.
Figure 5: Earnings outlook important for election
6
Figure 6: UKIP gains first MP in Clacton by-election
Regular pay growth, single month estimates, % yoy
25,000
Clacton by-election results, number of votes
5
4
20,000
2010 general election
3
2014 by-election
2
15,000
1
0
10,000
-1
-2
Nominal
-3
Real (delfated by CPI)
-4
2002
5,000
0
2004
2006
2008
2010
Source: Deutsche Bank, ONS, Haver Analytics
2012
2014
Con
Lab
Lib Dem
UKIP
Source: Deutsche Bank, BBC
The outcome of the election will also depend on the performance of the UK
Independence Party (UKIP) – the changing support for which the electoral
calculus website does not take full account of. While UKIP is unlikely to win
anywhere near as many seats as its current 15% polling suggests (thanks to
the first-past-the-post electoral system used in the UK), its support could be
crucial depending on which of the larger parties it ends up milking its support
from. Typically, one would expect more votes to be leaked more from the
Conservatives given their questioning of the UK’s membership of the EU and
their right-of-centre political stance, but some Labour heartland constituencies
in the north of England, for example, may also be at risk.
What the parties are offering
It is worth looking briefly at the fiscal announcements made by the three
largest parties (by parliamentary seats) at their recent Party Conferences.

Conservatives: On the theme of austerity a two-year freeze in working age
benefits starting in 2016 (estimated GBP3bn saving) and a tightening up of
Page 26
10 October 2014
multi-national tax avoidance. Manifesto sweeteners will include raising
the income tax-free allowance from £10,500 to £12,500 and raising the
threshold for the 40% income tax band from just under £42,000 currently
to £50,000 – both by the end of the next parliament.
Labour: The Conference headlines were more focused on Labour’s plans to
raise money through a mansion tax on properties worth over £2m, reintroducing the 50% top rate of income tax and extending the cap on child
benefit increases. That said, it seems likely that Labour would opt to
reduce the structural budget deficit at a slower pace than a Conservative
government would (see Figure 7 below). Figure 8 shows – intriguingly –
that Labour’s plans back in their final Budget of March 2010 were to cut
the deficit more quickly than the Conservative coalition actually ending up
doing. However, we suspect that had Labour been re-elected in May 2010
the eventual decline in the deficit would have been even less than what
has been delivered to date by the coalition. After all, the Conservatives in
the run up to the 2010 general election were suggesting the need for a
faster reduction.

Figure 7: Current coalition plans to reduce the deficit
3
2
Change in
structural
deficit as %
of GDP
Figure 8: Deficit cuts relative to Budget plans
OBR March
2014 forecasts
9
Structural deficit (ex Royal Mail
& APF transfers), % of GDP,
inc official forecasts
6
1
3
0
0
-1
Budget Mar 2010
Budget Jun 2010
Budget Mar 2014
Source: Deutsche Bank, Office for Budget Responsibility, HM Treasury

18-19
17-18
16-17
15-16
14-15
13-14
12-13
11-12
10-11
09-10
08-09
07-08
06-07
05-06
04-05
03-04
-2
-3
90-91
94-95
98-99
02-03
06-07
10-11
14-15
18-19
Source: Deutsche Bank, Office for Budget Responsibility, HM Treasury
Headlines from the Liberal Democrat Conference were dominated by plans
to spend an extra GBP1bn per year on the National Health Service funded
by reducing pension tax relief (among other policies), and Vince Cable’s
(Business Secretary) arguments against the Conservative coalition
partner’s focus on deficit reduction.
The current coalition may be the market’s best friend
Given the above fiscal – and other macroeconomic – plans of the main political
parties, are there any conclusions we can draw as to the impact on the
financial markets/economy as a result of different election results come next
May?
