Global Economic Research

August 2011

Foreign Exchange Outlook
Heightened volatility in equity securities, European sovereign debt turmoil, ongoing quest for safe-haven assets, deteriorating US fiscal and growth outlook, profit-taking activity in emerging markets, uneven monetary policy normalization and commodity price shifts are the primary drivers of capital flows in currency markets. The USD outlook is negative. Economic softness, aggressive monetary stimulus, international reserve-asset diversification dynamics, eroding creditworthiness and governance challenges weigh on the mid-term outlook for the USD. Despite near-term consolidation, the CAD has become a favourite “shadow currency” in the Americas. The European debt distress remains present. Fragile sovereign debt/fiscal conditions in selected core and periphery economies weigh on the EUR outlook, to be somewhat offset by attractive interest rate differentials. The CHF is well positioned to benefit from diversification-oriented flows eyeing a European option. Asian currencies remain in vogue. Ongoing strength in the JPY and CNY has prompted national governments to intensify intervention to moderate currency gains. The regional shadow-currency, the AUD, will resume an appreciating trend once global financial markets stabilize.
Index
Market Tone & Fundamental Focus ......................................................................................... 3 US/Canada.................................................................................................................................. 5 Europe ........................................................................................................................................ 6 Asia/Oceania .............................................................................................................................. 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

August 2011

Foreign Exchange Outlook

Global Foreign Exchange Outlook
August 4, 2011
Euro Yen Sterling Canadian Dollar Australian Dollar Mexican Peso
EURUSD Consensus* USDJPY Consensus* GBPUSD Consensus* USDCAD Consensus* AUDUSD Consensus* USDMXN Consensus*

Actual Q2a 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Q1 13
1.41 79.0 1.63 0.98 1.05 12.00 1.45 81 1.61 0.96 1.07 11.71 1.45 1.43 79 82 1.61 1.61 0.96 0.97 1.08 1.05 11.95 11.78 1.50 1.42 80 84 1.63 1.62 0.96 0.98 1.09 1.03 12.04 11.85 1.48 1.42 82 85 1.65 1.63 0.95 0.98 1.09 1.02 12.14 11.93 1.46 1.41 83 87 1.67 1.64 0.95 0.99 1.10 1.00 12.09 12.02 1.43 1.40 84 88 1.69 1.64 0.94 0.99 1.10 0.99 12.18 12.09 1.40 1.39 85 89 1.70 1.64 0.94 1.00 1.11 0.98 12.36 12.16 1.38 1.38 87 89 1.70 1.63 0.93 1.00 1.11 0.97 12.40 12.23

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

EURUSD
EUR/ USD

USDJPY
125 118 111 104 97 90
USD/ JPY 1 Day 00 200 Day 100 Day 200 Day

1.62 1.52 1.42 1.32 1.22 1.12

83 76

Au g06 Ja n07 Ju n07 N ov -0 Ap 7 r08 Se p08 Fe b09 Ju l-0 D 9 ec -0 M 9 ay -1 0 O ct -1 M 0 ar -1 Au 1 g11

GBPUSD
2.11 1.96 1.81 1.66 1.51 1.36
GBP/ USD 100 Day 200 Day

Au g06 Fe b07 Au g07 Fe b08 Au g08 Fe b09 Au g09 Fe b10 Au g10 Fe b11 Au g11

AUDUSD
0.97 0.89 0.82 0.74 0.67 0.59
AUD/ USD 1 Day 00 200 Day

(*) Source: Consensus Economics Inc. July 2011

Au g06 Fe b07 Au g07 Fe b08 Au g08 Fe b09 Au g09 Fe b10 Au g10 Fe b11 Au g11

Au g06 Fe b07 Au g07 Fe b08 Au g08 Fe b09 Au g09 Fe b10 Au g10 Fe b11 Au g11

Au g06 Fe b07 Au g07 Fe b08 Au g08 Fe b09 Au g09 Fe b10 Au g10 Fe b11 Au g11

Au g06 Fe b07 Au g07 Fe b08 Au g08 Fe b09 Au g09 Fe b10 Au g10 Fe b11 Au g11

USDCAD
USD/ CAD

1.30 1.22 1.14 1.06 0.98 0.90

100 Day 200 Day

USDMXN
15.2
USD/ M XN

14.1 13.0 11.9 10.8 9.7

100 Day 200 Day

2

Global Economic Research

August 2011

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

Renewed investor focus on the US (and global) economic outlook, the prospect of multiple US credit rating downgrades, fundamentally-driven adjustments in commodity prices, aggressive government intervention in Japan and Switzerland, interest rate differentials and intensifying global risk aversion in the context of excess global liquidity are key factors shaping capital flows in foreign exchange markets. The volatile debt-ceiling debate in the US highlighted a higher degree of policy-related uncertainties with a negative effect on investors’ perceptions of US creditworthiness. The broad-based sentiment against the US dollar (USD) will likely resume in the months ahead. The gradual shift towards global asset diversification (in line with the process of global economic rebalancing) weighs on the USD and favours a group of so-called “shadow currencies” such as the Swiss franc (CHF), the Canadian dollar (CAD) and the Australian dollar (AUD). Currency trends in the Americas portray a period of shortterm US dollar stability following a period of heightened political risk. The trade weighted DXY index, which serves as a proxy measure of the value of the USD, shows a surprising stability phase despite all the fuzz connected with the likelihood of a credit rating downgrade; indeed, over the past three months, the DXY index has appreciated by almost 3% (with the general weakness in the European and commodity currencies being offset by strength in the safe havens of CHF and JPY). The US economic recovery remains weak as stressed by recent Federal Reserve statements and the massive US Treasury quarterly refinancing programme of US$72 billion, which reflects a fragile fiscal situation. The non-USD NAFTA currencies struggled in late July and into August as the US growth outlook deteriorated, increasing the vulnerability of the Canadian and Mexican economies to downside risk. However, the outlook for the CAD is still strong due to the country's relatively strong fundamental position. In addition, CAD is thought of as a play on commodities, the Asian growth story and as a ‘shadow currency’, leaving it well supported relative to the USD and MXN. The adjustment in energy prices, together with persistent fragility in selected sectors of the US economy, has moderately affected the value of the Mexican peso (MXN). Elsewhere in the region, Latin American currencies have been subject to downward pressure on the back of rising global risk aversion and profit-taking activity. In Europe, currency dynamics are influenced by the global shift away from US$-denominated holdings and by divergent monetary and economic developments between core and Southern periphery economies. The heightened situation present in sovereign debt markets, particularly in

Greece, Portugal, Ireland and, to a lesser degree, Spain and Italy continue to be a primary issue in investors’ radar screens. The European Central Bank (ECB) is resuming bond-purchasing activity as a way of supporting the region’s credit markets. Over the past three months, the euro (EUR) has behaved in an erratic way, maintaining a depreciating bias against the USD. EURUSD has been trending downwards since reaching a peak of 1.4940 on May 4th, trading as low as 1.37 in early July. Nevertheless, interest rate differentials and the broad USD outlook remain a relative EUR supportive factor into year-end. Indeed, the ECB remains committed to secure price stability within the euro zone; the process of interest rate normalization remains in place despite latest decision to keep the benchmark interest rate unchanged at 1.5%. Elsewhere in the region, the CHF, broadly considered a safe-haven currency, has been subject to decisive intervention by the Swiss monetary authorities to moderate its strengthening bias, proof of which is the recent decision to lower its target rate. The two largest risks for the monetary union are financial market contagion into the core and a lower growth trajectory than is currently priced in. However, the balancing factor for the currency will be the generally negative USD outlook. We expect USDCHF to have stabilized into year-end at 0.77. The British pound rallied through much of July, but is entering August on a softer note. Near-term strength could materialize on the back of USD weakness, yet it will not be sustainable. The combination of loose monetary policy and a low growth outlook should weigh on the currency. The Asian currency outlook remains positive. Both the Japanese yen (JPY) and the Chinese yuan (CNY), the regional leading currencies, remain subject to strong appreciation headwinds. The Japanese authorities decided to firmly intervene to moderate currency gains (USDJPY traded as low as 76.30 on August 1st) while announcing an increase in the asset-purchase program to 15 trillion yen. Although the Australian dollar has weakened in response to consolidation dynamics from strong levels, our long-term bullish view remains in place. The CNY continues to make gains in line with our view of over 5% per year and Chinese authorities have reiterated that they favour a more flexible yuan. The emerging Asian block of currencies, including the Malaysian ringgit (MYR), the Philippine peso (PHP) and Thai baht (THB) benefit from rising interest rates, diversification flows and strong growth. Meanwhile, others such as the Singapore dollar, the South Korean won and the Indian rupee, have already appreciated to levels that we think should justify some stabilization.

