Global Economic Research

July 2010

Renewed USD weakness, evidence of global economic slowdown, prolonged monetary stimulus in developed economies, European banking sector audits, currency regime shifts in China, and technical overvaluation in emerging countries are swaying capital flows in global currency markets. The USD is in retrenchment mode. NAFTA zone currencies are on the defensive as global recovery uncertainties minimized the premium linked to interest rate differentials. However, the CAD should regain strength and reach parity vs. the USD, while the MXN will be vulnerable to oil price swings. Renewed EUR strength will be short-lived due to persistent structural weaknesses in Europe linked to debt/fiscal sustainability and banking sector auditing/restructuring activity. The GBP has appreciated following the release of the UK budget. In Asia, a sharp JPY appreciation may revive Japan’s intervention fears. A more flexible currency policy in China instilled a positive tone into other floating currencies such as the KRW and the MYR. Meanwhile, high-yield currencies such as the BRL, ZAR and TRY are vulnerable to profit taking activity.

Index
Market Tone & Fundamental Focus ......................................................................................... 3 US/Canada.................................................................................................................................. 5 Europe/Japan (Majors) .............................................................................................................. 6 Asia/Oceania/Europe................................................................................................................. 8 Developing Asia....................................................................................................................... 10 Developing Americas .............................................................................................................. 12 Developing Europe/Africa....................................................................................................... 14 Global Currency Forecast....................................................................................................... 16

Foreign Exchange Outlook is available on www.scotiabank.com and Bloomberg at SCOE

Global Economic Research

July 2010

Global Foreign Exchange Outlook
July 7, 2010
Euro Yen Sterling Canadian Dollar Australian Dollar Mexican Peso
EURUSD Consensus* USDJPY Consensus* GBPUSD Consensus* USDCAD Consensus* AUDUSD Consensus* USDMXN Consensus*

Actual
1.27 87.4 1.52 1.05 0.86 12.84

Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11 Q3 11 Q4 11
1.35 1.35 93.5 93.5 1.52 1.52 1.02 1.02 0.92 0.92 12.37 12.37 1.22 1.22 88 88 1.49 1.49 1.06 1.06 0.84 0.84 12.94 12.94 1.17 1.20 93 94 1.48 1.43 1.01 1.03 0.88 0.86 12.65 12.48 1.19 1.20 95 95 1.50 1.44 1.00 1.03 0.90 0.86 12.80 12.44 1.21 1.20 97 97 1.51 1.44 0.99 1.03 0.91 0.86 12.94 12.40 1.22 1.20 98 99 1.52 1.45 0.98 1.03 0.92 0.87 12.96 12.35 1.24 1.20 99 99 1.54 1.46 0.97 1.04 0.93 0.87 13.08 12.57 1.26 1.21 100 99 1.55 1.48 0.97 1.04 0.94 0.87 13.22 12.78

Spot Price vs. 100 Day Moving Average vs. 200 Day Moving Average - (5yr Trend)

EURUSD
1.62
EUR/ USD

USDJPY
121 114 107 100 93 86
Ju n05 D ec -0 5 Ju n06 D ec -0 6 Ju n07 D ec -0 7 Ju n08 D ec -0 8 Ju n09 D ec -0 9 Ju n10
USD/ JPY 1 Day 00 200 Day

1.52 1.42 1.32 1.22 1.12

1 Day 00 200 Day

Ju n0 N 5 ov -0 Ap 5 r06 Se p06 Fe b07 Ju l-0 D 7 ec -0 M 7 ay -0 8 O ct -0 M 8 ar -0 Au 9 g09 Ja n10 Ju n10

GBPUSD
2.11 1.96 1.81 1.66 1.51 1.36
Ju n05 D ec -0 5 Ju n06 D ec -0 6 Ju n07 D ec -0 7 Ju n08 D ec -0 8 Ju n09 D ec -0 9 Ju n10
GBP/ USD 1 Day 00 200 Day

USDCAD
1.30 1.22 1.14 1.06 0.98 0.90
Ju n05 D ec -0 5 Ju n06 D ec -0 6 Ju n07 D ec -0 7 Ju n08 D ec -0 8 Ju n09 D ec -0 9 Ju n10
USD/ CAD 1 Day 00 200 Day

AUDUSD
0.97 0.89 0.82 0.74 0.67 0.59
Ju n05 D ec -0 5 Ju n06 D ec -0 6 Ju n07 D ec -0 7 Ju n08 D ec -0 8 Ju n09 D ec -0 9 Ju n10
AUD/ USD 1 Day 00 200 Day

USDMXN
15.2
USD/ M XN

14.1 13.0 11.9 10.8 9.7

100 Day 200 Day

(*) Source: Consensus Economics Inc. July 2010

Ju n05 D ec -0 5 Ju n06 D ec -0 6 Ju n07 D ec -0 7 Ju n08 D ec -0 8 Ju n09 D ec -0 9 Ju n10

2

Global Economic Research

July 2010

MARKET TONE & FUNDAMENTAL FOCUS
Pablo F.G. Bréard +1 416 862-3876 Camilla Sutton +1 416 866-5470

Intensifying global risk aversion, reversal of US dollar (USD) strength, increasing concerns about global economic deceleration, commodity price shifts, systemic risk management in the European financial sector, adjustments to China’s exchange rate policy, ongoing risk repricing in sovereign credit markets, and emerging monetary policy adjustments in key emerging-market economies will shape capital flows in foreign exchange markets in the near term. The USD has adopted a defensive bias following six months of steady appreciation versus major peer currencies. Persistent weakness in labour and housing markets as well as discouraging manufacturing activity instilled a negative sentiment. In response to the intensifying stress in short-term funding markets as a result of the deteriorating European fiscal situation, the US Federal Reserve (Fed) reinstated a program of reciprocal currency arrangements with major central banks. Within the NAFTA zone, the Canadian dollar (CAD) and the Mexican peso (MXN) were adversely affected by the renewed USD weakness and commodity price shifts. Weak US economic releases, combined with disappointing Canadian April GDP data and soft Chinese PMI have all put downward pressure on the global growth outlook. However, we believe that USDCAD will move towards parity into yearend, based on a relatively strong sovereign position, global appetite for CAD-denominated assets, interest rate differentials and relatively strong fundamentals. However in the near term, the risks have shifted towards continuing CAD softening during the summer. The regional monetary outlook remains stable as the Fed is not hinting at an adjustment in the market-sensitive Fed funds. Banco de Mexico does not seem to be in a hurry to follow Canada in increasing its policy-setting rate. Asian currency market dynamics are dominated by the renewed strength of the Japanese yen (JPY) coupled with potential deceleration in China’s economic activity and recent adjustments to its currency regime. The JPY has been a major beneficiary from the renewed USD weakness despite Japan’s significant fiscal challenges. Japanese policymakers traditionally become more cautious when USD/JPY trades, as is currently the case, below the 90 mark. China introduced changes to its currency policy in mid-June allowing a more flexible trading band which pushed the renminbi (CNY) from 6.82 to 6.76 per USD. We expect USDCNY to close at 6.60 and 6.20 in 2010 and 2011, respectively. The core group of floating Asian currencies may receive a major boost from the appreciating forces in both Japan and China in the weeks ahead; the South Korean won (KRW) and the Malaysian ringgit (MYR) in particular may accelerate their revaluation pace due to alignment to an appreciating CNY. However, a