There are four likely political configurations following next May’s election: a
Conservative or Labour outright victory, or either of those parties forming a
coalition with the Liberal Democrats. Of course there are many other, arguably
less likely, possibilities particularly with the Liberal Democrats potentially
losing a sizable number of seats (based on current polling at least) and
uncertainties over UKIP’s performance. These include: a grand coalition, a
coalition with more than one smaller party as well as the Liberal Democrats
(UKIP, for example, given their latest performance in the Clacton by-election
Page 27
10 October 2014
and the European Parliamentary elections earlier in the year), a minority
government with the ‘support’ of smaller party (outside of a formal coalition
agreement) or even fresh elections. The 1970s provides the precedent for the
latter two options; in 1974 Harold Wilson ran a Labour minority government
until a second election was called later in the year, while Prime Minister James
Callaghan made a pact with the Liberal Party in the late 1970s when byelection defeats turned his fragile Labour majority government into a minority.
Back in 2010 at the time of the last election there was fear of what a coalition
government might mean for the markets. After all, this was the first time a UK
general election had not delivered a majority government since the mid-1970s.
This time round, however, it may be that a continuation of the current coalition
is the market’s preferred and ‘least-uncertain’ outcome.
Consider the
market/economic issues that the various configurations would generate:

Conservative majority: The biggest potential concern over an outright
Conservative victory would likely be Mr Cameron’s promise of a
referendum on EU exit by the end of 2017. An exit looks to be a more
risky prospect than Scotland voting to leave the UK (see Figure 9 below)
and would be highly dependent on the scale of renegotiation that Mr
Cameron achieves over what is a relatively short time horizon (Figure 10).
After all, it would not be long into a new Conservative government that
campaigning would begin and arrangements made for the vote. Business
and inward investment – and thus in turn economic growth – are likely to
be negatively impacted in the run up to the referendum as would be the
Bank of England’s willingness to normalise policy during such a period of
uncertainty. Increased austerity by the Conservatives (relative to other
political parties) too could negatively affect growth in the medium term –
though, as we’ve argued in the past, it may be positive for the long term if
reflected in lower yields through tighter risk premia.
Figure 9: Polling suggests EU exit vote neck and neck
Figure 10: Much depends on the extent of renegotiation
55
60
If there were a referendum on Britain's membership
of the European Union, how would you vote?
50
50
45
40
40
30
45
39
In
38
Out
32
23
20
35
10
30
Leave the EU
Remain in the EU
25
2011 2012
Source: Deutsche Bank, YouGov

How would you vote in an EU
referendum if David Cameron secured: (%) 52
2013
0
No renegotiation
2014
Modest
renegotiation
Major
renegotiation
Source: Deutsche Bank, YouGov
Labour majority: Here the focus would be squarely on a more limited pace
of deficit reduction (which may help growth in the short term but not
necessarily further ahead – see comments above). In addition, the risks to
the London housing market (which we discussed in our housing market
special report ‘London vs. the rest’, 18 July 2014) may be larger under a
Labour administration with a Mansion Tax on highly valued properties
potentially removing the key support of overseas buyers from the top of
the market.
Page 28
10 October 2014

Labour/Lib Dem coalition: Both Labour and the Liberal Democrats favour a
Mansion Tax, and with both parties being outwardly more sympathetic to
the less financially fortunate, this coalition would probably reduce the
deficit less quickly than the Conservatives (and raise taxes on higher
incomes more generally). That said, the Liberal Democrats may provide
some break on the aspirations of a Labour administration given that in
their conference they argued in favour of reducing the structural deficit to
zero by 2018 (though that may simply reflect the fact they are part of a
coalition government which agreed such forecasts in its last Budget).

Conservative/Lib Dem coalition: This would be more of the same as we’ve
had over the past four years. While it may be difficult to see a similar
coalition lasting another five years, it may be a case of ‘better the devil you
know’ in terms of market impact. Moreover, the Liberal Democrats would
almost surely resist Mr Cameron’s promise of an EU referendum. Another
issue is that if the Lib Dems win far fewer seats this time round compared
to the 2010 general election, there may be demands among Conservative
ranks to clip their wings in government. As kingmaker and having played
an important role in government over the past four years, however, the Lib
Dems may be unwilling to readily accept a commensurate reduction in
power to their loss in seats.
In summary, therefore, other configurations than the current Conservative/
Liberal Democrat coalition could present increased uncertainty to the markets
thanks to policies on housing, taxation, deficit reduction and Europe. It may
be that a repeat of the current coalition is the best option in terms of lower
uncertainty and market reaction.