3

Global Economic Research

August 2011

Foreign Exchange Outlook
CANADA
Camilla Sutton +1 416 866-5470 Eric Theoret +1 416 863-7030

The Canadian dollar (CAD) was a mid-performer in July, up 0.9% versus the USD despite a spike in risk aversion that occurred towards the end of the month as markets became concerned over the approaching US debt ceiling deadline. The CAD underperformance relative to the Australian (AUD) and New Zealand (NZD) dollars, its peers in the commodity currency space, was apparent as they rose 2.5% and 6.0%, respectively, versus the USD over the same period. The CAD’s responsiveness to risk aversion has dropped as evidenced by its muted correlation with equity volatility (VIX) which now stands at 0.1 (30-day rolling). However, its correlation with WTI oil remains high at 0.87. Oil prices remain below US$100, though we do not expect much downside movement below current levels. Scotia Economics has a 2011 average price forecast of US$98 and current prices are supportive of a strong CAD. Fundamentally, the Canadian economy remains strong, though the year-over-year pace of expansion has slowed to nearly half of the levels seen at this time last year. We believe the slowdown in GDP to be temporary and highlight the Scotia Economics Q3 2011 forecast of 2.5% y/y. The outlook for growth for both the US and the global economy remains challenged by high levels of debt in the US and EU, and the need for fiscal retrenchment is likely to keep unemployment in those economies at elevated levels over the medium term. The Bank of Canada has cited these exogenous concerns as the key downside risk to its outlook and the main reason for its reluctance to tighten monetary policy. Despite this, the Bank’s most recent statement was slightly less dovish than it had previously been. As such, according to CFTC data, market participants have been increasing their net long CAD position to US$3.8 billion as of July 26. We expect flows to continue to benefit the CAD given its position as a strong sovereign credit, and see evidence of this with the most recent international securities transactions rising to levels not seen in over a year. Overall, investors have been diversifying away from USD and EURbased assets as evidenced by the rallies in gold, CHF, AUD and CAD. Finally, we maintain a base case for broad USD weakness into year-end, which by default is positive CAD. We expect the CAD to be supported by the above, and we hold a year end forecast of 1.04 (USDCAD at 0.96).
Currency Trends
FX Rate AUDCAD CADJPY EURCAD USDCAD 12 m 0.931 83.98 1.344 1.030 Going Back 6m 0.998 81.96 1.371 1.001 3m 1.037 85.91 1.399 0.945 Spot 4-Aug 1.027 80.85 1.381 0.977 3m 1.046 82.64 1.408 0.960 Outlook 6m 1.043 84.32 1.429 0.957 12 m 1.041 88.03 1.373 0.947 FX Rate AUDCAD CADJPY EURCAD USDCAD

AUDCAD
1.05 88.0 1.02 85.5 0.98 83.0 0.95

CADJPY

80.5

0.91 Aug-10

Oct-10

Dec-10

Fe b-11 Apr-11

Jun-11 Aug-11

78.0 Aug-10

Oct-10

De c-10

Fe b-11 Apr-11

Jun-11 Aug-11

EURCAD
1.45 1.06 1.41 1.38 1.34 1.31 1.27 Aug-10 1.04 1.02 1.00 0.98 0.96 0.94 Aug-10

USDCAD

Oct-10

De c-10

Fe b-11 Apr-11

Jun-11 Aug-11

Oct-10

Dec-10

Fe b-11

Apr-11

Jun-11

Aug-11

4

Global Economic Research

August 2011

Foreign Exchange Outlook
CANADA AND UNITED STATES
Fundamental Commentary Adrienne Warren +1 416 866-4315 Gorica Djeric +1 416 866-4214

UNITED STATES - A disappointing second-quarter GDP report reiterated weakness seen in monthly indicators. The US economy advanced at a tepid 1.3% q/q annualized, roughly half the consensus expectation as recently as June. Business investment in machinery & equipment and exports took over from consumer spending as the main drivers of growth. In contrast, household spending – which accounts for two-thirds of the US economy – came in flat, its weakest performance in two years. Aside from the weaker-than-expected second-quarter figures, historical revisions showed that the economic rebound was frontloaded to the first half of 2010, with steepening downward adjustments extending into 2011, averaging quarterly growth of only 1.6% over the past year. The revised numbers also show that the downturn witnessed a peak-totrough GDP decline of 5.1%, a percentage point greater than previously estimated. While soft, second-quarter results can be partly attributed to temporary factors – the Japanese earthquake, high gasoline prices and unseasonable weather conditions – a number of cyclical and structural headwinds remain at play. US consumers are wary of spending, faced with high gasoline prices and soft hiring activity. Ongoing household, financial and public deleveraging is further constraining domestic demand. The housing market is also expected to show little improvement – the home ownership rate is at a thirteen-year low – frustrated by the oversupply, foreclosures and a stubbornly high unemployment rate. That said, exports and business investment should lead growth in the months ahead, as solid demand in the emerging markets boosts sales, and a weaker dollar and increased labour productivity improve competitiveness. Despite elevated commodity prices, measures of underlying inflation remain subdued and longer-run inflation expectations well-anchored.

CANADA - The Canadian economy is expected to experience moderate economic growth, averaging 2½% annually over the 2011-12 period. High household debt levels relative to disposable income and high food and gas prices have begun to moderate consumer spending on big-ticket discretionary items, though continuing job and income gains should support modest household spending growth. Residential construction and sales are being supported by a healthy job market and low interest rates, but are likely to soften with home ownership at record levels and high home prices straining affordability. Canada’s fiscal position compares favourably to most of its advanced nation counterparts. Nonetheless, government stimulus spending is winding down, and will act as a drag on growth and employment creation in 2012 as fiscal shortfalls are addressed. In this environment, business investment and exports will need to drive growth. Firms have been steadily ramping up outlays on machinery & equipment and resource-related exploration, supported by a strong currency, firm commodity prices, healthy corporate profitability and balance sheets, as well as favourable credit conditions. Business investment is expected to add over a percentage point to growth this year and next. The recent performance and outlook for exports is mixed. While benefitting from high commodity prices and strong emerging market demand for Canadian resources, producers are being challenged by CAD strength and weaker US consumer demand. Despite having a surplus in commodity goods trade of around $100 billion, a rapidly rising deficit in manufactured goods has essentially eliminated Canada’s traditional merchandise trade surplus. This is unlikely to turn around notably in the near-term with the Canadian dollar expected to remain strong and sales to the US, the destination of 75% of Canadian exports, sluggish.
Karen Cordes Woods +1 416 862-3080

MONETARY POLICY COMMENTARY

Derek Holt +1 416 863-7707

UNITED STATES - While we expect the Federal Reserve to start raising its fed funds target rate in Q3 2012, the risk that the Fed will keep this rate on hold for a while longer or that we will witness an increase in unconventional easing has started to rise. However, we don’t think QE3 is prudent at this point although we cannot dismiss it outright given the Fed’s view that QE2 was successful. Nonetheless, the US has experienced much weaker than expected growth in not only Q2, which is partly due to the Japanese disasters, but also in Q1, which witnessed the slowest pace of growth in two years. And, Q3 growth will likely be weak as well as the US consumer retracts amid sluggish employment and wage growth while a pullback in government spending creates fiscal drag. On the inflation front, weak consumer spending continues to limit businesses’ pricing power although a reversal in commodity prices has provided consumers with some much needed relief. Either way, inflation remains well contained, buying the Fed some time to remain on hold.

