ECONOMIC RESEARCH

Contents
The main points at a glance 3

USA
Expansionskatingonthinice 4

Eurozone
ECBchecksgrowth 6

Germany
Theboomisover 8

United Kingdom
Problemsbelowthesurface 10

Switzerland
SNBstaysonatighteningcourse 10

Eastern Europe
Stronggrowth 11

Japan
Shortbreather–upwardtrendintact 12

China
Cangrowthbeheldincheck? 13

Bond markets

USA:Yieldlowthissummer 14
Eurozone:Riseinyieldscomingtoanend 15

Foreign-exchange markets

Dollarunderpressureincomingmonths 16
Swissfranc:Weaknessnotoveryet 17
Sterling:UnderpressurefromafurtherECBratehike 18
Yen:Boostedbygreateraversiontorisk 18

Forecast tables

Growthandinflation 19
Interestrates 20
Exchangerates 21






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 Printedon2April2007

2  2 April 2007
 ECONOMIC RESEARCH

The main points at a glance

Dr. Jörg Krämer WhiletherearegrowingsignsofadownturnintheUS,theeconomyintheeuro-zone
ChiefEconomist andinGermanyhascontinuedtoexpand.However,inthemediumtermEuropecan-
++496913623650 notescapetheimpactofaUSslowdown.
USA: Investment already falling
TheUSachievednomorethan2.5%growthinthefourthquarteroflastyear,which
wasthethirdpoorquarterlygrowthresult.Weenvisageafigureofonly1½%forthe
coming quarters, as following their January slump orders for capital goods have
continued to decline. Investment demand is thus clearly in retreat for the first time
sincetherecessionatthestartofthedecade.Theemergingweaknessininvestment
willreininjobgrowthanddampenprivateconsumption,whichwillinanycasebehit
bythehousingmarketcrisis.Consequently,wehaveloweredourUSgrowthforecast
fortheyear2007asawholefrom2.1%to1.8%.

The Fed’s main concern is still inflation, but in contrast with previous months the
wordingithaschosennowsuggeststhatitmaybeconsideringcuttinginterestratesif
theeconomysuffersaserioussetback.Thisisinfactwhatweexpect,andweseethe
FedstartingtoloweritskeyrateinAugustbyatotalof75basispointsto4.5%.Fears
ofarecessionpointtothe10-yearTreasuryyield,nowat4.7%,droppingbackto4.3%
bylatesummer.
Eurozone: boom flattening out
Both Germany and the eurozone as a whole achieved growth in the final quarter of
2006onascalelastseenintheboomyear2000,andeventheGermanlabourmarket
has benefited. The number of employees liable to social security contributions has
risenbynolessthan1½%overthelastyear.However,itwouldbeunwisetoassume
that this strong upward trend will continue. For one thing, the ECB has meanwhile
raiseditskeyinterestrateby175basispoints,whichwillnodoubtdampencorporate
investment. In addition, the US economy is likely to cool off even further. Conse-
quently, we are still assuming that the eurozone and Germany will see less rapid
growth over the next few quarters compared with 2006. Nevertheless, the ECB will
probably not revise its optimistic view of the economy for some time yet, and will
raiseitskeyratefromthecurrent3.75%to4.0%inJune.Theyieldonten-yearBunds
canbeexpectedtofallalittlebymid-year,onaccountofexpectationsofUSratecuts.
Euro: set to pass $1.35 briefly
FearsofaUSrecessionandhintsofimminentFedratecutswillhelptheeurotoap-
preciateto$1.36thissummer.Itislikelytodropbacktotheareaof$1.30inthesec-
ond half of the year, though, as the Fed’s moves dispel concern about a recession.
Moreover,theeuroisextremelyexpensiveintermsofthecurrentfundamentaldata,
and the premium for the large US current-account deficit is generous. The deficit
shouldshrinkinanycaseasUSgrowthslowsdown.



TABLE1: Economic forecast 2007/2008
Region Growth Inflation *)
2006 2007 2008 2006 2007 2008
USA 3.3 1.8 2.3 2.5 2.3 1.7
Eurozone 2.7 2.4 1.9 2.2 1.7 1.7
Germany 2.7 1.7 1.8 1.7 1.4 1.0
*) USA: consumer prices excl. energy and food. Sources: Global Insight, Commerzbank Economic Research

2 April 2007  3
ECONOMIC RESEARCH

USA: Expansion skating on thin ice

Patrick Franke ThegrowthrateoftheUSeconomyremainedbelowitslong-termtrendattheendof2006
++496913624525 despite a very mild winter and the notable drop in oil prices. Real GDP expanded by just
2½%qoq(annualrate)inQ4.Althoughprivateconsumptionremainedveryrobust,invest-
mentinequipmentandsoftwaredisappointed.Basedonthenegativesurprisesinthedu-
rablegoods dataareboundinearly2007isnotinthecards.Asustaineddownturninin-
vestmentdemandwouldhaveseriousconsequencesfortheoverallgrowthoutlook.Apart
from the direct effect, investment on equipment and software is highly correlated with
employment growth. A notable correction in investment spending is always associated
withasoftlabourmarket.Overthenextsixmonths,theperiodofweakgrowthisthusset
to continue, with GDP expanding at an average pace of just 1.5% (see chart 1). This im-
pliesanotableriseintheprobabilityofarecession.Evensmallshockscouldbesufficient
tobringaboutaneconomiccontraction.