Summary
At present the political opinion polls – despite having moved sizably in favour
of the Conservatives over recent weeks – fall within what we might call a
‘hung parliament zone’. This zone of uncertainty is between the parties being
neck-and-neck and the Conservatives polling 5% more than Labour. Anything
outside of that range should produce an outright majority for one of the two
major parties.
Six months is a very long time in politics, and anything could happen en route
to next May’s general election. The way in which the polls on Scottish
independence moved in the months ahead of last month’s vote is proof
enough. Whatever the result, any other government configuration than the
current coalition could generate additional market and economic uncertainty.
Page 29
10 October 2014
Central Banks & Financial Forecasts
Euro Area
Financial Forecasts
Euro Area
Draghi’s rhetoric took a step back in October, not repeating that the ECB is
ready to adjust the “size and composition” of purchases and de-emphasising
balance sheet targets. We view this as reflecting patience within the Council
and don’t see it as a challenge to our new view of public QE within 6 months.
UK
Expectations of the first rate rise have been gradually put back since Governor
Carney’s remarks suggesting a hike could be delivered by year-end. Weak
wage/price pressures have been the cause, despite strong growth, and as a
result we have put back our call for the first move to February 2015.
Switzerland
The SNB left policy and its statement unchanged in September. Despite small
revisions to its inflation view, we see no change in policy within the next year.
Latest Dec 14 Mar 15 Sep 15
Refi rate
0.05
0.05
0.05
0.05
3m Euribor
0.08
0.10
0.10
0.10
10Y govt bond
0.89
1.30
1.40
1.60
EUR/USD
1.26
1.25
1.22
1.18
Bank Rate
0.50
0.50
0.75
1.00
3m Libor
0.56
0.55
0.75
1.00
10Y govt bond
2.24
3.00
3.10
3.30
GBP/USD
1.60
1.62
1.61
1.59
EUR/GBP
0.79
0.77
0.76
0.74
3m Libor Tgt
0.00
0.00
0.00
0.00
EUR/CHF
1.21
1.22
1.23
1.25
Repo rate
0.25
0.25
0.25
0.25
EUR/SEK
9.14
8.95
8.90
8.80
Deposit rate
1.50
1.50
1.50
1.50
EUR/NOK
8.24
8.00
7.95
7.85
Lending rate
0.20
0.20
0.20
0.20
EUR/DKK
7.44
7.46
7.46
7.46
2w repo rate
2.00
1.75
1.75
2.00
EUR/PLN
4.18
4.13
4.08
4.03
UK
Switzerland
Sweden
Sweden
We broadly agree with the Riksbank’s latest forecasts showing official rates
remaining at current levels until the end of next year before rising gradually.
Norway
Norges Bank left rates unchanged at 1.50% in September. The Bank continues
to expect the first rate hike from end 2015.
Norway
Denmark
Poland
Denmark
Following the ECB’s decision to cut rates, the Nationalbank took deposits rates
back into negative territory, though left the lending rate unchanged at 0.20%.
Poland
Rates remained on hold in September, but rhetoric from the NBP is very dovish.
We expect two 25bps rate cuts, one in October and one in November.
Hungary
Base rate
2.10
2.10
2.10
2.60
EUR/HUF
305.8
315.0
319.0
324.0
Repo rate
0.05
0.05
0.05
0.05
EUR/CZK
27.5
27.0
27.0
27.0
O/N Call Rate
0.10
0.10
0.10
0.10
3m Tibor
0.21
0.20
0.20
0.20
Czech Rep.
Memo
Hungary
Rates are expected to remain on hold given that the NBH has already
undertaken aggressive easing and inflation is showing signs of picking up
gradually.
Japan
10Y govt bond
USD/JPY
0.51
0.55
0.65
0.70
107.9
112.0
114.0
118.0
Czech Republic
US
0.125
0.125
0.250
1.000
The CNB has stated that fx intervention, with the same target level for EURCZK
(27), will continue until 2016. With inflation picking up, albeit gradually, a
further weakening of the fx floor is now unlikely.