CANADA - We continue to expect the Bank of Canada to remain on hold until Q2 of next year, in line with the current fundamentals picture which suggests that Q2 economic growth will come in much weaker than the Bank of Canada's downwardly revised forecast of 1.5% q/q annualized. While some of this weakness can be attributed to the Japanese disasters, which constrained supply chains and led to a large decline in auto production during the quarter, the magnitude of the pullback and the fact that inventories accounted for much of the growth in Q1 suggest that the Canadian economy was already starting to show signs of softening at the beginning of the year. In addition, the recent June inflation report came in much lower than expected on both headline and core which, when taken together with the weak growth numbers, provides the Bank of Canada with further room to remain on the sidelines for reasons other than the global turmoil.

5

Global Economic Research

August 2011

Foreign Exchange Outlook
EUROPE
Currency Outlook Camilla Sutton +1 416 866-5470 Eric Theoret +1 416 863-7030

EURO ZONE - The intra and inter-day volatility of the euro (EUR) continued in July, leaving the currency struggling within its multi-month 1.39 to 1.47 range. We recognize that the risks to the currency are significant and that the sovereign issues have no simple or even foreseeable solution. However, the USD side of the equation is also a weak one, which is likely to benefit the EUR into year-end. According to the CFTC, investors have maintained a positive stance on the EUR, even adding to their net long position in recent weeks. We hold a year-end 1.50 forecast. UNITED KINGDOM - The British pound (GBP) has found support as an intra-European diversification vehicle given the debt woes besieging the singular currency, even as the medium term drivers of loose monetary policy, low growth and strict austerity remain negative. Investors have recently shown their favour by positioning themselves to be net long vs the USD. The GBP remains well supported on a technical basis by its 50 and 100 day MAs (1.6218 and 1.6262). We hold a year-end target of 1.63. SWITZERLAND - The Swiss franc (CHF) has strengthened dramatically this year, reaching new record highs against the USD, EUR and most other currencies. As we enter August, most valuation tools suggest that the currency is overvalued; however, the trend is a challenging one to fight as the franc’s safe haven status combined with its use as a nonEUR inter-European diversification vehicle leaves it as a market darling. The threat of intervention remains an important risk, though to date, the SNB has limited itself to the use of monetary policy tools to counter the strength in the currency. We expect the franc to stabilize into year-end and hold a Q411 target of 0.77 against the USD. NORWAY - The Norwegian Krone (NOK) remains bound by its range extending to mid-May, though it is likely to see limited movement in the absence of significant changes in oil prices. Energy prices are vulnerable in the near term given a slowdown in global manufacturing PMIs. USDNOK is supported at roughly 5.33 while its upper bound is seen at 5.60. We hold a year-end target of 5.25.
Currency Trends
FX Rate EURUSD GBPUSD EURCHF USDNOK 12 m 1.31 1.57 1.36 6.08 Going Back 6 m 1.37 1.60 1.29 5.78 3 m 1.48 1.67 1.28 5.25 Spot 4-Aug 1.41 1.63 1.08 5.49 3 m 1.47 1.62 1.15 5.30 Outlook 6 m 1.49 1.64 1.15 5.24 12 m 1.45 1.68 1.10 5.19 FX Rate EURUSD GBPUSD EURCHF USDNOK

EURUSD
1.68 1.45 1.64 1.40 1.60 1.35 1.56

GBPUSD

1.30

1.25 Aug-10

Oct-10

De c-10

Fe b-11 Apr-11

Jun-11 Aug-11

1.52 Aug-10

Oct-10

De c-10

Fe b-11

Apr-11

Jun-11

Aug-11

EURCHF
6.40 1.36 6.10 1.29 5.80 1.21 5.50

USDNOK

1.14 1.06 Aug-10

Oct-10

De c-10

Fe b-11 Apr-11

Jun-11

Aug-11

5.20 Aug-10

Oct-10

De c-10

Fe b-11 Apr-11

Jun-11

Aug-11

6

Global Economic Research

August 2011

Foreign Exchange Outlook
EUROPE
Fundamental Commentary Tuuli McCully +1 416 863-2859

EURO ZONE - The euro zone sovereign credit turmoil continues despite substantial effort by European policymakers to contain the crisis. The heads of state of the euro area and various European Union (EU) institutions came to an agreement on July 21st on a second bailout package for Greece, worth some €159 billion, amidst a major deterioration in confidence and risk appetite in financial markets. The framework contains three important features: an EUsponsored Greek buyback of its own debt on the secondary market, a debt swap involving private sector creditors on a voluntary basis, and a substantial expansion in the size and role of the European Financial Stability Facility in order to effectively contain the risk of contagion. Nevertheless, increasing Spanish and Italian government bond yields indicate persistent nervousness among market participants as significant longer-term structural challenges linger. We expect the euro zone economy to expand by 1.7% this year, followed by a 1.5% expansion in 2012, with major growth differences remaining in place between the core economies and the periphery. Euro zone monetary policymakers will likely continue the gradual process of monetary normalization in the coming months, taking the main refinancing rate from the current level of 1.50% to 2.0% by the end of the first quarter of 2012. Headline inflation is expected to ease from the current rate of 2.5% y/y towards the European Central Bank’s inflation target of “below, but close to, 2%” in 2012. SWITZERLAND - Swiss monetary authorities are intensifying their fight against the Swiss franc’s (CHF) appreciation pressures as they consider the CHF to be “massively overvalued”. On August 3rd, the Swiss National Bank cut the target rate for the three-month Libor to “as close to zero as possible” from 0.25%, and increased the supply of CHF liquidity. Since the currency’s appreciation pressures have not resulted from attractive interest rate differentials, we do not expect the CHF to reverse its course in the coming quarters. The Swiss economy’s solid economic fundamentals provide a framework for the currency’s safe-haven status. The economy enjoys a strong external position with the current account surplus averaging 10% of GDP through 2012. Meanwhile, public finances are healthy with the government accounts in a balanced position and gross public debt relatively low at slightly above 50% of GDP. The Swiss economy continues to perform robustly, with real GDP expansion likely to reach around 2.0% through 2012. Domestic demand remains supported by healthy balance sheets, accommodative monetary policy and improving labour market conditions (the unemployment rate decreased to 2.8% in June). The export sector is performing well, though momentum will likely decelerate in the coming quarters due to a weaker external environment. Despite the positive growth outlook, inflationary pressures remain virtually absent due to the strong currency. The harmonized consumer price index increased by 0.6% y/y in July.