End of housing boom will hit consumer spending

Stagnatingorslightlyfallinghouseprices–thisiscurrentlyourbaselinescenario–willde-
pressconsumerdemandrelativetotherecentpastviathewealtheffect.Thisfactoralone
willprobablybeenoughtocutconsumptiongrowthbyoveronepercentagepoint,aspri-
vatehouseholdswilllikelyrespondtotheirhousesnolongergaininginvaluebystopping
thedeclineinthesavingsratio.However,thiseffectisturningouttobeverygradualand–
against the backdrop of an unexpectedly enduring upward trend in house prices (Q4:
+1.1%qoq)–likelytotakeabitlongertomaterialisethanwepreviouslyassumed.Another
factortobeconsidered,butonethatisdifficulttoquantify,isthepotentialimpactofhigher
short-term interest rates. Households with adjustable rate mortgages (ARMs) and option
ARMsareincreasinglyfindingthemselvesindifficulties,whichcouldalsohaveaknock-on
effectonlargebanks.Sofar,though,therearefewsignsofacrisisspreadingbeyondthe
veryriskiestsegmentofmortgagelending.
Moreover,thesituationonthelabourmarketremainsbetterthananticipated,underpinning
solid income growth. The unemployment rate remains at 4.5% and payroll growth is ro-
bust.However,theweakeningofresidentialconstructionandcorporateinvestmentshould
increasinglyshowupinthelabourmarket.Theresultinglossofincomeandaslightrisein
unemploymentshoulddampenhouseholdspending.
We look for real GDP growth of 1¾% in 2007, clearly below the potential rate of around
3%. However, it is becoming increasingly likely that trend growth in the US is shifting
downanotch.TheFedandtheCongressionalBudgetOffice(CBO)haverecentlyadjusted
their estimates to 2¾% or thereabouts. If this is correct, the degree of overall capacity
utilisationintheUSeconomywillnotfallbyasmuchaswecurrentlyexpect.
TABLE2: USA – economic forecast 2007/2008
Indicator 2005 2006 2007 2008 2006 2007 2008
Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
Consumerspending1) yoy/qoq 3.5 3.2 2.7 1.8 2.6 2.8 4.2 3.2 1.8 1.0 1.6 1.8 2.1
Businessinvestment1)2) yoy/qoq 6.8 7.2 0.6 2.4 4.4 10.0 -3.1 0.6 -2.6 -0.4 1.7 3.0 3.6
Domesticdemand1) yoy/qoq 3.3 3.2 1.4 2.0 2.2 2.3 0.9 1.8 0.6 1.2 1.8 2.2 2.4
Exports1) yoy/qoq 6.8 8.9 8.0 8.3 6.2 6.8 10.6 7.4 8.2 7.4 7.6 7.8 8.7
Imports1) yoy/qoq 6.1 5.8 3.1 4.8 1.4 5.6 -2.6 8.2 2.0 2.2 3.4 4.3 6.4
GDP 1) yoy 3.2 3.3 1.8 2.3 3.5 3.0 3.1 2.1 1.8 1.7 1.6 1.9 2.2
 qoq 2.6 2.0 2.5 1.4 1.2 1.7 2.2 2.5 2.5
Unemploymentrate3) % 5.1 4.6 4.8 5.0 4.7 4.7 4.5 4.6 4.7 4.8 5.0 5.1 5.1
Consumerprices yoy 3.4 3.2 1.6 1.8 4.0 3.3 1.9 2.3 1.5 1.0 1.8 1.3 1.5
-Corerate4) yoy 2.2 2.5 2.3 1.7 2.4 2.8 2.7 2.7 2.4 2.1 2.1 1.9 1.7
Current-accountbalance3) bn$ -792 -857 -770 -770 -218 -229 -196 - - - - - -
1) Real (chain-weighted), quarterly figures: seasonally adjusted change on quarter, expressed as annual rate; 2) equipment and software and commercial buildings; 3)
quarterly figures seasonally adjusted; 4) consumer prices excluding food and energy; yoy/qoq = percentage change on year/quarter; forecasts shaded.
Sources: Global Insight, Commerzbank Economic Research

4  2 April 2007
 ECONOMIC RESEARCH

Nextyeartheeconomyshouldgainsomemomentumbutwithoutachievingagrowthrate
above potential. Investment demand and residential construction should stabilise. How-
ever,thewealtheffectfromhousepricesonconsumptiongrowthshouldactuallybelarger
in2008thanthisyear.AnnualGDPgrowthin2008shouldbe2¼%.

Inflation pressure easing

Despitethesharpdropinenergypricesitistooearlyforanall-clearontheinflationfront.
Althoughtheyear-on-yearchangeintheCPIhasfallenconsiderablyandwillprobablyde-
cline further in 2007 (see chart 2), the underlying upward pressure on prices at the con-
sumer level remains high. The annual core inflation rate is expected to remain close to
2½% into the spring. Rents, for example, are set to increase at an above-average pace
overthenextfewmonths.Therecentsubstantialdropinautopriceswilllikelyfadeascar
makers work off their inventory overhang. Later on in the year, though, price pressure
shouldease,andtherearevirtuallynosignsofawage-pricespiralorofanyseriousinfla-
tion problems. The employment cost index is the most reliable indicator of wage cost
growth,andthisisstillrisingonlymoderately.Welookforannualinflationasmeasuredby
thecoreCPItofalltoaround2%.

Fed to react to recession risks and cut rates in late summer

Against this backdrop, the Fed is unlikely to raise interest rates further, especially as the
economyisexpectedtogrowatapacebelowpotentialoverthenextquarters.Although
theFederalOpenMarketCommittee(FOMC)keptitsasymmetricriskassessmentinplace
at the March meeting, it gained some additional freedom of action by deleting the pre-
commitmenttofurtherratehikes.Welookforaperiodofslowgrowthandagradualde-
clineinpricepressure.ThatshouldcausetheFedtoswitchtoaneutralriskassessmentin
thecomingmonths.However,duetoremainingupsiderisksontheinflationrateanynear
termratecutsseemunlikely.Onlywhenunemploymentstartstoshowasignificantrisedo
weexpecttheFedtoreacttoincreasingrecessionrisks.
We look for rate cuts totalling 75 basis points starting in August. The funds rate is then
likelytostayat4.5%,asgrowthshouldbegintopickuptowardstheendoftheyear.




CHART1: USA – growth to stay below potential  CHART2: USA – inflation pressures to ease
RealGDP,annualisedpercentagechangeonquarter,seasonally Consumerprices,percentagechangeonyear,monthlyfigures,
adjustedquarterlyfigures,forecastasofQ12007 forecastasofMarch2007


6 5

5 4

4 3
3 2
2 1
1 0
0 2004 2005 2006 2007 2008
2005 2006 2007 2008
headlineindex excludingfoodandenergy
 
Sources: Global Insight, Commerzbank Economic Research  Sources: Global Insight, Commerzbank Economic Research

2 April 2007  5
ECONOMIC RESEARCH

Eurozone: ECB checks growth

Christoph Weil
++496913624041
Theeurozoneeconomyisbooming,with2006fourth-quarterrealGDPup0.9%quarteron

quarter,and3.3%yearonyear.Thelasttimesuchahighyearonyearratewasachieved
wastheendof2000.Theupswinghasnowestablishedabroadbase:
• Investment picked up speed last year, and compared with the previous boom period,
investmentinmachineryandequipmenthasrisenbyroughly5percentagepointsmore
overthefouryearsfromitslowestpoint.Soundearningsandhighercapacityutilisation
suggestthatcorporateinvestmentshouldremaindynamic.
• The mood throughout the economy is one of optimism, despite the ECB’s rate hikes,
theUSeconomycoolingoffandGermany’staxincreases.Theindicatorsofsentiment
forindustry,constructionandretailareclosetothehighsofthelastboom,andonlyin
theservicesectorisconfidencestillwellbelowthelevelofthelastcyclicalhigh.
• Jobgrowthhasaccelerated,withthenumberofemployedpeoplerisingby2.15million
or1.6%lastyear.Theunemploymentratedroppedto7.4%inJanuary,thelowestlevel
since 1981.  Employment levels should continue to rise this year, as increased
productioncapacitywillcallforadditionalpersonnel.Ontopofthis,thelabour-market
reformsofrecentyearsnowseemtobetakingeffect,andstructuralunemploymentis
falling.
• The healthier labour market is also reflected in above-average consumer confidence,
suggesting that the increase in real disposable income may translate into stronger
consumerdemand.