3m Libor
0.23
0.35
0.35
1.30
10Y govt bond
2.23
2.80
2.90
3.15
Page 30
Fed Funds Tgt
Sources: DB, Bloomberg Finance LP, National Central Banks
10 October 2014
Euroland Data Monitor
B’berg
code
Q4
Q1
Q2
Q3
Apr
May
Jun
Jul
Aug
Sep
2013
2014
2014
2014
2014
2014
2014
2014
2014
2014
51.9
53.1
53.4
52.8
54.0
53.5
52.8
53.8
52.5
52.0
Business surveys and output
Aggregate
PMI composite
ECPMICOU
Industry
EC industrial conf.
EUICEMU
-4.1
-3.5
-3.6
-4.9
-3.5
-3.1
-4.3
-3.8
-5.3
-5.5
PMI manufacturing
51.9
53.4
52.4
50.9
53.4
52.2
51.8
51.8
50.7
50.3
Headline IP (% pop )
PMITMEZ
Index
EUITEMUM
2.3
0.7
-0.2
1.1
-1.1
-0.3
1.0
Capacity Utilisation
EUUCEMU
78.4
80.1
79.5
79.8
EUCOEMU
-28.6
-29.0
-30.7
-28.1
-30.4
-30.1
-31.7
-28.2
-28.4
-27.7
1
Construction
EC construction conf.
Services
EC services conf.
EUSCEMU
-1.3
3.4
3.9
3.3
3.5
3.8
4.4
3.6
3.1
3.2
PMI services
PMITSEZ
Index
51.2
52.1
53.1
53.2
53.1
53.2
52.8
54.2
53.1
52.4
National Sentiment
Ifo
GRIFPBUS
108.8
110.8
110.4
106.3
111.2
110.3
109.6
108.0
106.3
104.7
INSEE
INSESYNT
98.7
100.0
99.3
96.3
101.0
99.0
98.0
97.0
96.0
96.0
-14.4
-11.2
-7.7
-9.9
-8.6
-7.1
-7.5
-8.3
-10.0
-11.4
-0.5
2.4
1.3
2.1
0.1
0.2
0.3
-0.4
1.2
5.0
5.1
3.9
4.9
5.3
3.2
3.2
5.7
4.4
-14.7
-14.4
-14.8
-14.8
-15.0
-14.4
-15.1
-14.8
-14.1
1.7
4.4
0.7
-0.4
0.8
-0.3
-0.2
Consumer demand
EC consumer survey
Retail sales (% pop)
EUCCEMU
RSSAEMUM
New car reg. (sa, % yoy)
Foreign sector
Foreign orders
Exports (sa val. % pop)
EUI3EMU
Imports (sa val. % pop)
Net trade (sa EUR bn)
XTSBEZ
-4.8
5.6
-0.1
-0.5
0.5
0.6
0.9
43.5
42.6
43.6
14.6
15.2
13.8
12.2
-15.6
Labour market
Unemployment rate (%)
Change in unemployment
(k)Employment (% yoy)
UMRTEMU
11.9
11.7
11.6
11.5
11.6
11.6
11.5
11.5
11.5
-175.3
-258.7
-215.3
-116.5
-84.0
-3.0
-129.0
39.0
-137.0
-0.4
0.1
0.5
Prices, wages and costs
Prices (% yoy)
Harmonised CPI
ECCPEMUY
0.8
0.7
0.6
0.3
0.7
0.5
0.5
0.4
0.4
0.3f
Core HICP (Eurostat)
CPEXEMUY
0.8
0.8
0.8
0.8
1.0
0.7
0.8
0.8
0.9
0.7f
Harmonised PPI
PPTXEMU
-1.2
-1.6
-1.1
-1.3
-1.1
-0.8
-1.1
Oil Price (USD)
EUCRBRDT
109.3
108.2
109.7
102.0
107.8
109.5
111.8
106.8
101.8
97.4
EUR/USD
EUR
1.4
1.4
1.4
1.3
1.4
1.4
1.4
1.4
1.3
1.3
15.4
13.1
8.5
6.4
7.4
9.6
8.5
8.6
6.6
4.0
1.7
0.5
-0.9
-0.7
-1.3
-1.3
-0.1
0.4
-0.7
-1.8
Unit labour cost
0.7
0.4
0.9
Labour productivity
0.9
0.8
0.2
Compensation.