prolonged correction in Chinese equity securities as investors revisit potential overheating and property sector bubble risks may limit currency gains in Asia. The euro (EUR) is in recovery mode following six months of steady weakening versus major currencies; indeed, the EURUSD rate traded as low as 1.1877 in early June, down from 1.5144 on November 25, 2009. At the heart of the sudden move is the market realization that decisive and collaborative European/IMF/US action would prevent the emergence of a regional banking crisis as a result of intensifying stress in European sovereign debt markets. The process of regional financial stabilization is gathering speed. Global investors are eagerly awaiting the results of the stress tests being conducted on 25 major European financial institutions. However, too many significant risks weigh on the EUR outlook. Ongoing fears over the potential for a Greek debt restructuring, the European Central Bank bond buying program, the upcoming bank stress tests, European Union (EU) liquidity and general EUR overhang should allow for at least another round of EUR weakness in the third quarter. It seems that technical undervaluation may have emerged in the EUR and other impaired currencies in Europe; in fact, the British pound (GBP) also entered a recovering phase against both the USD and the EUR, with further relief in store for the GBP. The budget released on June 22nd was as expected removing market uncertainty. Inflation pressures in the United Kingdom (UK) have eased, but remain elevated. The Bank of England’s latest minutes proved more hawkish than expected. Fiscally, the UK debt position is weak, but because the maturity profile is long and most of the debt is held domestically, market participants are less concerned with the UK's profile than the rest of Europe. We currently expect GBP/USD to close the year at 1.50. Emerging-market currencies are vulnerable to asset reallocation shifts in commodity and equity securities markets. The Chinese currency shift is occurring in the midst of a steady correction in Chinese share prices; indeed, the benchmark CSI300 equity market index lost 30% since the beginning of the year, injecting a cautious attitude amongst emerging-market (equity) investors. Within the universe of capital flows-sensitive emerging-market currencies, the Brazilian real, the South African rand and the Turkish lira are the most vulnerable to weakness should China trigger a synchronized correction in the emerging-market asset class. Energy-sensitive currencies such as the MXN or the Russian ruble may be more affected by shifts in crude oil prices. A major speculative boost in favour of gold will continue to support the outlook for the Chilean peso and the Peruvian sol.

3

Global Economic Research

July 2010

CANADA

Camilla Sutton +1 416 866-5470 Sacha Tihanyi +1 416 862-3154

The risks of a weakening Canadian dollar (CAD) have increased materially since our June FX Monthly report; however the majority of the factors that underpin our bullish CAD outlook remain in place. Accordingly, we have made no change to our CAD forecast and expect it to close this year at parity with the USD. Over the last month, there has been increasing evidence that the outlook for both US and global growth has deteriorated. We would characterize this as a downshifting in the expectations as opposed to a radical change in the outlook for growth. Scotia Economics is forecasting 2010 US growth of 3.2% and Chinese growth of 10%. Though the outlook has weakened, the recovery is still progressing, just at a more moderate pace. Changing growth expectations and ongoing risk aversion will continue to be a key risk for CAD over the summer months. On the more positive side, there are several themes that continue to support our outlook for a strengthening CAD. These include: 1) the outlook for interest rates. The Bank of Canada (BoC) has entered its interest rate hiking cycle and the spread between the Canadian overnight rate and the US is expected to widen to 75bpts by year-end. 2) The economic backdrop has deteriorated over the last month, but Canada is still firmly in recovery mode. On a relative basis, the fundamental backdrop remains solid. 3) The commodity outlook has weakened along with global growth expectations; however Scotia Economics continues to look for crude oil prices to average US$79 per barrel in 2010, a level which is supportive of CAD. 4) Canada’s sovereign debt position is strong compared to its G7 colleagues, which has already driven CAD positive flows this year. We expect this trend to continue, which will keep buyers of CAD active in the market. 5) If the US fails to provide a credible fiscal plan by the late Fall we would expect sentiment to turn against the USD, pressuring it materially lower. 6) The desire to diversify away from USD-based reserves combined with uncertainty over Europe has increased speculation that the CAD might become an attractive home for a small percentage of reserves. 7) Finally, speculative long CAD positions have decreased, but investors remain net long the currency, highlighting that CAD is still a currency of choice for investors. Accordingly, as we look out to year-end, we acknowledge that the risks have increased, but believe that a move to parity is fundamentally justified.
Currency Trends
FX Rate AUDCAD CADJPY EURCAD USDCAD 12 m 0.937 82.9 1.631 1.162 Going Back 6m 0.945 88.3 1.508 1.053 3m 0.931 92.1 1.372 1.015 Spot 7-Jul 0.907 83.4 1.327 1.049 3m 0.889 92.1 1.182 1.010 Outlook 6m 0.900 95.0 1.190 1.000 12 m 0.902 100.0 1.196 0.980 FX Rate AUDCAD CADJPY EURCAD USDCAD

AUDCAD
0.98 0.97 0.95 0.94 0.92 0.90 0.89 0.87 Jul-09 94 92 90 88 85 83 81 79 Jul-09

CADJPY

Se p-09 Nov-09

Jan-10 M ar-10 May-10

Jul-10

Se p-09

Nov-09

Jan-10

M ar-10 May-10

Jul-10

EURCAD
1.60 1.56 1.51 1.47 1.43 1.38 1.34 1.29 1.25 Jul-09 Sep-09 Nov-09 Jan-10 M ar-10 May-10 Jul-10 1.16 1.13 1.11 1.09 1.06 1.04 1.01 0.99 Jul-09

USDCAD

Se p-09

Nov-09

Jan-10

M ar-10 May-10

Jul-10

4

Global Economic Research

July 2010

CANADA AND UNITED STATES
Fundamental Commentary

Adrienne Warren +1 416 866-4315 Gorica Djeric +1 416 862-3080

UNITED STATES - There has been much debate regarding the efficacy of leading economic indicators over time, but that debate is intensifying once again as the economy has approached a turning point away from a temporary ‘V’ shape toward less robust growth prints. At issue is whether the US economy faces a renewed downturn within a twelve-month horizon, based on readings from some leading market and composite indicators of economic growth. Recall that leading indicators are guides that may be used and interpreted with caution, as none is infallible. That caveat is particularly true at this juncture of the recovery phase. Upon surveying four leading economic indicators – one market determined and three constructed – it appears that the likelihood of a US downturn in the next six to twelve months is remote, at least for now. To clarify, a downturn in this case is not defined on the basis of shortlived data blips that are likely to occur. It would be a material sustained slowdown characterized by back-to-back quarterly contractions in GDP or satisfying an NBER-style definition of a renewed dip. In the near term, GDP growth will likely be supported by capital investment, inventory contributions and a mild pace of consumer expansion. Abruptly softer two-handled growth later this year and into next could well, however, further disappoint the risk trades even if a decline in GDP is temporarily avoided. Ongoing investors’ concerns about the US economy are on a different time frame. A renewed decline over the next two to three years is still likely. Witdrawal of fiscal stimulus in 2012-13 could shave about 3 percentage points off GDP growth in each of those years. Private demand would need to grow by 5-6% to offset this effect and net out twohandled GDP growth. Such a rate of growth in private demand would be highly unusual that far into the recovery, especially given that fiscal drag will weigh against private demand.

CANADA - After posting a strong cyclical recovery over the final quarter of 2009 and the first quarter of 2010, Canada’s economic expansion appears to be losing some momentum, with many recent indicators coming in below expectations. Labour market conditions remain strong, with the economy having fully recouped 75% of its recession job losses as of May, and hiring surveys pointing to further gains in the months ahead. Nonetheless, consumer sentiment and big-ticket spending cooled somewhat through the spring, suggesting some trepidation among households over the sustainability of the global economic recovery. Housing activity too has come off the boil as high home prices and tighter lending criteria temper home sales, prices and residential construction intentions. On balance, however, we expect continued, even if more moderate, output growth through the latter half of the year and into 2011. Resource-related exports, production and investment are ramping up again amid the continuing strength of emerging market demand and profitable pricing, helping to offset a winding down in public infrastructure spending. Similarly, business investment in machinery & equipment as well as industrial and commercial leasing activity are on the rise, supported by increased capacity utilization and healthy corporate balance sheets. Inventory restocking will continue to add to production this year, given lean stockpiles at the manufacturing, wholesale and retail levels. Leading composite indictors are still showing a broadly based expansion, as is our diffusion index of GDP, which continues to trend around its highest level in over two years. While slowing global growth is expected to moderate the increase in domestic export volumes in the latter half of the year and into 2011, Canada’s relatively healthy fiscal and banking sector fundamentals should keep the nation at the top end of the G7 performance ladder.
Gorica Djeric +1 416 862-3080

MONETARY POLICY COMMENTARY

Derek Holt +1 416 863-7707

UNITED STATES - The FOMC kept rates unchanged in June and maintained its key buzzwords, supporting the view that the Fed will remain on hold until at least early next year. Kansas City Fed President Hoenig was still the sole dissenter. The statement was modestly more dovish, on developments abroad and the pace of economic recovery at home. More insight will be available when the meeting minutes get released on July 14. Should the Fed wait longer to start a hiking campaign, it is unlikely that it would do so in late 2011-12, since 2012 is the year of maximum fiscal retrenchment, Basel III and a Presidential election. Tightening monetary, fiscal and regulatory policy would imply a simultaneous adjustment – that is a dicey game following political debate over Fed independence. The next most likely scenario would be to leave rates on hold until well into 2013-14, and thus skip the headwinds of 2012-13. The Fed has enormous other powers to withdraw liquidity (reverse repos, term deposit sales) and is likely to exercise them first.