Growth will lose momentum

Despite all the support forthcoming, the economy is unlikely to expand quite so rapidly
overthecourseofthisyearasithasbeendoing
• Aftertheusualdelay,theratehikestotalling175basispointswillhelptoreinindemand.

• Withglobaldemandnolongerquitesobuoyant,andtheeuronowstronger,theexport
boomcanbeexpectedtoeaseoff.
• ThetaxeshikesandotherfiscalchargesinGermanandItalianwillhaveamarkedimpact
thisyear,cuttinggrowthintheeurozonebyalmostaquarterofapercentagepoint.
Oncetheshockofthehighertaxbillfades,theeconomyshouldpickupalittlemomentum
againthissummer,butitisunlikelytoreachtheexceptionalpaceofgrowthachievedlast
year.Onbalance,though,the2.4%envisagedthisyearwillstillbewellabovethelong-
termaverage.

TABLE3: Eurozone - economic forecast 2007/2008
Indicator 2005 2006 2007 2008 2006 2007 2008
Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
Consumerspending1)2) yoy/qoq 1.5 1.8 2.1 2.0 0.3 0.7 0.6 0.4 0.6 0.6 0.6 0.5 0.5
Capitalinvestment1)2) yoy/qoq 2.7 4.3 3.3 2.9 2.1 0.6 1.2 0.6 0.5 0.8 0.9 0.5 0.7
Domesticdemand1)2) yoy/qoq 1.8 2.4 2.7 2.4 0.9 0.7 0.1 1.0 0.6 0.7 0.7 0.7 0.6
Netexports2)3) % -0.3 0.4 -0.2 -0.8 0.0 -0.1 0.8 -0.5 -0.1 -0.2 -0.3 -0.1 -0.2
GDP 1)2) yoy 1.3 2.7 2.4 1.9 2.8 2.7 3.3 2.9 2.4 2.4 1.9 1.9 1.7
qoq 1.0 0.6 0.9 0.4 0.6 0.5 0.4 0.4 0.3
Unemploymentrate2) % 8.6 7.8 7.2 6.9 7.8 7.7 7.5 - - - - - -
Consumerprices yoy 2.2 2.2 1.7 1.7 2.5 2.1 1.8 1.8 1.4 1.5 1.9 1.8 1.4
-Corerate4) yoy 1.4 1.4 1.8 1.8 1.4 1.4 1.5 1.8 1.6 1.9 2.0 2.1 1.7
Current-accountbalance bn€ -8.3 -16.9 -10.0 10.0 -10.5 -4.5 11.0 - - - - - -
1) In constant prices; 2) quarterly figures seasonally adjusted; 3) percentage change in GDP; 4) consumer prices excl. energy, food, drink and tobacco; yoy/qoq =
percentage change on year/quarter; forecasts shaded. Sources: Global Insight, Commerzbank Economic Research

6  2 April 2007
 ECONOMIC RESEARCH

Inflation under control

As growth slows down, there will be less risk of the goods market or the labour market
overheating.Unitlabourcoststhroughouttheeconomycanbeexpecttoriseby1¼%this
year,onlyslightlyabovethe2006figureof1%.Thecoreinflationrateshouldremainvery
moderate,andpricestabilityasdefinedbytheECB’sinflationtargetshouldprevailinthe
region this year and next.  We expect consumer prices to rise by 1.7% in both years,
assuminganaveragepriceof$57forabarrelofBrendcrude.


ECB raises rates to 4%, cut to follow in mid-2008

Dr. Michael Schubert
++496913623700
CHART3:Eurozone - inflation down to under 2%
Consumerprices,percentagechangeonyear,forecastasofApril
2007
WeareexpectingtheECBtoraiseinterestratesafinaltimeinJuneto4.0%.Atthattime,
leadingindicatorswillhavefallenonlymarginally,sothattheECBwillnodoubtsticktoits
optimisticoutlookfortheeconomy.
Afterwards,theECBislikelytotakeupawait-and-seestance.Indicatorsofsentimentto
which the bank pays close attention, such as the Economic Sentiment Indicator, can be
expected to fall more quickly. Furthermore, leaving interest rates unchanged would be in
line with a more pronounced weakening of the US economy. We expect the Fed to cut
ratesbyatotalamountof75basispointsbetweenAugustandOctober.
Our longer-term view differs considerably from the bank’s, though, not only as regards
economicperformance.Foronething,weexpect1.7%growthnextyear,whichisroughly
threequartersofapercentagepointlowerthantheECBforecast.Secondly,whileinflation
islikelytoreacharound2%attheturnoftheyear,itshouldaverage1.7%in2008,which
is roughly a third of a percentage point less than the ECB envisages.  And finally, M3
growthissettoslowdownastheeconomyshiftsdownagear.Moreover,thebankwill
probably take greater account than it has been doing of the factthat monetary growth is
strongpreciselybecauseofitsratehikes.Theflatyieldcurveafterallmeansthatthereis
little incentive to opt for longer-term commitments, i.e. outside M3.  If we are right, the
ECB’sreappraisalshouldintheendpromptittocutrates,asthebankwillhavetorevise
its view of the economy quite drastically, and it will no doubt also see little danger of
inflationaccelerating.Weexpectafirstratecutinthemiddleof2008.




 CHART4: Key rate determined by inflation and growth
expectations
EuriborandTaylorRuleonbasisofprojectionsforgrowthand
inflation


5.5
3.0

2.5 4.5

2.0 3.5

1.5
2.5
1.0
2004 2005 2006 2007 2008 1.5
99 00 01 02 03 04 05 06 07
headlineindex excl.energy,food,alcoholandtobacco Euribor Taylorrate(consensus) Taylorrate(ECBprojections)
 
Sources: Global Insight, Commerzbank Economic Research  Sources: Economist, ECB, Commerzbank Economic Research

