Wealth Management Research 24 June 2011

UK economicsThe Greek tragedy continues

• The Greek debt crisis remains the dominant topic in financialmarkets. Next Tuesday's vote in the Greek parliament toapprove a new package of cuts and taxes must be approvedby all parties.

• While we expect the latest austerity package to pass,obviously a negative result would destabilise the situation inGreece and the Eurozone.

• In the UK the MPC minutes sent Sterling into something of aspin, as the prospect of more QE in the UK was mentioned.

• With inflation expected to hit 5% in the next few months,we suspect that this is perhaps a more carefully orchestratedbluff designed to push sterling lower. It worked.

Market overviewEquity markets swung back and forth this week as the Greekdebt crisis dominated events. A vote of confidence for GeorgePapandreou's government earlier in the week helped ease tensions,as did backing by Europe for a general framework for Greece's nextbail-out. Britain will not participate in the package.

On June 30th a vote will take place in the Greek parliament forapproval for its fiscal austerity measures, and while expected topass, a no vote could seriously destabilise the situation in Greeceand the Euro-zone. European leaders finally seem to be realisingthat they cannot kick the can down the road into perpetuity. Atsome stage a restructuring of Greek debt will be required, andEuropean leaders are trying to ensure that it happens in an ordinarymanner with some type of "voluntary" haircuts, rather than adisorderly default which could destabilise the entire banking system.

Despite all the turmoil equity markets were little unchanged. InLondon the FTSE fell 0.3% on the week to close at 5698. In NewYork the S&P was trading at 1274. Oil suffered large declines asthe IEA announced it would release 30 million barrels of oil to easesupply constraint, much to the annoyance of OPEC who earlier thismonth decided to leave production quotas unchanged. As a resultWTI fell 2.9% on the week to $90.73, but Brent fell 6.9% to closeat $105.7. In FX Sterling lost ground against both the Euro andDollar closing at 1.127 and 1.601 respectively on the back of somecomments in the MPC minutes regarding QE.

Next week the focus of attention will remain on Greece.

Brian O'Reilly, strategist, UBS AG

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 5698 -0.3 -3.4

FTSE 250 11528 -1.1 -0.3

S&P 500 1274 0.2 1.3

Euro Stoxx 50 2716 -2.0 -2.8

CAC 40 3785 -1.0 -0.5

DAX 7121 -0.6 3.0

SMI 5998 -2.4 -6.8

Nikkei 225 9679 3.5 -5.4

Commodities

Gold (USD/Oz) 1517 -0.7 7.4

Oil (USD/bbl) 90.73 -2.9 -3.7

Foreign Exchange

GBPUSD 1.601 -1.1 3.4GBPEUR 1.127 -0.5 -2.7

Fixed Income

UK 10 yr Gilt 3.13% - -

US 10 yr Treasury 2.89% - -

Source: Bloomberg, UBS WMR

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

The week in review...MPC minutes: The MPC minutes showed a 7-2 split in favour ofkeeping rates on hold, with new member Ben Broadbent votingwith the consensus. The members did slip into the minutes that Q2output was likely to have grown at an underlying pace similar to Q1(0.5%) which is encouraging. The MPC also thought that the dis-ruptions triggered by the Japanese earthquake, alongside the im-pact of a rising oil price, could account for much of the recent weak-ness, but they remained nervous about the service sector slowdownand US employment data.The MPC remain puzzled that measuresof spare capacity now appear normal, given the substantial fall inoutput during the recession. They look to an upwards revision ofthe GDP data to resolve this problem.

Will QE2 set sail? Meanwhile the MPC expect CPI to rise above 5%in the near term before subsiding. The committee thought down-side risks to meeting the inflation target outweighed the upsideones. Tucked away in paragraph 25 of their minutes is the sentence"For some of these members, it was possible that further asset pur-chases might become warranted…". We think this may be not toosubtly a ploy to talk sterling lower. This is not the first time the BoEwould have used such a strategy.

We think the objective is to keep sterling weak. In the near-term, it is exports that are driving UK output growth and helping tooffset weak consumption growth. The MPC want to protect this – tothat extent they are doing a good job. The price they appear willingto pay is to take a hit on the "near-term" inflation outlook. TheMPC think that if this near-term overshoot extends to the mediumterm they can always do something about it. Yes they can – but iftheir priority is growth over inflation, they won't.

