Global Economic Research July 2, 2010

Tuuli McCully
1 (416) 863-2859
tuuli_mccully@scotiacapital.com

Pablo Bréard
1 (416) 862-3876
pablo_breard@scotiacapital.com

• Mixed European market signals: declining equity asset price coupled with EUR strength
• Euro zone sovereign credit turmoil remains at center of attention
• G-20 Summit: economic recovery, fiscal consolidation and financial reform on top of agenda
• Polish monetary policy on hold due to global uncertainties; economic recovery continues

Mixed European market signals: declining equity asset price coupled with EUR strength

The euro (EUR) is in recovery mode while global investors await the release of the stress tests per-
formed on 25 European financial institutions scheduled for the second half of this month. After touching
the low mark of US$1.1877 on June 7th, the EUR has gained some strength trading as high as 1.26 by
the end of the week. Some of the European currency strength has been the result of a weakening mo-
mentum affecting the US dollar (USD); in fact the trade-weighted DXY index (where the EUR has a
58% weighting) has been in declining mode since June 7th. Despite the modest EUR rally, European
equity securities have been losing ground since late April in line with correcting markets in the US,
China and the UK; indeed, the Euro Stoxx 50 price index has lost 25% since the beginning of the year
in USD-adjusted terms. Government bond markets in the core group of countries within Europe have
recovered some of the ground lost this week, yet they remain sensitive to developments in the fiscally
distressed Southern economies. In fact, credit default swap (CDS) metrics still point towards persistent
stress in sovereign credits such as Spain and Portugal, currently priced at 262 basis points (bps) and
306 bps, respectively. After reaching a level of 1,125 bps on June 24th, Greece’s CDS cost declined to
910 bps by the close of the week.

Euro zone sovereign credit turmoil remains at center of attention

Economic sentiment across the euro zone improved in June after the turmoil stemming from fiscal con-
cerns in Greece caused a dip in confidence in May. While consumer and industrial confidence re-
mained unchanged from the previous month, sentiment in the services sector improved. Nevertheless,
it would be premature to describe the tone as upbeat since debt sustainability issues in some highly
indebted euro zone countries remain at the center of investor attention. The region-wide purchasing
managers’ index for the manufacturing sector showed a mildly weaker reading in June to 55.6 from
55.8 in May, indicating a growing, yet decelerating, business context. With banks in the euro zone
seemingly somewhat unwilling to lend to each other due to uncertainties regarding their exposure to
riskier sovereign credits, the fact that the European Central Bank’s (ECB) €442 billion one-year liquidity
facility expired on Thursday created some concerns regarding liquidity issues in the region’s banking
sector. Nevertheless, investor worries eased on Wednesday as banks borrowed significantly less
money from the ECB at the three month tender than was anticipated before. In addition to short-term
volatility in investor sentiment, the debt sustainability crisis in Europe will also cause longer-term growth
implications; tough austerity measures implemented in some European countries to restore fiscal credi-
bility 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.

G-20 Summit: economic recovery, fiscal consolidation and financial reform on top of agenda

Leaders of the major developed and developing countries attended a G-20 meeting in Toronto on June
26th-27th, hosted by Prime Minister Stephen Harper. The concluding statement reiterated the impor-
tance of the world’s major economies working together to promote “strong, sustainable and balanced”
economic growth, while strengthening public finances. The G-20 participants pledged to achieve the
previous summits’ commitments to reform the financial sector.

Europe Weekly Outlook is available on www.scotiabank.com, Bloomberg at SCOE

Global Economic Research
As many economic challenges remain in place following
the global downturn, with economic growth being un-
even and fragile, G-20 leaders set their highest priority
to be safeguarding and strengthening the economic re-
covery. Responding to the debt turmoil in Europe, the
official G-20 communiqué recognized the importance of
sustainable public finances but noted that synchronized
fiscal adjustment in major economies may put the eco-
nomic recovery at risk. Therefore, only those nations
with serious fiscal challenges were encouraged to accel-
erate fiscal consolidation. The summit participants
agreed on halving budget shortfalls by 2013 and stabi-
lizing government debt/GDP ratios by 2016, while high-
lighting the need for fiscal consolidation plans that sup-
port longer-term growth. An enforcement mechanism for
meeting the targets was not set up; nevertheless, the
austerity measures unveiled recently in the UK and in
many euro zone countries are in line with the summit
goals.
The proposed strategy for strengthening the resilience
of the financial sector is based on four pillars: regulatory
reform, improved supervision, addressing systemically
important financial institutions and transparent interna-
tional assessment and peer review. The G-20 leaders
agreed that the centerpiece of all financial sector reform
must focus on improving the strength of capital and li-
quidity while simultaneously discouraging excessive
leverage. Participants were also in agreement that the
financial sector must make a significant contribution to
ensuring a crisis such as the one we are emerging from
does not happen again. However, they did not reach a
conclusion as to the means of this prevention. Despite
the fact that last week the French, UK and German gov-
ernments jointly announced a decision to implement a
banking levy, the G-20 leaders concluded that other
countries may pursue different approaches. Fighting
protectionism and promoting trade and investment was
one of the summit themes, with participants recognizing
the importance of open markets to sustainable growth.
The G-20 countries lengthened their commitment to re-
frain from raising or imposing new trade or investment
barriers until the end of 2013. The fact that the G-20
participants continue to express a commitment to main-
taining an open global trade environment suggests that
trade issues will remain a somewhat troublesome ele-
ment on the international agenda.
July 2, 2010
Polish monetary policy on hold due to global uncer-
tainties; economic recovery continues
Polish central bankers maintain a neutral policy stance,
as the fiscal crisis in Greece and euro area fiscal con-
solidation efforts create uncertainties for the regional
economic outlook. Following the Monetary Policy Coun-
cil meeting on June 29th-30th, the authorities left the ref-
erence 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 be-
fore while retail sales increased by 3.1% m/m and 4.3%
y/y. The inflation outlook is promising, with the con-
sumer price index increasing by 2.2% y/y in May, run-
ning below the central bank’s target of 2.5%. The mone-
tary 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 tighten-
ing is important for macroeconomic stability. Neverthe-
less, with the country in the midst of an electoral cycle,
aggressive fiscal consolidation is not in sight. The sec-
ond round of the presidential election will take place on
July 4th. In the first round, the ruling Civic Platform’s
candidate, the acting president Bronislaw Komorowski,
claimed 41.2% of the vote while the opposition’s candi-
date Jaroslaw Kaczynski received 36.7%. Parliamentary
elections will take place next year. We expect the Polish
zloty (PLN), trading currently at 4.15 per euro, to face an
appreciating bias in the coming months on the back of
the country’s relatively sound economic fundamentals.
The Polish authorities have expressed interest in a new
one-year precautionary arrangement under the Interna-
tional Monetary Fund’s Flexible Credit Line. The succes-
sor arrangement would provide a useful insurance
against external risks, further supporting the PLN.
2
 Global Economic Research July 2, 2010

INTERNATIONAL RESEARCH GROUP

Pablo F.G. Bréard, Head

1 (416) 862-3876
pablo_breard@scotiacapital.com

Tuuli McCully
1 (416) 863-2859
tuuli_mccully@scotiacapital.com

Estela Ramírez
1 (416) 862-3199
estela_ramirez@scotiacapital.com

Oscar Sánchez
1 (416) 862-3174
oscar_sanchez@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.