2 April 2007  7
ECONOMIC RESEARCH

Germany: The boom is over

Matthias Rubisch Last year was one of the best for a long time, with no less than 2.7% economic
++4969136-22227 growththankstoanumberoffactors.Theglobaleconomywasflourishingtoo,and
theeurowassomewhatweaker,leavingexporterswitharecordrealgrowthofover
12%.Thingsbrighteneduponthedomesticfronttoo:Investmentintheconstruction
industryexpandedmorethanithaddonefor12years.Unfortunately,thesamecan-
not be said of consumption, which rose far more modestly.  No-one could have pre-
dictedtheseresultsayearorsoago,butatthesametimeitwouldbeprematureto
assumethatthetrendwillsimplycontinue. Anumberofbackgroundfactorsarefar
lessfavourablethanayearago,andtherecouldbesomeupsetsahead:
• AslowdownintheUSwillaffecttheentireglobaleconomy,andtheeuroislikelyto
provesomewhatstrongerthanitwaslastyear.Asaresult,Germanexportgrowth
willhardlykeeppacewithlastyear’sresult.Stagnatingordersfromabroadinthe
secondhalfoflastyearareanindicationthattheslowdownisalreadyinfullswing.
• The main reason for strong investment in construction last year was the rush to
build homes before the owner-occupier subsidy was abolished, and to avoid this
year’sVAThike.Thisisreflectedinthesubsequentdownturninorders.However,
output in the construction industry was aided up to the spring by the mild winter
weather,sotheprocessofcorrectionhasnotyetsetin.
• The ECB’s rate hikes of 175 basis points will rein in the economy.  After an
additional increases expected in June, the key rate of 4.0% will then have a
restrictiveeffect.
• Theconsolidationpackagewhich came intoforceinJanuary,the mainelementof
whichwastheVATincrease,leavestheprivatesectorshortof€20bnonbalance,or
almost1%ofGDP.
Our Early Bird indicator for the monetary and foreign-trade environment clearly illus-
tratesthedownturninunderlyingconditions(seegraph5).Thetaxhikeinparticular
canbeexpectedtotranslateintoonlymodestgrowthinthefirsthalf.Thegenerous
carry-overfromlastyear–GDPwasup1.3%onthe2006averageatyear-end–will
neverthelessmeangrowthabovethelong-termaverage.
Second-half growth should prove somewhat stronger, as by then there will be little
fallout from the tax hikes, and there should also be some good news favouring
growth:


TABLE4: Germany - economic forecast 2007/2008
Indicator 2005 2006 2007 2008 2006 2007 2008
Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
Consumerspending1)2 yoy/qoq 0.1 0.8 0.9 1.7 -0.1 0.7 0.3 -0.5 0.5 0.5 0.5 0.3 0.3
Capitalinvestment1)2) yoy/qoq 0.8 5.6 2.7 2.2 4.4 1.1 1.0 1.5 -1.8 0.5 1.0 0.0 0.8
Domesticdemand1)2 yoy/qoq 0.5 1.6 1.6 2.2 1.1 0.3 -1.3 1.6 0.3 0.6 0.6 0.5 0.4
Exports1)2 yoy/qoq 6.9 12.5 7.1 7.4 0.7 4.5 6.0 -1.8 1.5 1.5 1.5 1.8 1.8
Imports1)2 yoy/qoq 6.5 11.1 7.2 9.0 0.4 4.0 1.6 1.2 1.7 2.1 2.1 2.1 2.0
GDP1)2 yoy 0.9 2.7 1.7 1.8 2.8 3.1 3.7 2.9 2.0 1.6 1.1 1.4 1.5
 qoq – – – – 1.2 0.8 0.9 0.1 0.3 0.4 0.4 0.4 0.3
Unemploymentrate2) % 11.7 10.8 9.2 8.7 11.1 10.6 10.1 9.3 9.2 9.1 8.9 8.9 8.8
Consumerprices yoy 2.0 1.7 1.4 1.0 2.0 1.6 1.3 1.7 1.4 1.1 1.1 0.9 0.8
-Corerate3) yoy 1.3 0.9 1.6 1.2 0.9 0.9 1.1 1.6 1.8 1.8 1.5 1.3 1.1
Current-accountbalance2) bn€ 90.3 100.9 110 95 24.3 22.3 35.5 – – – – – –
1) In prices of the previous year; 2) quarterly figures seasonally adjusted; 3) Consumer prices excl. energy and food; yoy/qoq = percentage change on year/quarter;
forecasts shaded. Sources: Global Insight, Commerzbank Economic Research

8  2 April 2007
 ECONOMIC RESEARCH

• Lowerenergypriceshaveboostedprivatehouseholds’purchasingpower,amarked
improvementonrecentyears.Consumerpricesarelikelytoriselessthanlastyear,
despitetheVATincrease.
• Last year’s strong growth has led to a turnaround on the labour market, and the
trendshouldcontinue,albeitataslowerpace,onaccountofthetimeittakesfora
morebuoyanteconomytotricklethroughtoemployment.Inaddition,wagegrowth
is likely to prove stronger than in recent years, and this in turn will favour private
consumption.
• Cost-cuttingmeasuresandgeneralwagerestraintinrecentyearshaveleftGerman
companiesfarmorecompetitiveandraisedtheirearningsconsiderably.Thispoints
tosteadygrowthincorporateinvestment,althoughhigherwagecostsandinterest
rateswillreininearningsgrowth.
Inspiteoftheseencouragingdevelopments,growthratesarestilllikelytofallshortof
lastyear’s,asindicatedabove,andevenlessmomentumseemsprobablein2008.By
thattime,higherinterestrateswillincreasinglybemakingtheirmark,andweexpect
no more than 1.8% growth.  Of this, 0.3 percentage points can be accounted for by
the larger number of working days, i.e. the pace of activity will no doubt be slightly
belowthelong-termaverage.

Inflation still moderate

Sofar,thehigherVATratehashadlessimpactonpricesthangenerallyexpected,but
ithashadsomeeffect(seegraph6).Thedropinenergypricestolevelsjustalittle
above their year-ago equivalents has helped rein in headline inflation, though, and
apart from the VAT increase there is little other domestic pressure on prices.  The
moderate pay settlements of recent years are still having a positive effect, and we
envisagenomorethan1.4%inflationthisyear.Moregenerouspayawardsthisyear
are more a return to normal procedure than a threat to price stability, and in the ab-
sence of additional tax hikes, and provided energy prices remain stable, the inflation
rateshoulddropbackto1%in2008.

CHART5: Germany - unfavourable economic conditions  CHART6: Germany - low inflation pressure apart from tax
CommerzbankLeadingIndicatorfortheGermaneconomy effects
Consumerprices,percentagechangeonyear,forecastasofApril
2007

2.0
 3.0

1.5 2.5

1.0 2.0

1.5
0.5
1.0
0.0
0.5
-0.5
0.0
-1.0 2004 2005 2006 2007 2008
2003 2004 2005 2006 2007 headlineindex excludingenergyandfood
 
Sources: Commerzbank Economic Research  Sources: Global insight, Commerzbank Economic Research

2 April 2007  9
ECONOMIC RESEARCH

United Kingdom: Problems below the surface

Peter Dixon It is evident that GDP growth continues to run atabove-trend rates, eventhough the Q4
++442076537271
estimatewasreviseddownslightly.Butwhilstgrowthin2007islikelytoturnoutabove
trendonceagain,thisisnotthekeyissueatthetopoftheUKpolicyagenda.Thefirstis-
sueisinflation,andwhatitislikelytomeanforinterestrates.AlthoughCPIinflationinFeb-
ruarycameinaboveexpectations,at2.8%,itisstilllikelytobeclosetothecentreofthe
BoE'stargetbandbythesummeraslowerutilitybillsacttotaketheedgeoffinflation.But
the BoE continues to express fears that wage inflation may well react with a lag to the
pickupinpriceinflationlastyear.Forthisreason,wecontinuetolookforariseininterest
ratesinthespring.
The other feature of the economic landscape is the focus on government and external
deficits.Thecurrentaccountin2006registereditsbiggestdeficitsince1990andalthough
there are indications that the government deficit: GDP ratio is beginning to decline after
peaking in 2004, it is still sufficiently high to constrain the government's room for fiscal
manoeuvre.Indeed,ameasureofthedegreeofimbalancecanbegaugedbythefactthat
thesumofthetwodeficitsbreached6%ofGDPin2006–theworstperformancesince
1994.Overthenextcoupleofyears,wearelikelytoseethepublicdeficitdecline,asgov-
ernment spending is reined in, whilst we also look for the current account deficit to im-
proveonthebackofstrongerexportstotheeurozoneandamoderationinimportgrowth
as consumer spending loses momentum. Nonetheless, they will continue to remain live
issuesandthesizeofthecurrentaccountinparticularwillcontinuetoputdownwardpres-
sureonsterlingwhichisexpectedtodepreciatebyaround3%onaneffectivebasisover
thenexttwelvemonths.

