Wealth Management Research 22 August 2011

UK economicsHow slow is slow?

• Equity markets moved sharply lower this week on fearsof slower global growth, bank stresses, and furtherdevelopments in the Eurozone crisis.

• The Bank of England minutes showed the Monetary PolicyCommittee has now lost its hawkish bias, as last month itvoted 9-0 to keep rates on hold. One member continues tovote for more quantitative easing.

• UK inflation moved back up to 4.4% y/y for the consumerprice index, and stayed at 5% for the retail price index.Unemployment moved higher to 7.9%, based on a slightlyexpanded workforce.

Market overview

It was a week where markets grappled with questions such as: Justhow slow is slow growth? Is it slow enough to tip us back intorecession? Is interbank lending coming under stress? What next forthe Eurozone?

Equity markets sold off heavily as a result, particularly on Thursday,led lower by banks on fears of a transaction tax, and miners on fearsof lower global growth. The FTSE 100 fell 5.2% this week, brieflydipping below 5000, before closing at 5041. In the US, the S&P 500fell 3.1% , and was at 1143 in Friday mid-day trading. Volatility,as measured by the VIX index, shot back up to 42, from 36 just aweek ago.

Bond yields moved sharply lower again on renewed fears we areheading for a double-dip recession. Yields on UK 10-year Gilts nowstand at an astonishing 2.39%, and the US 10-year treasury yields2.10%.

Commensurate with growth concerns, we saw gold move higher,by 6.4%, to USD 1,851/oz, and oil (WTI) move 2.8% lower, to USD83/bbl.

Currency markets also stayed volatile, and the pound gained againstboth the dollar, to 1.654, and the euro to 1.150.

In addition to a strategically important meeting between GermanChancellor Angela Merkel and French President Nicolas Sarkozy,there were lots of economic data points this week, particularly in

Caroline Winckles, CFA, analyst, UBS AG

Mark Bulsing, strategist, UBS AG

Source: UBS

Performance dataCapital return performance, in %

Equity Markets Level % Week % YTD

FTSE 100 5041 -5.2 -14.6

FTSE 250 9759 -6.5 -15.6

S&P 500 1143 -3.1 -9.1

Euro Stoxx 50 2159 -6.4 -22.7

CAC 40 3017 -6.1 -20.7

DAX 5480 -8.6 -20.7

SMI 5094 -3.0 -20.9

Nikkei 225 8719 -2.7 -14.8

Commodities

Gold (USD/Oz) 1851 6.4 30.5

Oil (USD/bbl) 82.9 -3.0 -12.2

Foreign Exchange

GBPUSD 1.654 1.7 6.1GBPEUR 1.150 0.6 -1.5

Fixed Income

UK 10 yr Gilt 2.39% - -

US 10 yr Treasury 2.10% - -

Source: Bloomberg, UBS WMR

the UK. These included consumer price index (CPI) inflation at 4.4%y/y, a change of stance in the Monetary Policy Committee (MPC)minutes, and a rise in unemployment.

The main data points next week include revisions to UK and USsecond-quarter GDP, and purchasing managers index (PMI) datafrom the Eurozone. Additionally, Fed Chairman Ben Bernanke'sspeech at Jackson Hole will take place on Friday.

This report has been prepared by UBS AG. Please see important disclaimers and disclosures that begin on page 5.

The week in review...There was a big political focus this week, as Merkel and Sarkozymet, and Germany and France announced that they will proposea financial transaction tax, and will go ahead with more coordina-tion and harmonisation of financial and fiscal policy. The idea of aeurobond was rejected for the time being.

There were also lots of economic data points this week, particularlyin the UK. These included CPI inflation at 4.4% y/y, a change ofstance in the MPC minutes, and a rise in unemployment.

• Inflation picks up: UK inflation went back up this month, withCPI coming in at 4.4% y/y, up from 4.2% in June and abovemarket expectations for 4.3%. M/m CPI was flat at 0%. Theretail price index (RPI) stayed flat at 5% y/y. We continue toexpect CPI to reach 5% in coming months.

• Hawks retreat : The MPC minutes of the last rate meetingshowed a shift to dovishness. The two prior hawks, SpencerDale and Martin Weale, gave up their push for interest rate ris-es. The MPC therefore voted 9-0 to keep interest rates on holdat 0.5%. Adam Posen remains the one voter for more asset pur-chases of GBP 50bn. However, the minutes stated that "somemembers considered whether there was a case for increasingthe degree of monetary stimulus by undertaking a further pro-gramme of asset purchases". Clearly the members are lookinghard at how to balance high inflation and the risk of slowergrowth, particularly in the Eurozone. We think rates will stayon hold for quite some time, and QE would only be broughtin as a last resort.