1.6
1.2
1.1
Hourly labour costs (sa)
0.9
0.8
1.4
1.2
1.2
1.9
0.8
1.1
1.6
1.8
2.0
1.0
1.2
1.5
1.8
Inflation expectations
EC household survey
EC industrial survey
EUA8EMU
EUI5EMU
Unit labour cost (% yoy)
Money (% yoy)
M3
M3 trend (3m cma)
ECMAM3YY
ECMA3MTH
1.3
Credit - private
ECMSCDXE
-2.3
-2.2
-1.9
-1.6
-1.8
-2.0
-1.8
-1.6
-1.5
Credit - public
ECMSCDGY
-0.2
-0.2
-1.6
-1.5
-0.9
-1.4
-2.6
-1.8
-1.2
Quarterly data in shaded areas are quarter-to-date. Monthly data in the shaded areas are forecasts.(1) % pop = % change this period over previous period.
Quarter on quarter growth rates are annualised.
‘f’ stands for flash estimate
‘Source: Deutsche Bank forecasts, Eurostat, Ifo, INSEE, Reuters, European Commission, National statistical offices.
Page 31
10 October 2014
The Week Ahead: Euro Zone

In the Eurozone, markets will be focused on the inflation data for the region as well for big-4 economies. We expect
HICP for Euro area to rise by 0.4% in September. In soft data, ZEW surveys (Tue) will be important.

In other data releases, the trade balance (Thu), construction output (Fri) and new car registrations (Fri) for the region
as a whole are the other important releases due in the coming week.
Key Data & Events
Release
Day
Time (GMT)
Tue
06.45
French HICP (Sep)
0.5% (0.5%)
08.00
Italian HICP (Sep)
-0.2% (-0.2%)
08.00
Spanish HICP (Sep)
09.00
German ZEW survey (Current situation) (Oct)
16.0
09.00
German ZEW survey (Econ.Sentiment) (Oct)
0.0
09.00
Euroland ZEW survey (Current situation) (Oct)
09.00
Euroland ZEW survey (Econ. sentiment) (Oct)
09.00
Euroland Industrial production (Aug)
06.00
German HICP (Sep)
12.00
Spanish Trade balance (Aug)
08.00
Italian Trade balance (Aug)
EUR6.9bn
09.00
Euroland Trade balance (Aug)
EUR12.2bn
09.00
Euroland HICP (Sep)
09.00
Euroland Core HICP (Sep)
06.00
Euroland New car registration (Sep)
(2.1%)
10.00
Euroland Construction output (Aug)
0.0% (0.4%)
Wed
Thu
Fri
DB Forecast
Consensus
Previous
0.1% (-0.5%)
25.4
6.9
-43.8
14.2
-0.8%
-1.7%
1.0% (2.2%)
0.0% (0.8%)
0.0% (0.8%)
-EUR1.8bn
0.4% (0.3%)
(0.8%)
0.1% (0.3%)
0.1% (0.4%)
(0.9%)
dbCalendar: For more forward-looking calendars of data and events, as well as various tools to analyse data surprises, go to our new
online calendar: http://gm-secure.db.com/dbCalendar
Mon, 13
Thu, 16
ECB’s Praet to speak in Munich – 12:00 GMT.
Euro area finance ministers to meet in Luxembourg – 12:30 GMT.
ECB’s Weidmann to speak in Frankfurt
ECB’s Constancio to speak in Frankfurt – 07:45 GMT.
Wed, 15
ECB’s Draghi to speak in Frankfurt – 07:00 GMT.
ECB’s Nouy to speak in Frankfurt – 15:30 GMT.
ECB’s Draghi to speak in Frankfurt – 18:00 GMT.
Source: Various National Statistical Offices, Bloomberg Finance LP, Reuters, S&P MMS, DB Global Markets Research. Growth rates in parentheses are year-on-year, while those without parentheses are this period over
last period.