Switzerland: SNB stays on a tightening course

Patrick Franke The Swiss economy retains quite a bit of momentum. In Q4 real GDP growth, at 0.5%
++496913624525
quarter-on-quarter,wasstillinlinewithitstrendof1½%to2%p.a.Inthecomingquarters,
theeconomyshouldcontinuetoexpandatapaceofroughly½%,especiallyasthedentin
GermangrowthinQ12007islikelytobesmallerthanpreviouslythought.
Inflationisexpectedtoremainlowthroughtheforecasthorizon.Atthetwo-yearhorizonof
the Swiss National Bank (SNB) its definition of price stability – an increase in consumer
pricesoflessthan2%p.a.–shouldbeachieved.AgainstthisbackdroptheSNBhascon-
tinuedonitscourseofinterestratenormalisationandraisedthetargetcorridorforthe3-
monthLIBORinMarchby25bpsto1.75%-2.75%,aimingforthemid-pointat2.25%.It
alsoannounceditsintentiontograduallyremovepolicyaccommodationfurther.Bythefall
of2007theLIBORrateshouldreach2.75%.Lowinflationisultimatelynotanobstaclein
thisregard.Inaddition,therecentweaknessoftheSwissfranc(seep.17)alsosupports
furtherratehikes.

TABLE5: United Kingdom – economic forecasts 2007/2008 TABLE6:Switzerland - economic forecasts 2007/2008
Indicator 2005 2006 2007 2008 Indicator 2005 2006 2007 2008
Consumerspending1) yoy/qoq 1.4 1.9 2.6 2.0 Consumerspending1) yoy/qoq 1.3 1.9 1.8 1.5
Capitalinvestment1) yoy/qoq 3.0 6.5 4.7 3.3 Capitalinvestment1) yoy/qoq 2.9 6.9 3.8 1.4
Domesticdemand1) yoy/qoq 1.9 3.0 2.5 2.4 Domesticdemand1) yoy/qoq 1.4 2.1 1.8 1.2
Exports1) yoy/qoq 7.9 11.6 -0.6 5.6 Exports1) yoy/qoq 6.3 10.0 7.0 3.8
Imports1) yoy/qoq 7.0 11.8 -1.2 4.9 Imports1) yoy/qoq 5.3 9.9 8.0 3.0
GDP1) yoy 1.9 2.7 2.9 2.6 GDP1) yoy 1.9 2.8 2.0 1.8
Unemploymentrate % 4.9 5.4 5.4 4.9 Unemploymentrate % 3.8 3.3 3.0 2.8
Consumerprices yoy 2.1 2.3 2.4 1.9 Consumerprices yoy 1.2 1.0 0.8 1.3
Current-accountbalance bn£ -29.2 -43.4 -32.1 -31.7 Current-accountbalance bnsfr 75 80 75 70
1) In constant prices; yoy/qoq = percentage change on year/quarter; 1) In constant prices; yoy/qoq = percentage change on year/quarter;
forecasts shaded. forecasts shaded.
Sources: Global Insight, Commerzbank Economic Research Sources: Global Insight, Commerzbank Economic Research

10  2 April 2007

 ECONOMIC RESEARCH

Eastern Europe
Barbara Nestor Poland: growth accelerates
++442076537651 Economic activity has remained robust this year and data point to further acceleration of
GDPgrowth.Bothcorporatecredit-andprofitgrowthindicatethatthecurrenthighrateof
investmentgrowthhasprobablybeensustained.Inlinewiththis,theNBPtakesaccount
oftheriseinthenon-inflationarygrowthrateoftheeconomy.However,privateconsump-
tionhasalsobeenstrengtheningonthebackofacceleratingwagegrowthandconsumer
loansandconsumptiongrowthmayhavethusacceleratedto6%vs4.5%lastquarter.The
tightening of the labour market and the accompanying increase in wage growth suggest
that the service sector may experience a pick up in price pressures notwithstanding the
expectedstrongproductivitygrowthinothersectors.Inordertomaintaintheoverallinfla-
tionratecloseto2.5%,monetarytighteningmaybeneeded.TheNBPappearstobeap-
proaching a consensus on raising interest rates in Q2-Q3. This should contribute to the
attractivenessofthezloty,whichislikelytoappreciatethisyear.

Czech Republic: fiscal woes
The Czech economy continues to grow at an above-trend pace as domestic demand is
gainingstrength.Consumptionissupportedbythecontinuedrapidexpansionofcreditand
steadywagegrowth.Atthesametime,anotherinvestmentcycleintheautosectorisun-
der way. GDP growth is continuing at a 5.5%-6% pace, which is stronger than forecast,
but the CNB still looks for a gradual narrowing of the positive output gap in the coming
quarters.Despitestronggrowth,thegovernmentisplanningtosella7%(US$1.7bn)stake
instatepowerfirmCEZtoplugagapinthebudget,whichisexpectedtowidenfurtherin
2007 to CZK 91.3bn or 4.2% of GDP, vs 3.3% target in the country’s convergence pro-
gramme.Aslowinflationprevails,however,interestrateswillstillremainunchanged.

Hungary: conflict of dual monetary targets

TheinconsistencyoftheHungarianmonetaryframeworkhasbeenrepeatedlyhighlighted,
mostrecentlybytheappreciationoftheexchangeratetowardthestrongendofthetarget
band. Although the recent inflation shock is likely to have been contained, any additional
inflation shock may have to be overlooked if and when no further monetary tightening is
consistentwiththeexchangerateband.InthatcasetheNBHwouldhavetoabandonits
inflationtarget.Asharperthanexpectedslowdownofdomesticdemandandslowingcore
inflationmaythistimeallowtheNBHtogetawaywithitsdualtargets.However,inalow
volatilityenvironment,theimprovingriskpremiumofthesovereignmaykeeptheHUFata
10%-15%rangevsparityandrequiretheNBHtocutratesearly.Withthegovernment’s
EMUtargetshiftedoutto2012-2014,thefreefloatingoftheforintwouldbenecessaryand
reasonablethisyear.