• UK labour market disappointed: Jobless claims increased by37.1K, more than the 20K anticipated by the markets. Whilstsome of the increase was due to changes in benefit eligibili-ty rules, the Office for National Statistics state there is also anunderlying weakness in the labour market. The InternationalLabour Organization unemployment rate (3months) increasedto 7.9%, from 7.7% previously. The only good news is thatemployment expanded by 25,000 in the three months to June.Meanwhile, average weekly earnings for the 3m y/y grew at2.6%, higher than the 2.3% the market was looking for butfor now still below long-term averages.

• Consumer struggles on: ONS retail sales excluding auto fuelwere also slightly weaker than expected at 0.2% m/m, versus0.8% in June; and -0.2% y/y, versus 0.2% in June. Retail saleswith auto fuel were 0.2% m/m and 0% y/y, which compareswith 0.7% and 0.4%, respectively, for June. The market hadbeen anticipating 0.3% m/m and 0.3% y/y.

• US mixed: The Philadelphia Fed index of business outlook dis-appointed on Thursday, coming in at -30.7, versus consensusexpectations of 2, and a reading of 3.2 in July. This is the lowestit has been since March 2009. Industrial Production, however,grew more than anticipated in July, with a reading of 0.9%, ver-sus expectations of 0.5%, and a reading of 0.2% last month.Inflation, meanwhile, continues to rise, with CPI in the US nowrunning at 3.6% y/y.

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The week ahead...The main data points next week include revisions to UK and USsecond-quarter GDP, and PMI data from the Eurozone. Additionally,Fed Chairman Ben Bernanke's speech at Jackson Hole will take placeon Friday.

• How slow is slow? Eurozone PMI is due on Tuesday. Withconcerns about the rate of slowdown in growth, particularlyafter Germany's weaker 2Q GDP growth last week (0.1% q/q vs1.3% in Q1), all eyes will focus on forward-looking surveys. ThePMI composite is expected to have dropped to 50, from 51.1last month, led lower by Manufacturing to 49.5, and Servicesto 51. The German Ifo index on Wednesday will also get someattention with the consensus looking for a Business Climatereading of 111, versus 112.9 prior.

• How bad was Q2? The UK second-quarter GDP first revisionis due on Friday, with the market looking for growth to be leftunchanged at 0.2% q/q. Whilst over history, the majority of re-visions tend to be upwards, the risks this time probably lie tothe downside. UK consumer confidence from the Nationwide isdue out on Thursday, and is expected to have shown a drop inconfidence to 45, from 51. No doubt this is fuelled by the stag-nant housing data we have seen, and expect to keep seeing,combined with the recent rise in inflation and unemploymentannounced this past week.

• Adjusting expectations for the US: The US GDP revisionsare also due on Friday, with the market expecting a downwardchange to 1.10% q/q annualised, from a reading of 1.30% atthe preliminary release. The University of Michigan confidenceindex, also due on Friday, is expected to rise slightly to 56, butthe Richmond Fed Manufacturing Index due Monday is expect-ed to have declined from -1 to -8. Meanwhile, on Friday FedChairman Ben Bernanke makes his speech at Jackson Hole. Webelieve he will leave the door open for more quantitative easingif conditions deteriorate further, just as he did last year.

Key data and events this week

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Date Time Event Survey Prior08/23/2011 09:00 Eurozone PMI Composite 50 51.1

08/23/2011 09:00 Eurozone PMI Manufacturing 49.5 50.4

08/23/2011 09:00 Eurozone PMI Services 51 51.6

08/23/2011 10:00 Eurozone ZEW Survey (Econ. Sentiment) - - -7

08/23/2011 15:00 US Richmond Fed Manufact. Index -8 -1

08/24/2011 09:00 Germany IFO - Business Climate 111 112.9

08/25/2011 00:01 UK Nationwide Consumer Confidence 45 51

08/26/2011 09:30 UK GDP (QoQ) 0.20% 0.20%

08/26/2011 09:30 UK GDP (YoY) 0.70% 0.70%

08/26/2011 13:30 US GDP QoQ (Annualized) 1.10% 1.30%

08/26/2011 14:55 US U. of Michigan Confidence 56 54.9

25-31 AUG UK Nat'wide House prices sa (MoM) - - 0.20%

25-31 AUG UK Nat'wide House prices nsa(YoY) - - -0.40%

Source: Bloomberg, UBS WMR

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Appendix

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