CANADA - The Bank of Canada (BoC) hiked the overnight rate on June 1 by 25 bps to 0.50%, and re-established the normal operating band of 50 bps. The BoC is holding a neutral bias, conveyed through repeated use of language such as “nothing is pre-ordained”. There are two possible explanations for such a stance. One, the BoC is leaving options open, while trading off domestic strengths versus global fragilities. Under the second interpretation, the BoC is likely controlling the curve and the loonie, as not to prematurely tighten. Keeping the markets convinced of this neutral bias will likely become a challenge later in the year. The BoC is expected to tighten further in July and September – taking the overnight rate to 1.0% – before it takes a holiday in Q4. The risk that the Bank pause in July is modest. Lower bond yields and a weaker loonie are more stimulative to Main Street than modest tightening in the near term. While economic growth may shift into slightly lower gear through the second half of the year, Canada is not returning to emergency-style conditions.

5

Global Economic Research

July 2010

MAJOR CURRENCIES
Currency Outlook

Camilla Sutton +1 416 866-5470 Sacha Tihanyi +1 416 862-3154

EURO ZONE - EUR/USD stabilized in June after reaching its lowest level since February 2006. A great deal of EUR’s stabilization has been driven by the rapid reduction in the market’s historically extended short position. However, the market remains heavily short euros as the threat of sovereign debt stress and concerns over weakness in Euro zone’s bank balance sheets keeps sentiment heavily skewed against EUR. Until both issues are settled with finality, speculative sentiment should remain negative for the currency. JAPAN - The late June global equity sell-off, combined with the sharp deterioration in the yield advantage that US bonds have enjoyed over their Japanese counterparts, helped push JPY to its strongest level since late 2009. Our fundamental outlook suggests that this trend will be temporary. JPY is expected to weaken as risk aversion eases and speculators move back to net short against the yen as Japanese monetary dynamics leave it vulnerable to being used as a funding currency. UNITED KINGDOM - GBP’s late May stabilization was followed in June by GBP/USD’s best monthly performance since October 2009. This is consistent with a sharp improvement in GBP positioning as shorts have been pared back. A well received fiscal budget and a single dissent in favour of raising rates at the June Bank of England policy meeting have made the market less willing to bet against the GBP on the threat of a sovereign credit downgrade or persistently loose monetary policy. SWITZERLAND - The burst of risk aversion in mid June combined with the reluctance of the Swiss National Bank to resist CHF appreciation helped to drive CHF to historical highs against EUR, and a one-month 9% gain against the USD. The speculative community has failed to get fully behind this move however as the net CHF position remains in short territory. We expect a much more gradual appreciation in CHF through to the end of the year, with a six month target of 1.27 in EURCHF.
Currency Trends
FX Rate EURUSD USDJPY GBPUSD EURCHF 12 m 1.40 96 1.65 1.52 Going Back 6m 1.43 93 1.62 1.48 3m 1.35 93 1.52 1.42 Spot 7-Jul 1.27 87 1.52 1.33 3m 1.17 93 1.48 1.29 Outlook 6m 1.19 95 1.50 1.27 12 m 1.22 98 1.52 1.24 FX Rate EURUSD USDJPY GBPUSD EURCHF

EURUSD
1.49 1.45 1.41 1.37 1.33 1.29 1.25 1.21 Jul-09 98 97 95 93 91 90 88 86 Jul-09

USDJPY

Se p-09 Nov-09

Jan-10 M ar-10 M ay-10

Jul-10

Se p-09

Nov-09

Jan-10

M ar-10

M ay-10

Jul-10

GBPUSD
1.68 1.65 1.61 1.57 1.53 1.50 1.46 1.42 Jul-09 Se p-09 Nov-09 Jan-10 M ar-10 M ay-10 Jul-10 1.51 1.49 1.46 1.43 1.40 1.38 1.35 1.32 Jul-09

EURCHF

Se p-09 Nov-09

Jan-10 M ar-10 M ay-10

Jul-10

6

Global Economic Research

July 2010

MAJOR CURRENCIES
Fundamental Commentary

Tuuli McCully +1 416 863-2859 Oscar Sánchez +1 416 862-3174

EURO ZONE - Global investors await the release of the stress tests performed on 25 European financial institutions scheduled for the second half of this month. In addition to short-term volatility in investor sentiment, the ongoing debt sustainability crisis in Europe will also cause longer-term growth implications; tough austerity measures implemented in some European countries to restore fiscal credibility will dampen domestic demand prospects. Meanwhile, the significantly cheaper euro is providing a boost to exports, with better trade performance helping offset some of the economic effect from fiscal consolidation measures. Supported by robust exports, industrial activity across the euro zone is on the mend. For the region as a whole, production rose 0.8% m/m in April and 9.5% y/y though at the national level there were significant differences in performance between the core countries and the euro zone periphery. The regionwide purchasing managers’ indices for the manufacturing and services sectors showed mildly weaker readings in June, indicating a growing, yet decelerating, business context. The headline consumer price inflation figure of 1.6% y/ y for May remains comfortably within the European Central Bank’s (ECB) target of “below, but close to, 2%”. We expect the ECB to maintain the current monetary policy stance until the final quarter of 2011 due to the ongoing turmoil in the region and uncertain growth prospects.

JAPAN - The change at the helm of the Democratic Party of Japan (DPJ) has boosted its chances ahead of the July upper-house election. Japan’s incoming Prime Minister Mr. Naoto Kan (a former finance minister) has raised the possibility of increasing the controversial sales tax –although the hike would be at least two years away– with an aim of halving the public deficit by mid-decade. According to the most recent International Monetary Fund projections Japan’s budget deficit is estimated to approach 10% of GDP in 2010, taking gross public sector debt above 225% of GDP. Latest external trade figures continue to support the country’s economic recovery. Export volumes increased at a 1% m/m rate in May following April’s brisk 6.5% gain, taking the average for the two months 9% over the corresponding figure for the first-quarter. Foreign shipments have picked up consistently since last October as growing demand from China and developing Asia have bolstered the outlook of Japanese conglomerates. Foreign sales drove most of the first-quarter GDP gains when the economy grew at a 1.2% q/q rate, the highest expansion in a decade. An improvement in labour market indicators has been a by-product, as the unemployment rate has fallen to 5.2%. Consumer spending has yet to be re-ignited as evidenced by the 2% monthly fall in retail sales revenue during May. Euro weakness is bound to have an adverse effect in coming months as competitiveness losses vis-à-vis Germany’s manufacturing products are likely to dent some momentum. SWITZERLAND - Deflationary risks are easing in Switzerland, according to the Swiss National Bank (SNB), implying that monetary authorities will be less likely to intervene in order to stem an appreciation of the Swiss franc (CHF) against the euro (EUR). Nevertheless, the SNB’s policy committee opted to maintain an expansionary monetary policy and leave the benchmark interest rate target at 0.25% following its quarterly meeting on June 17th. The policymakers also noted the increased uncertainty in the financial markets related to the ongoing debt sustainability issues in some euro zone countries; should these tensions lead to an appreciating bias of the CHF against the EUR and a renewed threat of deflation, the authorities would be ready to intervene in the currency markets again. Consumer price inflation was 1.1% y/y in May compared with the 1.4% rate the month before; on a monthly basis, prices declined by 0.1%. The next monetary policy meeting is scheduled for September 16th. We anticipate an interest rate change in the final quarter of 2010 in the midst of the steady stream of positive news that is setting the stage for economic growth of 2.0% in 2010, according to SNB projections. With government finances in a considerably better shape than the European norm (the Swiss 2009 budget was virtually balanced), Switzerland has no immediate need for joining its regional peers in their fiscal consolidation efforts.