CHART7: Still on track for growth  CHART8: Hungary’s inflation rate has surged
RealGDP,percentagechangeonyear Consumerprices,percentagechangeonyear


8.0 10
7.0
8
6.0
5.0 6
4.0
3.0 4
2.0
2
1.0
0.0 0
2001 2002 2003 2004 2005 2006 2005 2006 2007

Poland Hungary CzechRep. Poland Hungary CzechRep.

 
Sources: Global Insight, Commerzbank Economic Research  Sources: Global Insight, Commerzbank Economic Research

2 April 2007  11

ECONOMIC RESEARCH

Japan: Short breather – upward trend intact

Dr. Gerald Müller
++496913624527
Againstthebackdropofweakordersformachinery,theslowdownoftheUSeconomy
andtheexpectedinventoryadjustmentofelectronicpartsanddevicesJapan’secon-
omyseemstobefacingadentinthefirsthalfoftheyear.Thefourthquarteroflast
yearsawstronggrowthof1.2%quarteronquarter,butthisislikelytobefollowedby
a considerable slowdown.  We envisage a figure of +0.2% in the first half, which
wouldalsobeinlinewithoutputexpectationsgivenintherecentsurveyonindustrial
production.
However,theperiodofcorrectionwillprobablynotbeallthatlong,andinthemedium
termtherewillbesupportfrombothprivateconsumptionandinvestment.Highlevels
ofcapacityutilisationinmanyareassuggestthatinvestmentswillbemadeinexpand-
ingcapacity.Financingcostsremainverylow,andtheflowoffundsstatisticsshow
thatcompanieswhichreliedlargelyontheirownfundstofinanceinvestmentsinthe
earlystagesoftherecoveryarenowturningincreasinglytothecapital market. This
trendshouldcontinue,graduallyleadingtohigherinterestrates.Sinceinterestrates
arestillverylowatpresent,itishardlysurprisingthatlandpricessoaredlastyear,es-
peciallyforcommercialuseinbigcities,insomeinstancesbymorethan20%.
Private households showed a reluctance to spend on consumption during the last
three months of 2006, but the retail sales figures for January and February point to
solid growth.  This makes our forecast of 0.4% growth in real private consumption
during the first quarter rather conservative.  The reason often given for consumers’
reticenceinthesecondhalfoflastyeariswages,whichinfactbarelyroselastyear,
contrary to expectations.  However, at the same time this also meant a drop in unit
labourcostsandstrongdemandforlabour.Companiesarenowcomplainingincreas-
inglythatithasbecomedifficulttofindgoodstaff.Wagescanthusbeexpectedto
start rising soon, especially in areas where there is already a shortage of labour.  As
yet, though, wages are exerting little pressure on consumer prices.  We are in fact
expectingthemtofall,asmeasuredontheaggregateindex,thankstofallingenergy
pricesandmobilephonecharges.Weenvisage-0.1%inflationthisyearand0.5%in
2008.
The Bank of Japan raised the overnight rate to 0.5% in February but left it at that in
March.Theminutesofthebank’smeetingsrevealthatinthebank’sviewthevirtu-
ouscircleofproduction,incomeandspendingremainedintact.Thebank,too,notes
increasing shortages on the labour market and rising real-estate prices.  So although
thereislittlepressureonpricesatpresent,thesecanbeexpectedtoriselateronin
theyear.However,thebriefweakperiodwhichweenvisagewillnodoubtdiscourage
thebankfromraisinginterestratesduringthefirsthalfoftheyear,andweexpectthe
nextmoveinAugust–aftertheelectiontotheupperhouseofparliament.


TABLE7: Japan - economic forecast 2007/2008 CHART9: Japan – Flat prices on the rise
Indicator 2005 2006 2007 2008 Index1995=100
Consumerspending1) yoy/qoq 1.5 0.9 1.2 2.0
Capitalinvestment1) yoy/qoq 6.6 7.3 4.8 4.6 115
Domesticdemand1) yoy/qoq 1.6 1.4 1.5 1.8 110
105
Exports1) yoy/qoq 6.9 9.7 5.1 5.9
100
Imports1) yoy/qoq 5.8 4.6 3.9 6.6 95
GDP1) yoy 1.9 2.2 1.8 1.9 90
Unemploymentrate % 4.4 4.1 4.0 3.7 85
Consumerprices yoy -0.3 0.2 -0.1 0.5 80
75
Current-accountbalance trill.yen 18.3 18.3 17.5 21.2
70
1) In constant prices; yoy/qoq = percentage change on year/quarter; 1995 1997 1999 2001 2003 2005 2007
forecasts shaded.
Sources: Global Insight, Commerzbank Economic Research

Sources: Cabinet Office, Global Insight, Commerzbank Economic Research

12  2 April 2007

 ECONOMIC RESEARCH

China: Can growth be held in check?

Dr. Michaela Kuhl TheChinesegovernmentwantstolimitgrowthto8%thisyear,butmaynotbeable
++496913621747
to do so.  Both investment and foreign trade, the main drivers of growth in recent
years,arestillexpandingrapidly.Urbaninvestmentwasupbyover23%yearonyear
during January and February, and while this is a smaller figure than that achieved at
thestartof2006,investmentinreal-estatealsoroseby24%.Thegovernmentispar-
ticularly eager to rein this in, as it sees a threat of over-investment.  The country’s
tradesurpluscontinuedtogrowinthefirsttwomonthsoftheyear,reaching$23.75bn
in February.  The total surplus for January and February was three times that of last
year.
Thegovernmentisanxioustoimprovethequalityofgrowth,andisconcernedabout
thefactthatChinaproduces5.5%ofglobaleconomicoutputbutuses15%ofglobal
resourcestodoso.Itisconcernednotleastofallinthiscontextabouttheenviron-
mentalimpactondailylife(airandwaterquality).Thecountryfellfarshortlastyearof
the target set in the 11th five-year plan (covering 2006-2010) of cutting energy con-
sumptionperunitofGDPby4%in2006,insteadreachingonly1.2%.Notargetwas
even set for this year, and reference was merely made to the fact that energy con-
sumptionperGDPunitistobecutby20%from2006to2010,andnoxiousemissions
by10%.Infact,though,thelatteractuallyincreasedin2006.
The central bank raised interest rates in mid-March, taking the deposit and lending
ratesup0.27percentagepointsto2.79%and6.39%respectively.Thisleavesinter-
est rates at their highest level in eight years.  Prior to this, the reserve requirement
wasraisedtwice.Theaimofallthesemeasuresistoreininbanks’generouslending
and help dampen galloping growth and inflation.  The latter has soared in recent
months,reaching2.7%inFebruary.Itwaspusheduplargelybyasharpriseinfood
prices, which account for one third of China’s basket of goods.  The government is
hopingtokeeppriceincreasesbelow3%thisyear,andthecentralbankisconfident
thatinflationwillnotriseanyfurther,asfoodpricesarelikelytoincreaselessrapidly
overthenextfewmonths.
ThePeople’sCongresspassedaresolutiononpropertyrightsplacingprivateproperty
on an equal footing with public property.  It remains to be seen whether individual
rights will actually be generally enforceable, though.  The new law is in any case of
littlevaluetofarmers,astheystillonlyenjoylanduserights,i.e.theywillstillnotbe
abletosell‘their’landorborrowagainstit.Themiddleclassandthebusinesssector
willbegivengreaterlegalsecurity,however.