Deficit remains on target: Although right now our budget deficitis remarkably similar to that of Greece, the difference is the expect-ed rate of contraction of these deficits.The OBR forecast a deficitof £122bn this financial year compared with an estimated £146bnlast year. The first 2 months of borrowing have totaled £27.4bn vs£25.9bn last year. The better than expected employment figures areshowing up in income tax and NI receipts, which are up 5.1% YoY,vs the OBR forecast for 3%. At the same time core spending is up1.2% YoY, vs an OBR projection of 2.3%, perhaps again reflectingpublic sector job losses.

Ireland's green shoots: While attention continues to focus on thetroubles in Greece, Ireland delivered some positive news for the pe-riphery nations as its economy returned to growth in the first quar-ter. The central statistics office of Ireland reported that first quar-ter GDP came in at 1.3% well ahead of economists estimates of0.5%. Exports reached a record level of EUR 40bn, rising by an im-pressive 3.8% qoq. However with the government's austerity mea-sures hitting household incomes, domestic consumption continuesto drag on growth. Consumer and government spending were bothdown 1.9% as households struggle under the weight of high debtburdens, the collapse of the housing market and a malfunctioningbanking sector

Given recent concerns that Ireland will follow a path to default sim-ilar to that of Greece, on the latest evidence these fears do not ap-pear justified. Austerity measures have been generally accepted by

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the Irish public and the political situation is much more stable. Withgross exports accounting for over 80% of GDP, Ireland's potentialfor recovery lies more in the prospects for global growth rather thana pick up domestic consumption. On this basis with exports reach-ing record levels we believe Ireland can distance itself from Greeceand the other periphery nations.

The week ahead...Next week there is a busy economic calendar. Attention will stayfocused on developments in Athens. Other notable releases includeUK PMI manufacturing and ISM data in the US.

Greece, Greece and more Greece: All eyes will be on the Greekparliament's vote on Tuesday on the latest spending cuts and taxproposals. A yes vote has been set as a prerequisite by the EU/IMFfor the payment of EUR12 bn from the existing package, and for anadditional package of around EUR 78. An emergency Euro-groupmeeting has been scheduled for 3rd July to finalise the Greek bail-out if the austerity package passes.

UK Manufacturing data for June: UK manufacturing PMI data isout on Friday with consensus expectations penciling in a marginalincrease from 52.1 to 52.3. A move higher will ease some concernsabout a contraction in the UK economy.

European Inflation: In Europe the consumer price index for Juneis due out on 30 June. In May the index eased back somewhatfor the first time since last summer, receding from 2.8% to 2.7%.Commodity prices have dropped in response to the economicslowdown, which in turn has reduced inflationary pressure.

US ISM: Last month the ISM manufacturing sector index (ISM) fellby a hefty 6.9 points, rattling the financial markets. Given the ral-ly in commodity prices since last summer, sales came in lower thanexpected and production is currently being scaled back. On 1 Ju-ly the eagerly awaited index for June will be released. Despite theadvancing recovery in Japanese auto production and the correc-tion in commodities, the index could fall further before stabilizing.

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Key data and events this week

Date Time Region Event Survey Prior

27-30 JUN UK Nat'wide House prices nsa(YoY) -1.3% -1.2%

06/28/2011 09:30 UK GDP (QoQ) 0.5% 0.5%

06/28/2011 09:30 UK GDP (YoY) 1.8% 1.8%

06/28/2011 15:00 US Consumer Confidence 61 60.8

06/29/2011 09:30 UK Mortgage Approvals 46.3K 45.2K

06/30/2011 00:01 UK GfK Consumer Confidence Survey -24 -21

07/01/2011 09:00 EC PMI Manufacturing 52 52

07/01/2011 09:30 UK PMI Manufacturing 52.3 52.1

07/01/2011 10:00 EC Euro-Zone Unemployment Rate 9.9% 9.9%

07/01/2011 14:55 US U. of Michigan Confidence 72 71.8

07/01/2011 15:00 US ISM Manufacturing 51.5 53.5

Source: Bloomberg

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Appendix

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