UNITED KINGDOM - The June 2010 Budget – delivered by the UK’s new coalition government of the Conservatives and the Liberal Democrats – contains austerity measures that will likely convince international credit rating agencies of the determination of the UK administration to repair its finances, preventing a sovereign credit rating downgrade in the foreseeable future. 77% of the announced fiscal consolidation will take the form of spending cuts while the remaining 23% will consist of tax increases. The fiscal shortfall will be reduced from £149 billion (10.1% of GDP) in FY-2010-11 to 1.1% of GDP in FY2015-16. Public sector net debt is projected to peak at 70.3% of GDP in FY2014-15. The major tax change in the budget is the increase in the VAT to 20% from 17.5% (effective January 2011). Also, the government will introduce a banking levy based on banks’ total liabilities structured to encourage less risky funding profiles. To secure ongoing economic recovery, a majority of the austerity measures will take place in the latter half of the forecast period. The budget’s underlying assumptions for economic growth are 1.2% this year, 2.3% in 2011 and 2.7-2.9% in 2012-2015. Despite persistent inflationary pressures in the UK (CPI increased by 3.4% y/y in May), the budget increases the likelihood of an accommodative monetary policy remaining in place for an extended period of time; we expect the Bank of England’s benchmark short-term interest rate to remain unchanged at 0.5% until the second quarter of 2011.

7

Global Economic Research

July 2010

ASIA/OCEANIA/EUROPE
Currency Outlook Camilla Sutton +1 416 866-5470

Oscar Sánchez +1 416 862-3174 Sacha Tihanyi +1 416 862-3154

AUSTRALIA - AUD has exhibited a high degree of volatility, something that has been reflected in speculative positioning shifts. The net long AUD position plunged to its lowest level in over a year as speculators aggressively cut their long positions, reflecting less conviction regarding the pace of the global growth expansion. Nevertheless, speculators remain net long AUD, reestablishing longs on dips towards 0.8050. We support such positioning as we forecast AUDUSD to appreciate to 0.90 by the end of 2010. NEW ZEALAND - NZD outperformed the other commodity currencies over the month of June thanks to rate support from the Reserve Bank of New Zealand. This helped reinforce a bottom in NZDUSD above 0.6570. Downtrend resistance off of the 2009 high poses a challenge at the 0.72 level, however we foresee a range trade for the pair with an appreciatory bias towards 0.70 by the end of the year. TAIWAN - The Taiwanese dollar has recently been captured by the global risk aversion trend that interrupted its secular appreciation evident through late April 2010. The recent policy shift away from extremely loose monetary conditions, Chinese exchange rate flexibility, and the recently adopted trade agreement with the mainland will provide support for the currency going forward. NORWAY - NOK underperformed almost all majors in June, dragged lower by risk aversion and its proximity to negative euro zone sentiment. We target 6.35 in USDNOK by the end of Q3, though our end of year target of 6.30 will first have to contend with the 2010 uptrend in the pair, formed off of the January and April lows. However, our constructive global growth and commodity outlook suggests that NOK weakness will only be temporary.

Currency Trends
FX Rate AUDUSD NZDUSD USDTWD USDNOK 12 m 0.81 0.65 32.8 6.43 Going Back 6m 0.90 0.72 32.0 5.79 3m 0.92 0.71 31.8 5.94 Spot 7-Jul 0.86 0.70 32.2 6.39 3m 0.88 0.69 31.0 6.35 Outlook 6m 0.90 0.70 30.0 6.30 12 m 0.92 0.72 29.2 6.20 FX Rate AUDUSD NZDUSD USDTWD USDNOK

AUDUSD
0.76 0.93 0.91 0.88 0.86 0.84 0.82 0.79 0.77 Jul-09 0.74 0.72 0.70 0.67 0.65 0.63 0.61 Jul-09

NZDUSD

Se p-09 Nov-09

Jan-10 Mar-10 May-10

Jul-10

Se p-09 Nov-09

Jan-10 Mar-10 May-10

Jul-10

USDTWD
33.00 32.75 32.50 32.25 32.00 31.75 31.50 31.25 Jul-09 6.61 6.47 6.34 6.20 6.06 5.92 5.79 5.65 Se p-09 Nov-09 Jan-10 Mar-10 M ay-10 Jul-10 5.51 Jul-09 Se p-09

USDNOK

Nov-09

Jan-10 Mar-10 May-10

Jul-10

8

Global Economic Research

July 2010

ASIA/OCEANIA/EUROPE
Fundamental Commentary

Tuuli McCully +1 416 863-2859 Oscar Sánchez +1 416 862-3174

AUSTRALIA - A reshuffling within Australia’s Labour party leadership resulted in Ms. Julia Gillard being sworn as prime minister on June 24th. Ms. Gillard takes over as Primer Minister in the midst of an outstanding economic rebound, as most figures continue to point towards expansion. Last week’s publication of leading and coincident indicators displayed a continuation of the favorable outlook that has been the norm since the turn of the year. On a similar note, Australia’s statistics bureau reported 36,400 full-time employment positions were created in May, bringing the total number of full-time jobs added since August 2009 to over 170,000; 2.2% of the labour force. The unemployment rate fell from 5.4% to 5.2%. With skilled job vacancies still on the rise, the robust demand for workers will likely be increasingly reflected in higher wages, with positive ramifications for consumer spending but potentially adverse implications for inflation. After its latest board meeting in early June the Reserve Bank of Australia kept the benchmark cash rate at 4.5% deeming that monetary conditions continue to be “appropriate for the near-term”. The Australian central bank has been a leader in the global monetary policy tightening cycle as it has raised the benchmark interest rate in six of the past nine policy meetings. The cash rate currently stands at 4.5%, after being raised by 150 basis points since October. Monetary policy tightening will likely be resumed later this year to prevent wage pressures from stoking inflation. TAIWAN - Industrial output has expanded for nine consecutive times on a yearly basis and is over 30% above last year’s levels. The value of export shipments is equivalent to 70% of GDP, making it a principal driver of the country’s economic activity. After being among the hardest-hit by the global economic downturn Taiwanese exporters have been leading the economic recovery in Asia with foreign shipments running at an over 30% y/y rate in the past six months. Looking ahead, although export orders during April and May fell on a monthly basis, they remain over 10% above first quarter levels as demand from China continues to propel ahead. Even orders coming out of the European market —about 17% of the total— have increased in the second quarter. The export-led economic rebound has spilled over to domestic demand, where the recovery in investment spending has been noteworthy. Job market conditions have improved as the unemployment rate came down in May to 5.2%, the lowest level in 17 months. The improvement in labour market data has been following the persistent strengthening of industrial activity a key cyclical determinant of employment and income growth. Inflationary concerns are yet to emerge with headline consumer price inflation at 1% y/y. This, however, did not stop the central bank from raising the rediscount rate by 12.5 basis points after its monetary policy meeting in May, with the interest rate increase representing a normalization of sorts as the benchmark rate was left still below 2%.