TABLE8: China - economic forecast 2007/2008 CHART10: China – Trade surplus still rising
Indicator 2005 2006 2007 2008 bnUS-Dollar
Consumerspending1) yoy/qoq 7.0 7.0 7.5 8.5
Capitalinvestment1) yoy/qoq 17.9 17.0 14.0 12.5 30
Domesticdemand1) yoy/qoq 9.5 10.0 9.5 9.5 25
Exports1) yoy/qoq 20.1 20.5 18.0 15.0 20
Imports1) yoy/qoq 13.0 19.0 17.5 16.5 15
GDP 1) yoy 10.4 10.7 9.5 9.0 10
Unemploymentrate % 9.7 9.7 9.6 9.6 5
Consumerprices yoy 1.8 1.5 2.5 2.5 0
Current-accountbalance bn$ 161 205 225 220 -5
1) In constant prices; yoy/qoq = percentage change on year/quarter; -10
forecasts shaded.
2002 2003 2004 2005 2006 2007
Sources: Global Insight, Commerzbank Economic Research

Sources: Global Insight, Commerzbank Economic Research

2 April 2007  13

ECONOMIC RESEARCH

Dr. Christoph Balz
++4969136-24889
Bond markets
USA: yield low this summer

USyieldshavebeenpusheddowninrecentweeksbyanumberoffactors:Onewasthe
question of whether defaults on sub-prime mortgages could infect the economy as a
whole.  The second was the disappointing order intake figures for capital goods, which
point to a serious slowdown in corporate investment.  Thirdly, the bond market has
benefittedfromtheupsetsontheequitymarketasinvestorsfledtosaferinvestments.
We expect yields to continue their slide over the months ahead.  For one thing, the US
economyhaslostconsiderablemomentum,owingmainlytotheFed’sratehikestotalling
425basispointsfrommid-2004tomid-2006.Economicgrowthwellbelowthelong-term
averageof3%willnodoubtprompttheFedtocutratesinthesecondhalfoftheyearbya
totalof75basispoints.Inthisclimate,the10-yearyieldcanbeexpectedtodropto4.30%
(seetable10,p.20).Wedonotseeitfallingbelowthislevel,sincelongbondsarealready
offering a much smaller yield than short-term investments.  Moreover, the market has
alreadypricedinalargepartofthismove.Themoneymarkethasfactoredinaratecuton
muchthesamescaleasweenvisage,althoughataratherlatedate,assuggestedatleast
byforwardratesforthree-monthmoney(seegraph11).
ItshouldthenbegenerallyrecognisedthisautumnthattheslowdownintheUSdoesnot
meantheeconomyisheadingforarecession,butthatinthewakeofratecutsitshould
starttopickupspeedagainin2008.Asaresult,speculationonadditionalFedratecuts
shouldfade,andthe10-yearyieldshouldriseagain(seegraph12).
Norareyieldslikelytorisedrastically,though,aseveniftheeconomystrengthensalittlein
2008,USconsumerspendingwillstillbeinfluencedbythefalloutfromtheailinghousing
market.Thebond-marketenvironmentwillalsobeaidedbythefactthatfollowingaperiod
ofsub-trendgrowth,pricesshouldnotincreasetoomuch.Wethereforeexpecta10-year
Treasuryyieldof4.6%inayear’stime.


CHART11: Rate cut in second half  CHART12: Yield low likely in summer 2008
Three-monthdollarLiborinpercentp.a. 10-yearTreasuryyield,forecastasofApril


5.6
5.5
5.4
5.2 5.0
5.0
4.8 4.5
4.6
4.0
4.4
4.2 3.5
spot Mar-07 Jun-07 Sep-07 Dec-07 Mar-08
2/4/2007 3.0
2004 2005 2006 2007 2008
money-marketfutures Commerzbankforecasts
 
Sources: Commerzbank Economic Research, Bloomberg  Sources: Commerzbank Economic Research, Federal Reserve

14  2 April 2007

 ECONOMIC RESEARCH

Eurozone: rise in yields coming to an end

OnthestrengthofourassessmentoftheUSbondmarketandECBpolicy,thetwomain
influencesoneurozoneyields,weexpectyieldsatthecurrentorslightlylowerlevelsover
therestofthisyearandin2008.
The main factor for the euro bond market over the coming months will be US Treasury
yields.Weareexpectingthesetodropasfaras4.30%thissummer,sincealessbuoyant
USeconomywillnodoubttranslateintoFedratecutsof75basispointsinthesecondhalf
oftheyear.
Eurozonemonetarypolicywillprobablytakeabackseat,though.Whileweareexpecting
the ECB to raise interest rates by 25 points to 4% in June, the move is unlikely to push
yields up any further, since money-market forward rates indicate that a rate hike has
already been priced in (see graph 13).  Consequently, the yield on 10-year Bunds should
droptobelow4%thissummer(seetable10,p.20).
OncetheUSeconomyhasstabilisedagainthisautumn,andthemarketcomestoexpect
the Fed’s rate cuts totrigger a recovery, both US and Bund yields should rise again, and
weenvisagea10-yearyieldintheeurozoneof4%attheendoftheyear.
Itislikelytodropbackbelowthe4%marknextspringthough,asspeculationonratecuts
in the region emerges.  By that time, the ECB should have to come to accept that the
eurozone is not immune to the global downturn, and that its growth and inflation
projectionswillhavetobelowered.Weexpectafirstratecutof25basispointsinmid-
2008.
As a result, the second half of 2007 will probably see an inverse yield curve.  In other
words, we expect the 10-year yield to fall roughly 10 basis points below the level of the
two-year yield.  The situation should return to normal next year, as the prospect of ECB
ratecutsislikelytomeantheyieldonshortbondsfallingmorethanthelongbondyield.
WeexpectthespreadwithUS10-yearTreasuriestonarrowtoaround40basispointsby
the summer, as the Fed will be cutting its key interest rate then, while the ECB will be
pursuingasteadycourse.Thespreadislikelytowidento80pointsagainnextyear,asthe
ECB will no doubt lower interest rates then, whereas the Fed will leave its rates
unchanged.