UNITED KINGDOM - The UK’s economic recovery continues to be subdued. Preliminary real GDP data show that output expanded by 0.2% q/q (0.7% y/y) in the second quarter of 2011, following a 0.5% q/q advance in the January-March period, with modest growth in the construction and services sectors offsetting substantial contractions in the production industries’ output. The weak outcome is partly related to the royal wedding and an additional bank holiday, as well as the impacts resulting from the Japanese tsunami. While we expect a rebound in the third quarter of the year (with output growing by 0.7% q/q), fiscal restraint and a cautious consumer are expected to limit the nation’s economic growth to 1.2% in 2011. Expansion should pick up to 1.5% in 2012 as the domestic recovery becomes more broadly-based. A modest improvement in private consumption will likely be taking hold towards the end of the year, counterbalancing some of the impact of reduced government spending. Consumer price inflation will continue to hover around 4½% in the second half of 2011, remaining significantly above the official target of 2%. Nevertheless, inflation will likely embark on a solid downward trajectory in early 2012, easing towards 2% by the end of 2012. Given the uncertain growth outlook and the expected ease in inflationary pressures, the Bank of England will likely not begin a gradual process of monetary policy normalization until the second quarter of 2012, taking the Bank Rate – currently at 0.5% – to 1.25% by the end of 2012. NORWAY - Norwegian monetary authorities maintain a gradual policy tightening bias. While the policy rate was kept unchanged at 2.25 % following the Executive Board’s meeting on June 22nd, the policymakers assess that the key rate should be within the interval of 2.25%-3.25% by October 19th, when a re-assessment of monetary policy guidelines will take place. The next policy meeting is scheduled for August 10th. While the potential for appreciation pressures for the Norwegian krone points to contained inflation prospects and cautious monetary tightening, the robust performance of the Norwegian economy together with low interest rates may cause sharp rises in wage and price pressures, justifying further normalization of monetary conditions. While inflation is currently low – headline CPI increased by 1.3% y/y in June while prices at the core level grew by 0.7% y/y – the central bank assesses that headline consumer price inflation will pick up to 2.5% in the course of the next two years. The Norwegian economy has gained a firm footing with capacity utilization close to a normal level and the output gap closing. The economy is set to expand by around 2% through 2012, supported by robust private spending and investment. Differing from many of its developed-world peers, Norway has very solid economic fundamentals: it enjoys healthy government finances (we expect the fiscal surplus to average 11½% of GDP in 2011-2012), and a strong external position (the current account surplus will likely hover around 12% of GDP through 2012). 7

Global Economic Research

August 2011

Foreign Exchange Outlook
ASIA/OCEANIA
Currency Outlook Camilla Sutton +1 416 866-5470 Eric Theoret +1 416 863-7030

JAPAN - The Japanese yen (JPY) strengthened dramatically in July on the back of positive flows. Both the level of JPY and the pace of appreciation is likely concerning authorities; however, to date there has been no official intervention in FX markets. We expect yen positive flows to continue to be an important driver of a stronger than expected JPY, but that the currency should stabilize into year-end. We hold a Q411 target of 80. CHINA - The Chinese renminbi (CNY) has continued its slow and measured pace of appreciation, having gained 2.7% on a year-to-date basis and 5.3% on a year-over-year basis. Elevated inflation, tighter monetary policy and international pressure are likely to keep the CNY on course for further appreciation within the 5% to 6% telegraphed to markets by authorities. We hold a year-end forecast of 6.25. AUSTRALIA - The Australian dollar (AUD) reached a 30-year record high in July on support from international diversification flows, increased expectations of a hawkish shift in tone at the RBA, and continued support from rising commodity prices, themes we expect to continue. A temporary retracement will find support at 1.0500, a near term level of congestion. Investors remain bullish, with CFTC data showing that the AUD remains the largest held net long against the USD at US$8.9 billion. We hold a year-end AUDUSD forecast of 1.09. NEW ZEALAND - The New Zealand dollar (NZD) is close to recent highs and should remain supported in the near term, given expectations of policy tightening at the central bank’s September meeting. Near term support would be found at the 50 day MA (0.8321), far below current levels given the near constant upward trajectory of recent NZD movement. CFTC data indicate that gross longs continue to add to their positions while gross shorts pare theirs, leaving the NZD held net long US$2.0 billion. We hold a year-end NZDUSD forecast of 0.85.

Currency Trends
FX Rate USDJPY USDCNY AUDUSD NZDUSD 12 m 86.5 6.77 0.90 0.73 Going Back 6m 82.0 6.60 1.00 0.77 3m 81.2 6.49 1.10 0.81 Spot 4-Aug 79.0 6.44 1.05 0.84 3m 79.3 6.32 1.09 0.86 Outlook 6m 80.7 6.22 1.09 0.85 12 m 83.3 6.03 1.10 0.84 FX Rate USDJPY USDCNY AUDUSD NZDUSD

USDJPY
85.5 6.80 6.72 83.0 6.65 80.5 6.57 78.0 6.50 6.42 Aug-10

USDCNY

75.5 Aug-10

Oct-10

Dec-10

Feb-11 Apr-11

Jun-11 Aug-11

Oct-10

De c-10

Fe b-11 Apr-11

Jun-11

Aug-11

AUDUSD
0.84 1.09 0.81 1.04 0.78 0.98 0.74 0.93 0.71 0.68 Aug-10

NZDUSD

0.87 Aug-10

Oct-10

De c-10

Feb-11 Apr-11

Jun-11 Aug-11

Oct-10

Dec-10

Feb-11

Apr-11

Jun-11

Aug-11

8

Global Economic Research

August 2011

Foreign Exchange Outlook
ASIA/OCEANIA
Fundamental Commentary Oscar Sánchez +1 416 862-3174

JAPAN - Safe haven waves will remain a supporting element for the Japanese yen (JPY), while excessive strengthening forces will move the Bank of Japan (BoJ) closer to further foreign exchange market intervention. The value of Japan’s exports has already rebounded to preearthquake levels after solid gains in May and June led to a quarterly average that is barely 4% below the first quarter level. Continued improvement is expected in coming months as companies seem to be managing the adverse effect of scarcity of parts faster than originally anticipated. The possibility of an expedited recovery continues to hinge on the prevalence of a trade-competitive JPY, with further BoJ intervention a latent risk in case significant appreciation resumes. Household spending showed further gains in June on the back of improving labour indicators. The country’s reconstruction effort is expected to gather momentum during the complementary part of 2011 and through 2012, leading us to continue to expect GDP to expand at a meager 0.3% this year with a 3.5% rebound anticipated for 2012. While dependence of imported fuel, and a higher energy tally, will bring back supply-side price pressures, the BoJ will retain a loose monetary policy stance throughout the recovery, with unsterilized interventions preventing excessive JPY appreciation. The BoJ also expanded its asset purchase program to JPY50trn this week, and we expect further advances through the turn of the year, and a first monetary policy tightening move in mid-2012. AUSTRALIA - The Australian dollar (AUD) will remain supported by solid fundamentals on the back of persistent terms of trade gains. The eventual resumption of monetary tightening by the Reserve Bank of Australia (RBA) will further support the AUD towards the end of 2011. Inflation will continue to challenge the RBA’s 2-3% target range as global raw material costs lie on top of local supply-side pressures resulting indirectly from the mining boom. Annual inflation picked up to 3.5% y/y during the second quarter, with underlying pressures accentuating as services costs underpinned a rise in core inflation with goods price inflation falling on the back of AUD strength. After keeping the status quo for five straight meetings, we expect the RBA to resume monetary tightening sometime in 2011Q3. GDP growth accelerated in the second quarter on the back of evidence of materials exports returning to normal levels after the adverse effects provoked by weather related events and the Japanese catastrophe. Rising investment and cautious consumer spending, the latter underpinned by falling unemployment, support domestic demand steadiness, with moderate bank credit expansion and somewhat softer asset prices providing the background for cautious household borrowing and spending behaviour. Australia’s output advance will average 3.2% y/y in 2011-12, with fiscal policy expected to be a drag on growth as the government aims at a fiscal surplus by 2012-13.