NEW ZEALAND - The policy committee of the Reserve bank of New Zealand decided to increase the official cash rate by a quarter point to 2.75% on June 10th. Central bank governor Allan Bollard stressed in a post-meeting statement that he expected to continue to gradually remove monetary stimulus. Inflationary pressures remain muted, as the headline consumer price index rose just 0.4% q/q in the first quarter of 2010 and is up 2% y/y (in the middle of the official medium-term target range of 1-3%), matching the advance in Q4 2009. However, the economy continues to propel forward at a reasonable pace after expanding during the first quarter at a 0.6% quarterly rate on the back of exports and government infrastructure spending. Improving terms of trade in Australia and persistent demand from China continue to support New Zealand’s agricultural exports. Latest indicators point towards growth becoming more broadbased as improving retail sales performance has been backed by consumer confidence gains and stronger labour market data. Although latest retail sales figures displayed a fall during April, they remain on an upward trajectory for the year with leading indicators for consumer spending pointing towards a solid pickup in May. This is consistent with an enhanced labour market picture that shows the unemployment rate coming down to 6% so far in 2010 from 7.1% in the last three months of 2009. We expect central bank to continue to move towards a less accommodative monetary policy stance during the second-half of 2010. NORWAY - Norway is shifting to a less aggressive monetary tightening path. Following Norges Bank’s Executive Board meeting on June 23rd, the key policy rate was kept unchanged at 2.0%. The rate has been raised by 75 bps since October 2009, with the most recent rate increase taking place in early May. In the official policy statement, monetary policymakers noted that the turmoil in global financial markets stemming from European debt sustainability issues is causing uncertainties for the country’s economic outlook. Substantial fiscal tightening in western European economies will dampen economic activity; the UK purchases almost a third of Norwegian exports. Therefore, the monetary authorities aim to keep the benchmark interest rate unchanged for a while with further tightening occurring later than previously envisaged. The policymakers’ strategy is to keep the key rate within the 1½-2½% range until the October 27th Board meeting when the new policy outlines will be published. The next policy meeting is scheduled for August 11th. The headline inflation rate − 2.5% y/y in May, down from 3.3% the month before − is in line with the central bank’s 2.5% target. On a monthly basis, prices decreased by 0.5%. The Norwegian economy is on solid footing; the general government budget as well as the current account will remain comfortably in surplus in 2010-11, averaging around 10% of GDP and 16% of GDP, respectively.

9

Global Economic Research

July 2010

DEVELOPING ASIA
Currency Outlook Oscar Sánchez +1 416 862-3174

CHINA - The lifting of the renminbi (CNY) peg against the US dollar announced by the People’s Republic of China in June will lead to a gradual appreciation in 2010-11. However, the prospect of a continuation of the downward trend in the trade surplus, as growth in imports continues to outpace exports, leads us to not foresee a large appreciation of the CNY in the next year and a half. INDIA - We expect the Reserve Bank of India to continue tightening monetary conditions in the months ahead, a policy that will provide some near-term support to the Indian rupee. The exchange rate - currently 47 per US dollar - has barely weakened by 1% this year; while moderate gains may be evident in the near-term, a reversal will eventually be required to compensate for India’s adverse inflation differential. KOREA - The South Korean won (KRW) has failed to regain the levels prior to the tensions that arose as a result of the breaking of relations with the North. We anticipate the currency to remain supported by strong economic fundamentals and a central bank switch towards monetary policy tightening in the coming months. The resumption of gradual appreciation of the RMB will also provide a strengthening tone to the KRW. THAILAND - The Thai baht (THB) lost barely 1% reaching 32.67 in early June as a result of the country’s political turmoil. It currently trades at 32.49 remaining well supported as the country’s fundamentals are expected to revert to normality in coming months. A recent downturn in inflationary pressures will prevent the central bank from joining the bandwagon of monetary tightening in the region.

Currency Trends
FX Rate USDCNY USDINR USDKRW USDTHB 12 m 6.83 47.9 1274 34.1 Going Back 6m 6.83 46.5 1164 33.4 3m 6.83 44.9 1131 32.3 Spot 7-Jul 6.78 47.0 1223 32.5 3m 6.75 45.7 1170 32.5 Outlook 6m 6.60 45.0 1120 32.5 12 m 6.40 46.0 1084 32.7 FX Rate USDCNY USDINR USDKRW USDTHB

USDCNY
6.836 6.834 6.832 6.831 6.829 6.827 6.825 6.823 Jul-09 48.6 48.0 47.3 46.7 46.1 45.5 44.8 44.2 Jul-09

USDINR

Sep-09 Nov-09

Jan-10 Mar-10 May-10

Jul-10

Sep-09 Nov-09

Jan-10 Mar-10 May-10

Jul-10

USDKRW
1319 1288 1256 1225 1194 1163 1131 1100 Jul-09 34.2 33.9 33.6 33.3 32.9 32.6 32.3 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 32.0 Jul-09

USDTHB

Sep-09 Nov-09

Jan-10 Mar-10 May-10

Jul-10

10

Global Economic Research

July 2010

DEVELOPING ASIA
Fundamental Commentary Oscar Sánchez +1 416 862-3174

CHINA - Tighter credit conditions so far in 2010 —as bank reserve requirements increases were complemented by official rhetoric discouraging excessive lending— to rein in goods and asset price pressures have resulted in a coolingoff in real estate activity. Moreover, no evident food cost acceleration and the dissipation of base effects due in coming months could well support an ebbing of price pressures notwithstanding the recent uptick in the annual inflation rate to 3.2% in May. It was within this context that the People’s Bank of China decided in June to allow the renminbi (RMB) to resume gradual appreciation. The announcement is therefore interpreted not as a strict monetary policy tightening move, but more as a formal recognition by Chinese authorities of the end of the policy stimulus put in place to counteract the global slump. Chinese policymakers have become more confident about the effects of moderate RMB appreciation, in particular given the fact that export values increased by over 30% y/y on average during the first five months of the year. This has not prevented a fall in the Chinese trade surplus, which declined by almost 80% in the first four months of 2010, a trend that will likely be supported by the exchange rate move as galloping imports continue to surpass the rise in exports during 2010-11. The expansion in industrial output as measured by its year-overyear growth rate has moderated from the peak at the end of 2009, and will likely become consistent with pre-crisis growth rates in coming months. KOREA - Industrial output increased for the eight consecutive month in May surpassing the level reached at the peak of the previous business cycle. Merchandise exports have played a prominent role in the recovery with overseas shipments increasing at an over 30% yearly rate. The pickup in economic activity has spilled to the job market as the unemployment rate has come down to 3.2% in May, from a 10year high of 4.8% in January. The improvement in labour market data follow a strengthening of Korean real GDP growth to 2.1% q/q in the first quarter of 2010, up from an average of 1.5% q/q in the previous four quarters. Although domestic demand has remained moderate, with private consumption edging up a sub-par 0.7% q/q in the first quarter, latest sales reports show persistent gains through May, signaling already improved prospects for consumer spending for the second quarter. Although investment expanded for the fifth consecutive term at the outset of 2010, it did so at a diminishing rate as investment in construction has lagged machinery and equipment outlays. The outlook for inflation has recently taken a turn for the worse as consumer prices rose 2.7% y/y in May breaking the downward trend prevalent since the start of 2010. Rising food and fuel costs were mainly to blame for accelerating price pressures. The Bank of Korea kept the overnight call rate unchanged for the 16th month in a row at a 2% record low in early June. We expect a switch to a monetary tightening stance after the central bank’s forthcoming July 8th meeting.