Page 32
10 October 2014
The Week Ahead: Rest of Europe & the USA

In the US, IP and retail sales data are the key releases this week. IP is expected to grow by 0.3% mom while retail
sales are expected to rise by 0.1% mom. Among the survey data, consumer sentiment is expected to improve
while Philly Fed is forecast to ease.

In the UK, the labour market report – and specifically earnings growth – will be the most important release next
week. Look out also for inflation (CPI & PPI) data on Tuesday too.
Key Data & Events
Day
Time (GMT) Release
Tue
Wed
Thu
Fri
DB Forecast
Consensus
Previous
07.30
Swedish CPI headline (Sep)
-0.1% (-0.2%)
08.30
UK Input PPI (Sep)
-0.2% (-6.5%)
08.30
UK Output PPI (Sep)
0.1% (-0.1%)
-0.1% (-0.3%)
-0.1% (-0.3%)
08.30
UK CPI (Sep)
0.3% (1.4%)
0.2% (1.4%)
0.4% (1.5%)
08.30
UK RPI (Sep)
0.3% (2.3%)
0.3% (2.3%)
0.4% (2.4%)
08.30
UK Claimant count rate (Sep)
2.8%
2.8%
2.9%
08.30
UK ILO unemployment rate (Aug)
6.1%
6.1%
6.2%
12.00
Polish CPI (Sep)
12.30
US PPI (Sep)
0.2%
0.1%
0.0% (1.8%)
12.30
US Retail sales (Sep)
0.1%
-0.2%
0.6% (5.0%)
13.30
US NY Fed empire state survey (Oct)
20.0
20.5
27.5
14.00
US Business inventories (Aug)
0.4%
0.4%
0.4% (5.9%)
08.30
Swedish Unemployment rate (Sep)
12.30
US Initial jobless claims (Oct 11)
13.15
US Capacity utilization (Sep)
79.0%
79.0%
78.8%
13.15
US Industrial production (Sep)
0.3%
0.4%
-0.1% (4.1%)
14.00
US NAHB housing market index (Oct)
58.0
59.0
59.0
14.00
US Philly Fed (Oct)
20.0
20.0
22.5
12.30
US Building permits (Sep)
1,100.0k
1,035.0k
998.0k
12.30
US Housing starts (Sep)
1,100.0k
1,002.0k
956.0k
13.55
US Consumer sentiment prelim (Oct)
86.0
84.2
84.6
-0.6% (-7.2%)
(-0.4%)
-0.4% (-0.3%)
7.4%
287.0k
dbCalendar: For more forward-looking calendars of data and events, as well as various tools to analyse data surprises, go to our new
online calendar: http://gm-secure.db.com/dbCalendar
Mon, 13
Fri, 17
Thu, 25
Fed’s Evans to speak in Indianapolis – 16:30 GMT.
Fed’s Yellen to speak in Boston – 12:30 GMT.
National B
setting me
Thu, 16
Fri, 26
Fed’s Plosser to speak in Pennsylvania – 12:00 GMT.
Fed’s Lockhart to speak in Rutgers – 13:00 GMT.
Fed’s Kocherlakota to speak in Montana – 14:00 GMT.
Fed’s Bullard to speak in Washington – 17:00 GMT.
SNB’s Jord
The list of data an
more complete li
Thu, 25
Source: National Statistical Offices, Bloomberg Finance LP, Reuters, S&P MMS, DB Global Markets
Research
The list of data and events for the US is not comprehensive. Please see the web-based week ahead for a
National
Bank of Poland to publish minutes of its April rate
more complete list
setting meeting
Fri, 26
SNB’s Jordan to speak in Berne – 08.00 GMT
The list of data and events for the US is not comprehensive. Please see the web-based week ahead for a
more complete list
Page 33
10 October 2014
Appendix 1
Important Disclosures
Additional information available upon request
For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this
research, please see the most recently published company report or visit our global disclosure look-up page on our
website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr
Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition,
the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation
or view in this report. Mark Wall
Page 34
10 October 2014
(a) Regulatory Disclosures
(b) 1. Important Additional Conflict Disclosures
Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the
"Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing.