CHINA - The Chinese renminbi (CNY) will maintain its strengthening trend as CNY appreciation fulfills both a short-term objective of monetary tightening, and the medium-term goal of domestic market development. Inflationary trends remain a concern as gains in costs have yet to show a respite, with the double-digit advance in food prices well ahead of non-food items’ cost gains of 3% y/y. While Chinese authorities have persisted in their credit tightening moves, a significant slowdown in domestic spending has yet to become evident, with investment and retail sales outlays continuing to portray well supported demand conditions. Notwithstanding signs of a “soft patch” in global demand, the value of Chinese exports has grown at an average 24% y/y through mid-2011, with imports advancing at a faster 28% yearly pace, implying a secular reduction of the trade surplus. The Chinese economy expanded at a 2.2% quarterly rate during the three months to June 2011, accelerating from the 2% q/q gain in the first quarter. We expect a 9.3% y/y output advance this year to be followed by a 9.5% increase in 2012 as the new generation of leaders heaves its support over an aggressive program of affordable housing development. While elevated lending by state controlled banks underpins double-digit yearly gains in investment spending, one or two more lifts in the benchmark interest rate are expected to take it to slightly over 7% by the end of 2011. NEW ZEALAND - The New Zealand dollar’s (NZD) stellar performance will continue to be underpinned by terms of trade improvements and rebounding output growth. Improving household spending on the back of better employment conditions has supplanted the initial adverse shock to confidence as a result of the Christchurch earthquake. Business activity has retained a solid up tone, with investment increasing as a result of lower borrowing costs and external account gains. Exports of agricultural goods have been a winner from the adverse shocks that hit the Asian region at the start of 2011. First quarter output disruptions had a minor effect on economic performance, as the real GDP expanded at a 0.8% rate from the previous quarter, with growth for 2010 uplifted to 1.5% y/y. We anticipate continued gains through the second half of 2011 as retail sales and capital stock improvements signal domestic strength. Inflation at 5.3% y/y remains well above the Reserve Bank of New Zealand’s (RBNZ) 1-3% comfort zone, with tradable goods prices now leading the advance notwithstanding NZD strength. Non-tradable goods inflation has finally shown a respite although rising services costs and a somewhat tighter labour market still have prices running at an over 5% yearly rate. The RBNZ remains sanguine about rising price pressures as it attempts to support the economic rebound, having left the benchmark official cash rate unchanged at 2.5% after the 50 basis point reduction decreed last March. We expect the RBNZ to resume monetary tightening some9

Global Economic Research

August 2011

Foreign Exchange Outlook
DEVELOPING ASIA
Currency Outlook Sacha Tihanyi +1 416 862-3154

INDIA - USDINR failed to sustain a close below the pivotal 44.0 level in July after the third such attempt in the past year, driven by the most prominent portfolio inflows since April. Aggressive monetary tightening and the recent off-consensus 50bp surprise rate hike by the RBI have helped restore some faith in the INR. A rebound in growth momentum would also be a welcomed development, but one that is currently absent from the mix. We target 44.8 in USDINR by the end of the year. KOREA - In July USDKRW broke the 1050 level, opening up significant downside potential, though the high-beta KRW remains subject to weakness on risk aversion. However, during normalized market conditions, a strong propensity to appreciate remains backed by proactive monetary policy, economic growth and less resistance to KRW appreciation by policymakers. With real interest rates still under pressure, further KRW-supportive monetary tightening is expected. We forecast 1030 in USDKRW for the end of the year. THAILAND - The baht has moved into consolidation mode after its massive appreciatory breakout on post-election foreign portfolio inflows. The picture looks constructive from here as the Bank of Thailand’s monetary pro-activity should combine with a potential fiscal expansion to drive THB gains. We expect USDTHB to break decade plus lows (and support) at 29.50 before the year is out, targeting 29.10 by the end of Q4. MALAYSIA - The MYR was at times the top performing Asian currency in July, reaching 14 year highs versus the USD as policymakers allowed appreciation as a key monetary tightening lever. MYR volatility has increased over the past month, reflecting ringgit susceptibility to global financial market stresses. However, the central bank’s focus on currency relative to interest rates as the key policy variable argues for sustained MYR appreciation. We forecast USDMYR to reach 2.92 by Q4.
Currency Trends
FX Rate USDINR USDKRW USDTHB USDMYR 12 m 46.41 1183 32.24 3.18 Going Back 6m 45.91 1121 30.93 3.06 3m 44.22 1072 29.88 2.96 Spot 4-Aug 44.55 1062 29.89 2.98 3m 44.55 1040 29.36 2.94 Outlook 6m 44.69 1027 29.05 2.92 12 m 44.04 1012 28.75 2.89 FX Rate USDINR USDKRW USDTHB USDMYR

USDINR
47.30 46.70 1165 46.10 1135 45.50 44.90 44.30 43.70 Aug-10 1105 1075 1045 Aug-10 1195

USDKRW

Oct-10

Dec-10

Fe b-11 Apr-11

Jun-11 Aug-11

Oct-10

De c-10

Fe b-11

Apr-11

Jun-11

Aug-11

USDTHB
32.15 31.60 31.05 3.05 30.50 3.00 29.95 29.40 Aug-10 2.95 2.90 Aug-10 3.20 3.15 3.10

USDMYR

Oct-10

Dec-10

Fe b-11 Apr-11

Jun-11

Aug-11

Oct-10

Dec-10

Fe b-11

Apr-11

Jun-11

Aug-11

10

Global Economic Research

August 2011

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

INDIA - The Indian rupee (INR) will remain supported by interest rate and growth differentials. As annual price gains continue to top Asian economies, prospects for further monetary tightening hinge on the country’s performance on the inflationary front. Mounting inflationary expectations remain the main concern of the Reserve Bank of India (RBI) leaving it compelled to persist in its anti-inflationary stance. A slowdown in the pace of monetary tightening is envisaged for the second half. Wholesale price inflation sits currently at 9.4% y/y, below the recent 9.7% peak in March. Downtrending food cost gains have been compensated by a rising domestic fuel ticket driven mainly by the withdrawal of official subsidies. Annual inflation is expected to continue on a downward trend, with prospects for the fall harvest key to determine the extent of lowering food costs. The RBI has raised the benchmark repo rate a cumulative 275 basis points (bps) to 8%, and increased the reserve ratio for banks by 100 bps since October 2009. We expect one more 25 bps hike for the current year. As a lagged response to monetary tightening, data for April-May 2011 suggest the economy is undergoing some moderation after a solid 8.6% yearly advance for FY2010. We expect GDP growth of 8.4% in FY2011, as a downtrend in government outlays is compensated by rising discretionary consumer spending and net exports. Foreign sales averaged gains of 43% y/y through May of 2011, well over the 23% rise in imports, leading to an INR supportive external balance. THAILAND - The Thai baht (THB) will persist on a strengthening trend backed by favourable growth and interest spreads. The THB has regained all of the weakness brought about by the political uncertainty, having appreciated by almost 4% since the July 3rd elections. While the smooth electoral process helped ease some of the perceived country risks, the incoming government’s political platform also brought back expectations of populist measures –like minimum wage lifts and agricultural price warrantees– that would threaten the future trajectory of inflation. Price pressures have remained elevated as a result of the upbeat tone in local activity, with core inflation climbing but still within the Bank of Thailand’s (BoT) 0.5-3% target range at 2.6% y/y. Food costs, a leader item in the inflationary process, have stabilized after peaking at 8.6% y/y back in April. As expected, the BoT resumed monetary policy normalization after the elections, and we anticipate further benchmark interest rate increases in the coming months. Thailand’s economy will continue to rip the benefits of a privileged location within Southeast Asia, with local demand momentum running alongside solid foreign sales. Up-trending credit growth has supported a rebound in investment back to over 20% as a share of GDP after the global crisis slump. A retrenchment in manufacturing evident during the second quarter will lead to recovery in the third, with latest data pointing to an earlier than estimated rebound in export values back to pre-Japanese-catastrophe levels.