INDIA - Inflation in India is the highest among the major global economies, as the wholesale price index rose 10.2% y/y in May. While food prices have begun to moderate from elevated levels, nonfood inflation has picked up on the back of stronger manufacturing demand and higher fuel costs. The latter have come as a result of the government’s reform of the administered domestic pricing mechanism for petroleum products which linked petrol prices to global oil costs. Domestic spending gains and a recovery in foreign sales have been providing the foundation for output growth, with up trending price pressures in nonfood manufacturing a testament of the healthy economic pulse. Food price pressures are expected to ease in coming months as a result of an improved weather forecast for this year’s monsoon season, and due to the coming into play of high base effects. Notwithstanding the not too threatening inflationary prospects, the Reserve Bank of India has been in monetary tightening mode for some time. The repo interest rate was increased for the third time this year to 5.5% after an unscheduled announcement in early July. With Europe being India’s main trade destination, monetary authorities have underlined the possible effects that public budget restraining measures in Europe could have on Indian exports. So far, however, no effect has been detected as the Indian economy is enjoying a combination of improved foreign shipments amid robust domestic growth. We expect Indian GDP to expand by 8% in 2010 and 7% in 2011. THAILAND - Partly as a result of the stressful political environment Thailand’s industrial output eased in April and May. The imposition of curfews up until mid-May disrupted night shifts and product shipments with some factories suspending work amid the country’s worst political violence in two decades. Manufacturing output contracted by 1% in AprilMay vis-à-vis the first quarter, with the slowdown likely to prove temporary as export orders have recovered through May. Consumption and tourism were also affected by the turmoil, as tourist arrivals fell by 18% month-over-month in April with figures for May likely to prove worse. Although a pickup in consumer spending failed to persist through April, a comeback is anticipated as labour market conditions remain supportive of income gains. Business sentiment has yet to come back to pre-turmoil levels as it dipped in the midst of the April uncertainty but recovered significant ground in May. Policy efforts by the Thai government has supported the comeback offering incentives to local businesses and foreign investors. Contrary to global trends, the fiscal policy agenda has also been tilted towards expansion as government spending will take the 2010-11 public deficit all the way to the maximum allowed under the constitution. Yearly inflation of 3.3% in June displayed a favourable slowdown, leading us to expect the central bank to keep its benchmark interest rate unchanged at 1.25% during its July 14th policy meeting. We anticipate the economy to grow by 4.5% in 2010 followed by 4% in 2011. 11

Global Economic Research

July 2010

DEVELOPING AMERICAS
Currency Outlook Pablo Bréard +1 416 862-3876

BRAZIL - The Brazilian real (BRL) will remain in volatile trading in the months to come. Robust economic growth, aggressive interest rate hikes, steady accumulation of foreign exchange reserves, risk re-pricing in European sovereign credit markets, widening twin (current account and fiscal) deficits and commodity price shifts are the key factors shaping the outlook for the Brazilian real. . We expect USD/BRL to close the year at 1.80. MEXICO - The Mexican peso (MXN) has adopted a defensive tone. Expectations of decelerating global growth, delayed monetary tightening at home, persistently weak employment conditions in the US, increasing global risk aversion triggered by debt sustainability concerns in Europe and volatile shifts in energy commodity markets have been the key issues shaping the outlook for the Mexican currency. We expect USD/MXN to close the year at 12.8. CHILE - The Chilean peso (CLP) is in consolidation mode, trading in a range between 530 and 550 per USD. Chinese growth prospects, a devaluing USD, stabilizing (metals) commodity prices, domestic monetary policy shifts, accelerating economic growth prospects and inflation, and persistent tensions in European sovereign debt markets are the key drivers affecting the outlook for the Chilean currency. We expect USD/CLP to close the year at 540. PERU - The Peruvian Sol (PEN) remains in strengthening mode vis-à-vis the USD. A strong broad-based growth pattern, intensifying (foreign and local) investment activity, ongoing de-dollarization of the financial sector, increasing access to domestic credit, interest rate normalization, intensifying demand for local-currency debt securities, sporadic official intervention and a stable policy/political environment are key issues supporting the local currency outlook. We expect USD/PEN to close the year at 2.75.
Currency Trends
FX Rate USDBRL USDMXN USDCLP USDPEN 12 m 1.95 13.19 534 3.01 Going Back 6m 1.74 13.09 507 2.89 3m 1.78 12.37 524 2.84 Spot 7-Jul 1.76 12.84 536 2.82 3m 1.80 12.65 543 2.79 Outlook 6m 1.80 12.80 540 2.75 12 m 1.85 12.96 545 2.75 FX Rate USDBRL USDMXN USDCLP USDPEN

USDBRL
13.9 2.01 1.96 1.92 1.87 1.83 1.78 1.74 1.69 Jul-09 13.6 13.4 13.1 12.9 12.6 12.4 12.1 Jul-09

USDMXN

Sep-09 Nov-09

Jan-10 Mar-10 M ay-10

Jul-10

Se p-09 Nov-09

Jan-10 M ar-10 May-10

Jul-10

USDCLP
568 556 545 534 522 511 499 488 Jul-09 Se p-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 3.01 2.99 2.96 2.93 2.90 2.88 2.85 2.82 Jul-09 Se p-09

USDPEN

Nov-09

Jan-10

M ar-10 May-10

Jul-10

12

Global Economic Research

July 2010

DEVELOPING AMERICAS
Fundamental Commentary Pablo Bréard +1 416 862-3876

BRAZIL - The Brazilian economy is immersed in a strong and broad-based growth trajectory; the latest survey conducted by the central bank points to a 7% rate of economic expansion for this year. Strong lending growth, despite increasing interest rates, is also fuelling a high-growth environment which is leading to potential overheating risks. Inflationary pressures are also on the rise, as indicated by recent trends; indeed, the IPCA-based consumer price inflation rate is approaching the 5% mark. The combined fast growth-higher inflation scenario is prompting a reassessment of the interest rate cycle, following a 150 bps rate hike in two consecutive moves by the central bank. The next monetary policy committee decision will take place on July 21st, and a 75 bps rate increase to 11% is amply discounted. Moreover, the government-administered shortterm target SELIC rate may close the year at 12%, reinforcing a strong-currency environment for local-currency denominated assets. Meanwhile, the widening current account and fiscal deficits have placed the Brazilian investor community on alert; the external gap is estimated to close at US$47 billion and US$57 billion in 2010 and 2011, respectively. The 12-month consolidated public sector deficit increased to 3.3% of GDP at the end of May 2010. Despite a solid foreign exchange reserve position (US$250 billion), the intensifying global risk aversion as a result of riskrepricing activity in European sovereign credit markets has adversely affected Latin American bond markets. CHILE - The Chilean economy is strongly influenced by global trade dynamics. Renewed investor focus on the pace of international economic deceleration (with a special focus on the US and China) will affect demand for Chilean export products and currency-sensitive copper prices. Meanwhile, reconstruction efforts following the devastating earthquake/tsunami of the first quarter are paying off; indeed, the monthly indicator of economic activity expanded by 7.1% (year over year) in May and that industrial production also showed a 4.2% gain. The latest consensus indicates that the Chilean economy would expand by 4.5% this year and accelerate above 5.5% in 2011. In response to recovery evidence, the central bank began the process of interest rate normalization to guide inflation towards the officially established 3% +/- 1% range. Following a 50 bps rate hike last June, a move to 1.50% is likely on July 15th. Technical trading dynamics also affect demand for local currency assets; the reversal of USD strength as the EUR recovers injected a positive tone into the CLP over the past few weeks. Moreover, the high dose of speculative trading dynamics shaping demand for gold as a safe-haven asset also helped boost prices in precious and base metals; indeed, the price of gold touched a high mark of 1,264 US cents per pound before correcting below 1,200. Volatility in copper and crude oil prices usually translate into exchange rate swings in Chile.

MEXICO - The weakening trend affecting the USD in the recent past has fuelled increasing volatility in the MXN, which moved from 12.40 to 13 per USD in a short time frame. Intensifying corrective waves in place in equity securities markets in developing countries (primarily in China) have also instilled a bearish tone into the core group of Latin American stock markets since late April. The energysensitive Mexican currency has also been adversely affected by a downward adjustment in crude oil prices. Indeed, the light-crude WTI benchmark price traded as los as US$71 per barrel (down from almost US$80) over the past few weeks. Finally, interest rate differentials remain another factor shaping currency moves in Mexico. At the short end of the yield curve, prolonged status quo by the US Federal Reserve (Fed) is also preventing Mexico from increasing its short-term monetary policy rate (currently set at 4.5%) despite tightening moves already executed by the central banks of Brazil, Peru and Chile. In fact, derivatives markets do not discount a rate hike until the second quarter of 2011. Intensifying global risk aversion has also fuelled a cautious tone amongst global fixed-income portfolio investors, with the 10-year Mexico-US government bond spread widening to a level close to 400 basis points (bps), an attractive investment alternative in the context of abnormally low long-term interest rates in advanced economies.