(c) 2. Short-Term Trade Ideas
Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are
consistent or inconsistent with Deutsche Bank's existing longer term ratings. These trade ideas can be found at the
SOLAR link at http://gm.db.com.
(d) 3. Country-Specific Disclosures
Australia and New Zealand: This research, and any access to it, is intended only for "wholesale clients" within the
meaning of the Australian Corporations Act and New Zealand Financial Advisors Act respectively.
Brazil: The views expressed above accurately reflect personal views of the authors about the subject company(ies) and
its(their) securities, including in relation to Deutsche Bank. The compensation of the equity research analyst(s) is
indirectly affected by revenues deriving from the business and financial transactions of Deutsche Bank. In cases where
at least one Brazil based analyst (identified by a phone number starting with +55 country code) has taken part in the
preparation of this research report, the Brazil based analyst whose name appears first assumes primary responsibility for
its content from a Brazilian regulatory perspective and for its compliance with CVM Instruction # 483.
EU
countries:
Disclosures
relating
to
our
obligations
under
MiFiD
can
be
found
at
http://www.globalmarkets.db.com/riskdisclosures.
Japan: Disclosures under the Financial Instruments and Exchange Law: Company name - Deutsche Securities Inc.
Registration number - Registered as a financial instruments dealer by the Head of the Kanto Local Finance Bureau
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financial instruments or related services. We may charge commissions and fees for certain categories of investment
advice, products and services. Recommended investment strategies, products and services carry the risk of losses to
principal and other losses as a result of changes in market and/or economic trends, and/or fluctuations in market value.
Before deciding on the purchase of financial products and/or services, customers should carefully read the relevant
disclosures, prospectuses and other documentation. "Moody's", "Standard & Poor's", and "Fitch" mentioned in this
report are not registered credit rating agencies in Japan unless "Japan" or "Nippon" is specifically designated in the
name of the entity.
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may engage in transactions in a manner inconsistent with the views discussed herein.
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(e) Risks to Fixed Income Positions
Macroeconomic fluctuations often account for most of the risks associated with exposures to instruments that promise
to pay fixed or variable interest rates. For an investor that is long fixed rate instruments (thus receiving these cash
flows), increases in interest rates naturally lift the discount factors applied to the expected cash flows and thus cause a
Page 35
10 October 2014
loss. The longer the maturity of a certain cash flow and the higher the move in the discount factor, the higher will be the
loss. Upside surprises in inflation, fiscal funding needs, and FX depreciation rates are among the most common adverse
macroeconomic shocks to receivers. But counterparty exposure, issuer creditworthiness, client segmentation, regulation
(including changes in assets holding limits for different types of investors), changes in tax policies, currency
convertibility (which may constrain currency conversion, repatriation of profits and/or the liquidation of positions), and
settlement issues related to local clearing houses are also important risk factors to be considered. The sensitivity of fixed
income instruments to macroeconomic shocks may be mitigated by indexing the contracted cash flows to inflation, to
FX depreciation, or to specified interest rates - these are common in emerging markets. It is important to note that the
index fixings may -- by construction -- lag or mis-measure the actual move in the underlying variables they are intended
to track. The choice of the proper fixing (or metric) is particularly important in swaps markets, where floating coupon
rates (i.e., coupons indexed to a typically short-dated interest rate reference index) are exchanged for fixed coupons. It is
also important to acknowledge that funding in a currency that differs from the currency in which the coupons to be
received are denominated carries FX risk. Naturally, options on swaps (swaptions) also bear the risks typical to options
in addition to the risks related to rates movements.
Page 36
David Folkerts-Landau
Group Chief Economist
Member of the Group Executive Committee
Guy Ashton
Global Chief Operating Officer
Research
Michael Spencer
Regional Head
Asia Pacific Research
Marcel Cassard
Global Head
FICC Research & Global Macro Economics
Ralf Hoffmann
Regional Head
Deutsche Bank Research, Germany
Richard Smith and Steve Pollard
Co-Global Heads
Equity Research
Andreas Neubauer
Regional Head
Equity Research, Germany
Steve Pollard
Regional Head
Americas Research
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Focus Europe Investment gap Deutsche Bank Research

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