KOREA - The Korean won (KRW) will remain strong at least through 2011-12 as sustained economic growth combines with monetary policy skewed towards interest rate normalization. While the Bank of Korea (BoK) remains in inflation containment mode, a slowdown in the pace of monetary tightening is envisaged as the economy converges towards medium term speed. Supply chain disruptions conditioned economic performance during the second quarter as a slowdown in seasonally adjusted export volumes resulted in a GDP advance of 0.8% q/q, coming below the solid 1.3% gain of the first quarter. The value of foreign shipments fell from a 29% y/y advance during the first quarter to a 19% y/y gain in the second, with yearly growth in import values accelerating and thus dragging overall output gains. We expect a rebound in foreign sales in the coming months as evidence of production lines being brought to normality mounts, which would back our anticipation of an average 5% y/y GDP advance in 2011. Headline inflation has surpassed the BoK’s 3% ±1% target each month so far this year, with core inflation in a persistent advance reaching 3.7% y/y in June. Notwithstanding the slowdown in credit so far this year, economic conditions remain solid as the unemployment rate hovered close to an all time low of 3.3% in June. The BoK has decreed four 25 basis point benchmark interest rate increases to 3.25% during the past twelve months. We expect at least one more monetary tightening move before the end of 2011. MALAYSIA - The Malaysian ringgit (MYR) will remain on a strengthening path on the back of growth and inflationary dynamics. The appreciation of the MYR after the global recession has been the strongest within Southeast Asia, depicting currency gains that follow those of the Japanese yen and the Australian and New Zealand dollars. Inflationary trends continue to be driven by supply factors as limited evidence of excess demand pressures remain the norm. The country’s inflation rate quickened to 3.5% y/y, the fastest pace in over two years, on the back of rising food and fuel costs. Notwithstanding the pickup in inflation, Bank Negara Malaysia decided to keep the benchmark rate fixed at 3% after the latest monetary policy meeting. This contrasts with the situation in India and Thailand where benchmark rates were lifted. Malaysia’s industrial production has not kept pace with regional peers as it continued to fall through May with modest manufacturing gains failing to offset a plunge in mining instigated by falling oil prices. Improved conditions in Japan together with stable industrial growth out of China will lead to further gains in Malaysia’s manufacturing output in the coming months. Manufacturing accounts for 63% of industrial output. The county’s GDP contracted 3.1% on a quarterly basis during the first three months of 2011, an implied 4.6% yearly gain, which stands significantly lower than the 7.3% y/y advance of 2010. We anticipate a 5% y/y GDP expansion during 2011.

11

Global Economic Research

August 2011

Foreign Exchange Outlook
DEVELOPING AMERICAS
Currency Outlook Pablo F.G. Bréard +1 416 862-3876

BRAZIL - The Brazilian real (BRL) is technically positioned to extend gains versus the USD. Widening interest rate differentials, strong foreign capital inflows, persistent USD weakness, a rapid development of local securities markets and stillsupportive commodity prices bode well for the BRL in the near term. The government and the central bank are joining forces to moderate the pace of currency appreciation. We expect the USDBRL to close the year at 1.60. MEXICO - The Mexican peso (MXN) remains well supported by a mix of factors such as still-high crude oil prices, attractive interest rate differentials (versus the US), technical undervaluation against other top-tier emerging-market currencies, accelerating growth prospects, contained inflationary pressures and carry-trade capital flows. Declining stock prices may temper the pace of currency strength due to the sizable position of foreign holders of Mexican securities. We expect the USDMXN to close the year at 12.0. CHILE - The Chilean peso (CLP) may be subject to increasing volatility in the near term as uncertainties related with the pace of global economic growth dissipate. The CLP remains sensitive to adjustments to the country’s terms of trade. Any material correction in copper prices will instill a negative sentiment into the Chilean peso. Nevertheless, recent indicators point towards an accelerating growth scenario. We expect USDCLP to close the year at 470. COLOMBIA - The Colombian peso (COP) remains attractive. After testing a technical resistance of 1,750 per USD, the COP is immersed in a consolidation phase. Official intervention will likely intensify in order to mitigate the adverse economic effects (on labour-intensive non-tradable sectors) of a rallying currency. The central bank continues to accumulate FX reserves to manage an adverse external shock. We expect the USDCOP to close the year at 1790.
Currency Trends
FX Rate USDBRL USDMXN USDCLP USDCOP 12 m 1.75 12.65 521 1844 Going Back 6m 1.67 12.12 483 1867 3m 1.58 11.50 460 1767 Spot 4-Aug 1.58 12.00 463 1786 3m 1.58 11.98 465 1785 Outlook 6m 1.60 12.07 471 1797 12 m 1.63 12.12 479 1836 FX Rate USDBRL USDMXN USDCLP USDCOP

USDBRL
1.79 1.75 1.70 1.66 1.61 1.57 1.52 Aug-10 13.3 13.0 12.7 12.4 12.1 11.8 11.5 Aug-10

USDMXN

Oct-10

De c-10

Feb-11 Apr-11

Jun-11 Aug-11

Oct-10

De c-10

Fe b-11 Apr-11

Jun-11

Aug-11

USDCLP
2045 506 1995 1945 1895 1845 464 1795 450 Aug-10 1745 Aug-10

USDCOP

492

478

Oct-10

Dec-10

Fe b-11

Apr-11

Jun-11

Aug-11

Oct-10

De c-10

Feb-11 Apr-11

Jun-11

Aug-11

12

Global Economic Research

August 2011

Foreign Exchange Outlook
DEVELOPING AMERICAS
Fundamental Commentary Pablo F.G. Bréard +1 416 862-3876

BRAZIL - Political uncertainties and financial market volatility associated with the congressional debate on the US debt ceiling issue was, at the end, a BRL supporting factor: The Brazilian currency traded as low as 1.5290 per USD at the end of July before recovering to the current level of 1.56. The Brazilian monetary authorities seem to favour intensified factual and verbal intervention to address the highinflation strong-currency context: new taxes on FX derivatives transactions were put in place, adding to an increase in banking sector’s reserve requirements. One area of utmost concern is the ongoing distress affecting the local equity market which remains in bearish territory: the benchmark Sao Paulo Bovespa index has accumulated a 21% decline since the recent technical peak of April 6th (down 25% since Nov 2010). Nevertheless, widening interest rate differentials remain a key supporting factor. The Monetary Policy Committee (COPOM) increased the market-watched SELIC reference rate by 25 basis points to 12.50 % on July 20th; we anticipate that further tightening will not materialize at the August 31st COPOM meeting as the central bank assesses the increasingly volatile global economic conditions. However, the central bank will remain vigilant as sustained employment gains combined with increasing commoditydriven inflation build-up are exerting upward pressure on labour costs. On a positive note, monthly current account deficit data showed a slight narrowing in June in the context of still booming foreign direct investment inflows. CHILE - The CLP retains a steady bias towards appreciation against the USD, briefly interrupted by the heightened financial market volatility caused by the US-centered political noise. Persistently high copper prices (averaging US$4.27 per pound) continue to be CLP supportive. On a negative note, Chilean equity securities are depreciating in line with the trend in place in Brazil and other top-tier emerging markets in Asia. The CLP is holding very well irrespective of the bearish sentiment in stock markets. Chile is a highly open economy sensitive to the global economic cycle and (real sector) commodity price gyrations. The likelihood of financial contagion risk is real, yet the Chilean economy is adequately prepared to face USinspired global financial market turbulence. The Chilean central bank remains committed to its USD purchase programme: international reserves expanded by 38% to almost US$35 billion over the past 12 months. Progress on price stabilization is becoming more visible as the inflation rate is gradually moving towards the center of the official target range. Consumer prices (measured on a year-overyear basis) increased by 3.4% in June following a modest 0.2% monthly advance. In light of the progress achieved in containing inflationary expectations coupled with rising global economic uncertainties, the central bank kept its policy-setting rate unchanged at 5.25% on July 14th. However, a pause in the tightening cycle does not mean the end of the adjustment if price pressures re-emerge.