PERU - Peru enjoys a bright economic outlook ahead of the April 2011 elections. Government policy continuity is amply discounted irrespective of who becomes president. The economy is experiencing a sharp and broad-based expansionary phase. Domestic and foreign investment is on the rise and the systemically strong domestic banking sector is allowing a healthy expansion of local credit. In its latest inflation report, the central bank adjusted its projection for real GDP growth upwards to 6.6% and 6.0% for 2010 and 2011, respectively. The monetary authorities will ensure an orderly normalization of monetary conditions as the strong-growth phase fuels a manageable increase in inflationary expectations. Following an increase of 25 bps to 1.75%, market participants expect further moderate rate adjustments in the months to come. The authorities treated this last policy adjustment as a preventive mechanism in the absence of visible price pressures. A low interest rate environment is deepening the process of de-dollarization within the local banking sector. Although the relatively illiquid Peruvian stock market has not been immune to the profit-taking phase in place in the largest emerging markets, domestic institutional investors (primarily private pension fund management firms) are boosting demand for soldenominated debt securities, thereby accelerating the dedollarization process and contributing to the development of local capital markets. Meanwhile, the central bank will not hesitate to intervene in the currency market to prevent 13

Global Economic Research

July 2010

DEVELOPING EUROPE/AFRICA
Currency Outlook

Pablo Bréard +1 416 862-3876 Tuuli McCully +1 416 863-2859

RUSSIA - The Russian Ruble (RUB) is consolidating a trading range between 30.5 and 32 per USD after the April-May weakness caused by oil price decline and European debt sustainability concerns. Recovery dynamics, ongoing interest rate normalization, shifts in commodity energy prices, steady accumulation of international reserves and potential correction in equity securities markets due to China’s deceleration will shape the view on the RUB. We expect USD/RUB to close the year at 31. TURKEY - Following marked currency volatility in the midst of European debt sustainability concerns, prospects for normalization in the monetary policy stance in Turkey amid robust economic recovery should provide support to the Turkish lira (TRY). We expect the currency to close the year at 1.55 per USD. SOUTH AFRICA - The South African Rand (ZAR) is in stabilization mode following the market stress caused by the European sovereign credit shock and correction in commodity prices. Shifts in metal prices, interest rate differentials, post-world cup recovery dynamics and global risk aversion will be the key factors affecting the outlook for the South African rand in the near term. We do expect USD/ZAR to close the year at 7.80. POLAND - The Polish zloty (PLN) will be supported by expectations for relatively strong economic performance through 2011 and by prospects regarding Poland being the leader in monetary tightening in the region. A new one-year successor arrangement for Poland under the International Monetary Fund’s Flexible Credit Line – approved in early July – provides a useful insurance against external risks and supports the PLN.

Currency Trends
FX Rate USDRUB USDTRY USDZAR EURPLN 12 m 31.2 1.54 7.71 4.45 Going Back 6m 30.0 1.50 7.40 4.10 3m 29.4 1.52 7.29 3.86 Spot 7-Jul 31.1 1.55 7.62 4.09 3m 31.1 1.59 7.74 4.12 Outlook 6m 31.0 1.60 7.80 4.10 12 m 31.5 1.65 8.00 4.14 FX Rate USDRUB USDTRY USDZAR EURPLN

USDRUB
32.5 32.0 31.4 30.8 30.2 29.7 29.1 28.5 Jul-09 1.61 1.59 1.57 1.54 1.52 1.50 1.48 1.45 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 1.43 Jul-09

USDTRY

Sep-09 Nov-09

Jan-10 Mar-10 May-10

Jul-10

USDZAR
8.37 8.18 8.00 7.82 7.63 7.45 7.26 7.08 Jul-09 4.50 4.40 4.30 4.20 4.10 4.00 3.90 3.80 Jul-09

EURPLN

Sep-09 Nov-09

Jan-10 Mar-10 May-10

Jul-10

Sep-09 Nov-09

Jan-10 Mar-10 May-10

Jul-10

14

Global Economic Research

July 2010

DEVELOPING EUROPE/AFRICA
Fundamental Commentary

Pablo Bréard +1 416 862-3876 Tuuli McCully +1 416 863-2859

RUSSIA - The oil-sensitive Russian economy remains strongly influenced by gyrations in energy markets. Crude oil prices, currently trading at US$72 per dollar (WTI based), have somewhat recovered from the early-May high volatility and subsequent price adjustments. As the world’s largest oil producer, Russia is immediately affected by sudden directional shifts in crude oil and natural gas prices. Growing investors’ concerns about decelerating Chinese and US economic activity may have an adverse impact on Russian investor sentiment in the months ahead; however, the Russian central bank has continued to accumulate foreign exchange reserves, which are, once again, approaching the US$500 billion mark. The robust foreign exchange reserves position allows the central bank to intervene in the market to moderate ill-justified speculative exchange rate swings. The Russian economy returned to positive growth, expanding by 2.9% y/y in Q1 2010; additionally, recent data indicated that Russia reversed the loss from the first quarter and received US$4.5 billion in foreign capital inflows during the second quarter. The monetary outlook is improving; indeed, on the grounds of a steady process of disinflation (consumer prices increased by 5.8% y/y in June 2010), the monetary authorities have aggressively pursued a process of interest rate normalization: the policy-setting refinancing rate is currently set at 7.75%. The RUB has not been materially affected by interest rate cuts, but remains vulnerable to profit-taking activity in equity markets. SOUTH AFRICA - The fuzz of the FIFA World Cup is ebbing and the South African economy will be returning to a normal environment. The authorities believe that the economy may receive a boost equivalent to 0.4% of GDP from investment and tourism flows. The economy remains affected by conditions in commodity (primarily metal) markets. The gold price, which traded above the US$1,200 per ounce mark earlier in the month, is strongly influenced by speculative investment flows as investors reassess their views on the global economic recovery and the structural fiscal position of key countries in the euro zone. Monetary status quo will remain in place for the time being; the policy-setting rate has been reduced to 6.5% from 12% since December 2008. In fact, the central bank believes that the inflation rate will remain within the 3-6% target range through 2011, yet inflation dynamics will be influenced by shifts in government-administered prices. Technical data shows a strong correlation between the value of the ZAR and copper (not necessarily gold) prices. Moreover, the linkage between South African equity securities and their counterparts within the BRIC group is also high, increasing the vulnerability of South African investments to portfolio capital in/outflows in China. Non-deliverable forward (NDF) markets point towards a modest depreciation of the ZAR by the end of the year. Technical trends indicate a trading range of USD/ZAR 7.40-7.80 in the near term.

TURKEY - Monetary conditions remain on hold in Turkey for now, while policymakers are implementing first steps of the central bank’s exit strategy. Following the Monetary Policy Committee meeting on June 17th, the Turkish monetary authorities maintained the new policy rate, the oneweek repo rate, at 7.0% due to persistent uncertainties around global economic prospects. We expect that a monetary tightening cycle will be commenced by the end of 2010. As noted by the monetary policymakers, economic activity is recovering. Output expanded by 0.1% q/q in the first quarter of the year; however, in annual terms the economy ballooned by 11.7% due to a low comparison base in 2009. The growth was supported by household spending and investment. Diminishing joblessness − the unemployment rate decreasing to 13.7% in March from 14.4% the month before − is boosting consumer confidence. While industrial output, business confidence indicators and purchasing managers’ indices remain firmly in expansionary territory, slightly weaker perceptions regarding business conditions reflect the persistent uncertainties in the external outlook. Inflationary pressures continued to ease in June; the consumer price index increased by 8.4% y/y compared with 9.1% the month before. On a monthly basis, prices decreased by 0.6%. Next general elections, due in July 2011, will likely contribute to currency volatility in the medium-term. POLAND - Bronislaw Komorowski is Poland’s new president; the second round of the presidential election took place on July 4th with Mr. Komorowski claiming 53% of the vote. The fact that the pro-business Civic Platform party now has control of both the government and the presidency reduces the likelihood of a presidential veto on reforms. Polish central bankers maintain a neutral policy stance, as the fiscal crisis in Greece and euro area fiscal consolidation efforts create uncertainties for the regional economic outlook. Following the Monetary Policy Council meeting on June 29th-30th, the authorities left the reference rate unchanged at 3.50% for a 12th consecutive month. Economic recovery is firmly underway in Poland with industrial and construction output increasing and improving labour market conditions providing support to private spending prospects. The unemployment rate decreased to 11.9% in May from 12.3% the month before while retail sales increased by 3.1% m/m and 4.3% y/y. The inflation outlook is promising, with the consumer price index increasing by 2.2% y/y in May, running below the central bank’s target of 2.5%. The monetary authorities expect that inflation will hover within a 2.3-2.9% range in 2010, while real GDP is projected to increase by 2.5-3.9%. The policymakers reiterated their view that fiscal tightening is important for macroeconomic stability. Nevertheless, with parliamentary elections scheduled to take place next year, aggressive fiscal consolidation is not in sight. 15