MEXICO - Mexico is one of the world’s major energy exporters. Although they have been subject to slight downward adjustments lately, crude oil prices (averaging US$100 per barrel over the past six months) continue to exert a positive influence on the Mexican currency and fuel demand for MXN-denominated debt securities. A growing pool of international reserves is also acting as a strong shield against a speculative attack against the MXN triggered by an adverse development north of the border. A potential US credit rating downgrade may prolong a fragile sentiment towards the USD and extend investors’ preference for high-yielding currencies such as the peso. Indeed, interest rate differentials remain a powerful force swaying capital flows towards Mexican fixed-income securities. Following the announcement of the debt-ceiling approval by the US congress, the yield on the 10-year US Treasury (UST) debt securities declined to as low as 2.54, widening the Mexico-US yield spread to almost 400 basis points (bps). Despite a positive currency market momentum, recently reported weak economic data in the US would have an adverse impact on the US-interdependent Mexican economy. A downward revision in US growth expectations will also imply reduced output activity in Mexico, particularly in the US-dependent industrial sector. Meanwhile, the inflation outlook is quite positive: consumer prices increased by only 3.28% in June (y/y), marking a major achievement in converging towards the 3% target. COLOMBIA - Colombia offers a bright macroeconomic context. The economy and its credit market are in rapid expansion mode. Real GDP will grow, at a minimum, by 5.5% in 2011 following a strengthening of output activity during the first half of 2011 (up 5.1% in the first quarter). Domestic demand is growing at a 7% annual rate. The global commodity market provides a positive environment for Colombian exports thanks to favourable terms of trade (particularly in crude oil, nickel, coal, coffee and gold). In light of steady currency appreciation and well-contained inflationary pressures, the monetary authorities are in the process of normalizing monetary conditions. For a sixth consecutive month, the central bank opted to increase the reference rate by an additional 25 basis points to 4.5% at the end of July, stressing that it remains committed to maintaining price stability needed to accompany a period of sustainable production and employment growth. The authorities are acting on a pre-emptive way to avoid pressures originating in an excess of global demand; in fact, consumer prices remain well contained within the 2% +/1% target range (3.2% y/y in June). To an extent, increasing interest rates go against the government’s concern of sustained currency appreciation. Undoubtedly, given the near-zero interest rate environment in the US, the widening Colombia-US interest rate gap acts as an incentive to hold COP-denominated securities.

13

Global Economic Research

August 2011

Foreign Exchange Outlook
DEVELOPING EUROPE/AFRICA
Currency Outlook Tuuli McCully +1 416 863-2859

RUSSIA - Elevated energy prices will continue to support the Russian ruble (RUB); nevertheless, approaching parliamentary and presidential elections – together with a delayed nomination of the ruling party’s official candidate for presidency – will likely introduce periods of currency volatility. We expect USDRUB to close the year at 28. TURKEY - The Turkish lira (TRY) remains vulnerable to further downside risks as global investor sentiment continues to change rapidly. Larger financing needs resulting from a rapidly widening current account deficit and emerging signs of overheating of the Turkish economy are placing market participants on alert. We expect USDTRY to close the year at 1.68. CZECH REPUBLIC - The Czech Republic’s solid economic fundamentals together with the government’s commitment to fiscal prudence should continue to support the Czech koruna (CZK) through 2012. We expect the CZK to close the year at 24.0 per the euro. SOUTH AFRICA - The South African rand (ZAR) will continue to reflect fluctuations in commodity prices and rapid changes in investor sentiment. A widening current account deficit will point to a modest depreciating bias of the ZAR visà-vis the US dollar through 2012. We expect the ZAR to close the year at 7.0 per USD.

Currency Trends
FX Rate USDRUB USDTRY EURCZK USDZAR 12 m 30.2 1.51 24.78 7.30 Going Back 6m 29.8 1.60 24.19 7.19 3m 27.4 1.52 24.18 6.57 Spot 4-Aug 28.1 1.74 24.32 6.93 3m 27.8 1.68 24.07 6.87 Outlook 6m 28.1 1.68 23.98 7.02 12 m 28.6 1.66 23.88 7.17 FX Rate USDRUB USDTRY EURCZK USDZAR

USDRUB
31.6 30.9 30.1 29.4 28.6 27.9 27.1 Aug-10 Oct-10 1.71 1.66 1.60 1.55 1.49 1.44 1.38 Aug-10

USDTRY

Dec-10 Feb-11 Apr-11 Jun-11 Aug-11

Oct-10

Dec-10

Feb-11 Apr-11 Jun-11 Aug-11

EURCZK
7.50 25.35 7.25 25.00 7.00

USDZAR

24.65

24.30

6.75

23.95 Aug-10 Oct-10 Dec-10

Feb-11 Apr-11 Jun-11 Aug-11

6.50 Aug-10

Oct-10

Dec-10

Feb-11 Apr-11

Jun-11 Aug-11

14

Global Economic Research

August 2011

Foreign Exchange Outlook
DEVELOPING EUROPE/AFRICA
Fundamental Commentary Tuuli McCully +1 416 863-2859

RUSSIA - The Russian economic outlook remains dependent on energy prices and the corresponding export sector performance. According to preliminary estimates, the economy expanded by 3.9% y/y in the first half of 2011. We expect Russian real GDP growth to average 4¼% through 2012. While some cooling in the export sector momentum can be expected, the economic recovery is becoming more broadly-based, with recent retail sales and investment spending data indicating a pickup in domestic demand. Labour market conditions are improving – providing support to household spending – with the unemployment rate dropping from 7.8% in January to 6.1% in June. Supported by elevated oil prices, government finances are on the mend with the fiscal deficit narrowing substantially to close to a balanced position this year from 4% of GDP in 2010. Government debt remains low at slightly above 10% of GDP. Inflation eased somewhat in June to 9.4% y/y. We expect Russian policymakers to take a break from further monetary tightening in the near term in order to assess the impact of recent measures. Domestic politics will remain the centre of investor attention in the near term as parliamentary elections are scheduled for December, followed by a presidential ballot in March 2012. Both President Medvedev and Prime Minister Putin are considering running for the presidency; however, an official decision regarding who will be the ruling United Russia party’s candidate has not yet been made. CZECH REPUBLIC - Monetary conditions in the Czech Republic are set to remain on hold in the near term, as demand-led inflationary pressures remain virtually absent. The Czech National Bank has kept the benchmark interest rate unchanged at 0.75% since May 2010 and policymakers will likely begin a gradual process of monetary policy tightening in the final quarter of 2011 at the earliest. Headline inflation continues to hover below the central bank’s 2.0% target; the consumer price index increased by 1.8% y/y in June. While a planned increase in the value-added tax for 2012 poses upside risks to the inflation outlook, the strong Czech koruna should keep imported price inflation in check. We expect the consumer price inflation to close the year at slightly above 2% y/y. The export-oriented Czech economy is set to expand by around 2¼% in 2011 and 2012. Export sector performance and industrial production indicators continue to reflect the robust momentum of the German economy, the Czech Republic’s main trading partner, though some easing can be expected in the coming months. Private spending will likely pick up in the coming quarters as employment conditions continue to improve. Public finances of the Czech Republic compare favourably with many of its European peers. The government aims to narrow the fiscal deficit to 3.5% of GDP in 2012 from 4.2% in 2011, with public debt likely to remain below 45% of GDP through 2012.

TURKEY - Turkey’s current account deficit continues to widen rapidly, with the International Monetary Fund assessing that it may reach 10.5% of GDP this year compared with 6.7% in 2010. The sharp increase in local credit growth (at an annual rate of more than 40%) and the lack of dampening impact from higher reserve requirements form another area of intensifying investor nervousness. Inflation accelerated slightly in July to 6.3% y/y, with prices at the core level continuing to ascend as well (to 5.4% y/y). Double-digit price gains (10.3% y/y in July) further up the distribution chain together with depreciation pressures of the Turkish lira point to persistent inflationary pressures in the coming months. We expect the headline inflation rate to hover around 7% y/y at the end of 2011. The benchmark interest rate was kept on hold at 6.25% following the Monetary Policy Committee meeting on July 21st. We assess that policymakers will start raising the key interest rate towards the end of the year as further efforts by the central bank are required to limit soaring credit growth. Consumer confidence continues to recover, reflecting improving employment conditions; the unemployment rate dropped in April to below 10% for the first time since mid-2008. The economy is set to expand by around 7% this year before slowing to around 5% growth in 2012.

SOUTH AFRICA - High gold prices resulting from safe haven trading behaviour are providing support to the commodity-linked South African currency. Moreover, prolonged monetary stimulus in the US is a major exogenous factor in favour of emerging markets. Nevertheless, with the South African trade balance moving from a surplus position to a deficit, the current account is set to widen significantly from 2.6% of GDP in 2010 to around 5% of GDP in 2012. In the context of the country’s low savings rate and its dependence on volatile portfolio investment inflows, the shortfall points to modest selling pressures of the ZAR in the next two years. Moreover, potential changes to the foreign investor business climate in the country’s mining industry may have an adverse impact on investor sentiment towards South Africa. Inflation accelerated to 5.0% y/y in June from 4.6% the month before; regardless, it remains comfortably within the South African Reserve Bank’s (SARB) 3-6% target range. We expect inflation to approach the upper limit of the range toward the end of 2011. Because inflationary pressures are not demand-driven, the SARB opted to keep the benchmark interest rate unchanged at 5.5% following the Monetary Policy Committee meeting on July 21st. We do not foresee any changes to the monetary policy stance in the near term as the global economic outlook remains uncertain. We expect South African real GDP growth to average 3¾% through 2012.

15

Global Economic Research

August 2011

Foreign Exchange Outlook

GLOBAL CURRENCY FORECAST (end of period)
2009 2010 2011f 2012f Q1a 2011f Q2a Q3 Q4 Q1 2012f Q2 Q3 Q4

MAJOR CURRENCIES
Japan Euro zone UK Switzerland
USDJPY EURUSD EURJPY GBPUSD EURGBP USDCHF EURCHF 93 1.43 133 1.62 0.89 1.04 1.48 81 1.34 109 1.56 0.86 0.93 1.25 80 1.50 120 1.63 0.92 0.77 1.16 85 1.40 119 1.70 0.82 0.75 1.05 83 1.42 118 1.60 0.88 0.92 1.30 81 1.45 117 1.61 0.90 0.84 1.22 79 1.45 115 1.61 0.90 0.79 1.15 80 1.50 120 1.63 0.92 0.77 1.16 82 1.48 121 1.65 0.90 0.77 1.14 83 1.46 121 1.67 0.87 0.76 1.11 84 1.43 120 1.69 0.85 0.76 1.09 85 1.40 119 1.70 0.82 0.75 1.05

AMERICAS Canada North
Mexico Argentina Brazil South Chile Colombia Peru

USDCAD CADUSD USDMXN CADMXN USDARS USDBRL USDCLP USDCOP USDPEN

1.05 0.95 13.1 12.4 3.80 1.74 507 2044 2.89 2.15

1.00 1.00 12.3 12.4 3.98 1.66 468 1908 2.81 4.29

0.96 1.04 12.0 12.5 4.40 1.60 470 1790 2.76 4.30

0.94 1.06 12.4 13.1 5.00 1.65 485 1870 2.70 5.15

0.97 1.03 11.9 12.3 4.05 1.63 477 1871 2.80 4.29

0.96 1.04 11.7 12.2 4.11 1.56 467 1771 2.75 4.29

0.96 1.04 12.0 12.4 4.24 1.57 463 1783 2.79 4.29

0.96 1.04 12.0 12.5 4.40 1.60 470 1790 2.76 4.30

0.95 1.05 12.1 12.8 4.54 1.61 474 1810 2.74 4.50

0.95 1.05 12.1 12.7 4.69 1.62 477 1830 2.73 4.70

0.94 1.06 12.2 13.0 4.84 1.64 481 1850 2.71 4.92

0.94 1.06 12.4 13.1 5.00 1.65 485 1870 2.70 5.15

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 0.90 6.83 7.75 46.5 9.40 3.43 0.72 46.2 1.40 1164 33.4 32.0 1.02 6.61 7.77 44.7 9.00 3.06 0.78 43.8 1.28 1126 30.1 29.3 1.09 6.25 7.75 44.8 8.54 2.92 0.85 42.0 1.19 1030 29.1 28.5 1.11 5.88 7.75 43.5 8.40 2.87 0.83 41.0 1.17 1000 28.5 27.8 1.03 6.55 7.78 44.6 8.71 3.03 0.76 43.4 1.26 1097 30.3 29.4 1.07 6.46 7.78 44.7 8.58 3.02 0.83 43.4 1.23 1068 30.7 28.7 1.08 6.36 7.78 44.4 8.52 2.95 0.87 42.1 1.20 1044 29.5 28.7 1.09 6.25 7.75 44.8 8.54 2.92 0.85 42.0 1.19 1030 29.1 28.5 1.09 6.16 7.75 44.5 8.50 2.91 0.84 41.7 1.18 1022 28.9 28.3 1.10 6.06 7.75 44.1 8.47 2.89 0.84 41.5 1.18 1015 28.8 28.1 1.10 5.97 7.75 43.8 8.43 2.88 0.83 41.2 1.17 1007 28.6 27.9 1.11 5.88 7.75 43.5 8.40 2.87 0.83 41.0 1.17 1000 28.5 27.8

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 26.4 126 270 5.79 4.10 30.0 7.40 10.25 1.50 25.0 115 279 5.82 3.96 30.5 6.63 8.99 1.54 24.0 115 270 5.25 3.95 28.0 7.00 8.80 1.68 23.8 110 265 5.15 3.90 29.0 7.30 8.60 1.65 24.5 114 266 5.54 4.02 28.4 6.77 8.95 1.55 24.3 114 266 5.39 3.98 27.9 6.77 9.18 1.62 24.1 115 270 5.32 3.98 27.8 6.81 8.94 1.69 24.0 115 270 5.25 3.95 28.0 7.00 8.80 1.68 23.9 114 269 5.23 3.94 28.2 7.07 8.75 1.67 23.9 112 267 5.20 3.92 28.5 7.15 8.70 1.66 23.8 111 266 5.18 3.91 28.7 7.22 8.65 1.66 23.8 110 265 5.15 3.90 29.0 7.30 8.60 1.65

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

August 2011

Foreign Exchange Outlook

INTERNATIONAL RESEARCH GROUP
Pablo F.G. Bréard, Head pablo_breard@scotiacapital.com Daniela Blancas daniela_blancas@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
Karen Cordes Woods karen_woods@scotiacapital.com 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

Eric Theoret eric_theoret@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.

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