Global Economic Research

July 2010

GLOBAL CURRENCY FORECAST (end of period)
2008 2009 2010f 2011f Q1a 2010f Q2a 88 1.22 108 1.49 0.82 1.08 1.32 Q3 93 1.17 109 1.48 0.79 1.10 1.29 Q4 95 1.19 113 1.50 0.79 1.07 1.27 Q1 97 1.21 117 1.51 0.80 1.05 1.27 2011f Q2 98 1.22 120 1.52 0.80 1.02 1.24 Q3 99 1.24 123 1.54 0.81 1.01 1.25 Q4 100 1.26 126 1.55 0.81 1.01 1.27

MAJOR CURRENCIES
Japan Euro zone UK Switzerland
USDJPY EURUSD EURJPY GBPUSD EURGBP USDCHF EURCHF 91 1.40 127 1.46 0.96 1.07 1.49 93 1.43 133 1.62 0.89 1.04 1.48 95 1.19 113 1.50 0.79 1.07 1.27 100 1.26 126 1.55 0.81 1.01 1.27 93 1.35 126 1.52 0.89 1.05 1.42

AMERICAS Canada North L
Mexico Argentina Brazil South Chile Colombia Peru

USDCAD CADUSD USDMXN CADMXN USDARS USDBRL USDCLP USDCOP USDPEN

1.22 0.82 13.7 11.2 3.45 2.31 639 2249 3.13 2.15

1.05 0.95 13.1 12.4 3.80 1.74 507 2044 2.89 2.15

1.00 1.00 12.8 12.8 4.25 1.80 540 1950 2.75 4.30

0.97 1.03 13.2 13.6 4.80 1.90 550 2000 2.75 4.30

1.02 0.98 12.4 12.2 3.88 1.78 524 1920 2.84 4.30

1.06 0.94 12.9 12.2 3.93 1.80 546 1900 2.83 4.30

1.01 0.99 12.7 12.5 4.09 1.80 543 1925 2.79 4.30

1.00 1.00 12.8 12.8 4.25 1.80 540 1950 2.75 4.30

0.99 1.01 12.9 13.1 4.38 1.82 542 1962 2.75 4.30

0.98 1.02 13.0 13.2 4.52 1.85 545 1975 2.75 4.30

0.97 1.03 13.1 13.5 4.66 1.87 547 1987 2.75 4.30

0.97 1.03 13.2 13.6 4.80 1.90 550 2000 2.75 4.30

Venezuela 1/ USDVEB

ASIA / OCEANIA
Australia China Hong Kong India Indonesia 2/ Malaysia Philippines Singapore South Korea Thailand Taiwan
AUDUSD USDCNY USDHKD USDINR USDIDR USDMYR 0.70 6.83 7.75 48.8 11.12 3.47 0.58 47.5 1.43 1260 34.7 32.8 0.90 6.83 7.75 46.5 9.40 3.43 0.72 46.2 1.40 1164 33.4 32.0 0.90 6.60 7.75 45.0 9.25 3.15 0.70 44.0 1.36 1120 32.5 30.0 0.94 6.20 7.70 47.0 9.50 3.20 0.74 46.0 1.30 1050 33.0 28.5 0.92 6.83 7.76 44.9 9.10 3.26 0.71 45.2 1.40 1131 32.3 31.8 0.84 6.83 7.79 46.5 9.07 3.24 0.68 46.4 1.40 1222 32.5 32.1 0.88 6.75 7.77 45.7 9.16 3.19 0.69 45.2 1.38 1170 32.5 31.0 0.90 6.60 7.75 45.0 9.25 3.15 0.70 44.0 1.36 1120 32.5 30.0 0.91 6.50 7.74 45.5 9.31 3.16 0.71 44.5 1.34 1102 32.6 29.6 0.92 6.40 7.72 46.0 9.37 3.17 0.72 45.0 1.33 1084 32.7 29.2 0.93 6.30 7.71 46.5 9.44 3.19 0.73 45.5 1.31 1067 32.9 28.9 0.94 6.20 7.70 47.0 9.50 3.20 0.74 46.0 1.30 1050 33.0 28.5

New Zealand NZDUSD
USDPHP USDSGD USDKRW USDTHB USDTWD

EUROPE / AFRICA
Czech Rep. Iceland Hungary Norway Poland Russia South Africa Sweden Turkey
EURCZK USDISK EURHUF USDNOK EURPLN USDRUB USDZAR EURSEK USDTRY 26.9 121 266 6.95 4.15 29.4 9.53 10.94 1.54 26.4 126 270 5.79 4.10 30.0 7.40 10.25 1.50 25.5 130 285 6.30 4.10 31.0 7.80 9.50 1.60 25.0 125 300 5.80 4.18 32.0 8.20 9.35 1.70 25.4 127 265 5.94 3.86 29.4 7.29 9.75 1.52 25.7 128 285 6.50 4.15 31.2 7.67 9.54 1.58 25.6 129 285 6.35 4.12 31.1 7.74 9.55 1.59 25.5 130 285 6.30 4.10 31.0 7.80 9.50 1.60 25.4 129 289 6.25 4.12 31.2 7.90 9.46 1.62 25.2 127 292 6.20 4.14 31.5 8.00 9.42 1.65 25.1 126 296 6.00 4.16 31.7 8.10 9.39 1.67 25.0 125 300 5.80 4.18 32.0 8.20 9.35 1.70

a: actual; f: forecast; 1/ a new "strong bolivar" w as announced on January 1st, 2008, equivalent to 1000 bolivars; 2/ in thousands

16

Global Economic Research

July 2010

INTERNATIONAL RESEARCH GROUP
Pablo F.G. Bréard, Head pablo_breard@scotiacapital.com Tuuli McCully tuuli_mccully@scotiacapital.com Estela Ramírez estela_ramirez@scotiacapital.com Oscar Sánchez oscar_sanchez@scotiacapital.com

CANADIAN & U.S. ECONOMIC RESEARCH
Gorica Djeric gorica_djeric@scotiacapital.com Derek Holt derek_holt@scotiacapital.com Adrienne Warren adrienne_warren@scotiacapital.com

FOREIGN EXCHANGE RESEARCH
Camilla Sutton
camilla_sutton@scotiacapital.com

Sacha Tihanyi sacha_tihanyi@scotiacapital.com

Scotia Economics
Scotia Plaza 40 King Street West, 63rd Floor Toronto, Ontario Canada M5H 1H1 Tel: (416) 866-6253 Fax: (416) 866-2829 Email: scotia_economics@scotiacapital.com
This Report is prepared by Scotia Economics as a resource for the clients of Scotiabank and Scotia Capital. While the information is from sources believed reliable, neither the information nor the forecast shall be taken as a representation for which The Bank of Nova Scotia or Scotia Capital Inc. or any of their employees incur any responsibility.