CHART13: Market has priced in ECB rate hike to 4.25%  CHART14: End to yield climb
Three-monthEuriborinpercentp.a. Yieldon10-yearBunds,forecastasofApril


4.5 4.5

4.0
4.0

3.5

3.5
3.0
spot Mar-07 Jun-07 Sep-07 Dec-07 Mar-08
2/4/2007 3.0
2004 2005 2006 2007 2008
money-marketfutures Commerzbankforecasts
 
Sources: Commerzbank Economic Research, Bloomberg  Sources: Commerzbank Economic Research, Bloomberg

2 April 2007  15

ECONOMIC RESEARCH

Foreign-exchange markets
Dr. Michael Schubert Dollar under pressure in coming months
++496913623700
Theeuroroseto$1.33inMarch,owinglargelytothefollowing:
• anumberofsurprisinglypoorUSresults(seegraph15),

• acrisisontheUSmarketforsub-primemortgages,

• the Fed’s comments on its decision of 21 March.  It no longer specifically spoke of a
possiblefirmingofmonetarypolicy,butmoreneutrallyofanadjustment.
Nevertheless, the euro is still lower than might have been envisaged in view of the ex-
pectedinterest-ratespread(seegraph16).
The dollar will probably remain under pressure for the time being, since compared with
currentmarketexpectationswearepredictingstrongerFedratecutsinthesecondhalfof
thisyear.Inaddition,ourforecastofanECBratehikeinJuneiscurrentlynotfullypriced
in.
Inthemediumterm,though,weenvisageonlylimiteddownwardpressureonthedollar,
astheexchangerateisalreadybeingclearlyinfluencedbytherisksarisingfromthelarge
US current-account deficit.  It has been possible to explain the euro-dollar exchange rate
sincethe80s(andthedollar-D-markratepriorto1999)largelyintermsoftheyieldspread
and the productivity gap. There have been just a few exceptions: adjustment of the US
current-accountdeficitinthesecondhalfofthe80s,theneweconomyboomatthestart
ofthedecadeandthepresentsituation(seegraph17).Thedegreetowhichtheeurois
influenced by the US current-account deficit is meanwhile much the same as during the
processofadjustmentinthe80s.
Norisitclearatwhatpointacurrent-accountdeficitbecomesunsustainable.Therehave
beenpredictionsforyearsnowofthesituationtakingoncrisisproportionsintheformofa
seriousretreatofinternationalcapitalfromtheUS.Sofar,though,theyhaveprovedfalse,
andtherisksarisingfromthedeficitmaywellbeover-estimated:
• TheUSnetinternationalinvestmentpositionisnotnearlyasnegativeasthecumulative
current-account deficits would suggest, since it has improved in itself on account of
valuationgains,afactnotreflectedinthecurrent-accountstatistics.


CHART15: Unexpectedly bad US data undermine dollar  CHART16: Euro to be expected at 1.35 USD
Euroexchangerateandbalanceofsurprisinglynegativeandpositive Euroexchangerateandexpectedinterestratespreadobtainedfrom
USdata,cumulatednumbersincebeginningof2004 forwardratesforthree-monthmoneyinsixmonths'time

 -0.8 1.36
25 1.35
20
1.30
15 -1.2 1.31
10 1.25
5 -1.6 1.26
0 1.20
-5 -2 1.21
1.15
-10
-15 1.10
-2.4 1.16
2004 2005 2006 2007
Dec-04 Jun-05 Dec-05 Jun-06 Dec-06
cumulatedno.ofsurpriseUSdata(l) EUR-USD,8-weekmo.average(r) expectedspread(l) USDperEUR(r)
 
Sources: Bloomberg, Commerzbank Economic Research  Sources: Bloomberg, Commerzbank Economic Research

16  2 April 2007

 ECONOMIC RESEARCH

• TheUShasmoreinternationalcapitalavailablenowtofinancethedeficitthaninearlier
decades,asthetraditionalhomebiasofothercountriesinfavouroftheirownsecurities
hasmeanwhilegrownfarlessmarked.
• ItissometimesarguedthatanumberofAsiancentralbanksarebuildinguplargedollar
reservesinordertosupporttheirowneconomyviaafixedexchangeratetothedollar.
The US current-account deficit is said to be financed by mounting dollar reserves
elsewhere,whichwouldmeanthatitcanbesustainedforquitesometime.
Ourcurrent-accountdeficitforecastalsopointstonomorethanmoderateeurogains.We
expectthedeficittodropsubstantiallyto5.3%ofGDPbytheendoftheyear,compared
withafigureofalmost7%inthethirdquarteroflastyear.Moreover,iftheECBstartsto
lowerinterestratesasweenvisagefrommid-2008,thiswillalsosupportthedollar.Incon-
crete terms, we expect an exchange rate of $1.36 to the euro at the end of September,
and$1.31inmid-2008.


Swiss franc: Weakness not over yet

Patrick Franke TheSwissfranchasbeenlosinggroundtotheeuroalmostcontinuouslysinceMay.Aftera
++496913624525 temporary rebound to 1.60 francs per euro, weakness resumed and it recently traded at
around1.62francspereuro.Apartfrompositivesurprisesconcerningthestrengthofthe
euro zone economy, the continued depreciation is also likely to reflect so-called “carry
trades”, whereby investors borrow at low Swiss interest rates and invest the money
abroad.
WenowlookfortheECBtotightenbyanextra25bps,butfortheSwissNationalBank
(SNB)totightenpolicybyatotalof50bpsoverthecomingsixmonths.InSwitzerland,the
weakfrancisplayingarolehere,astheSNBisexpectedtotrytocounteranundesirable
easingofmonetaryconditions.
Bymid-2008theECBisexpectedtocutinterestrates,whilsttheSNBremainsonholdfor
awhilelonger.Thecarrytradesshouldalreadybegintolosesomemomentuminthecom-
ingmonths.Inthemediumterm,thefrancwillthusregainsomeground(seechart18).We
expectanexchangerateof1.57francspereuroinayear’stime.



CHART17: Regression model - euro-dollar exchange rate  CHART18: Franc weakness not over yet
clearly influenced by US current account deficit SwissFrancpereuro,month-endfigures,forecastasofApril2007
Explanatoryvariables:bondyieldspreadanddifferencesin
productivity;priorto1999:D-mark/dollar

1.5

1.65
1.4
1.3 1.60
1.2
1.1 1.55
1.0
1.50
0.9
0.8
1.45
90 92 94 96 98 00 02 04 06 08
2003 2004 2005 2006 2007 2008
USDperEuro 90%confidenceband
 
Sources: Global Insight, Commerzbank Economic Research  Sources: Bloomberg, Commerzbank Economic Research

2 April 2007  17

ECONOMIC RESEARCH

Dr. Gerald Müller Sterling: Under pressure from a further ECB rate hike
++496913624527 It seemed at the start of the year as if the Bank of England would have to continue
raising interest rates on a generous scale to combat inflation, but the situation has
meanwhileeased.Incontrast,speculationhascontinuedtomountintheeurozoneon
furtherratehikes,giventhesoundeconomicdata.Asaresult,thepoundlostaround
4%frommid-JanuarytotheendofMarch.
Itcouldreboundintheshortterm,butislikelytocontinueitsretreatinthemedium
term.Weexpecttheinterest-ratespreadtoshiftmoreinfavouroftheeurothanthe
financialmarketsenvisageatpresent.WhileweareexpectingtheECBtoraiseinter-
est rates another 25 basis points over the course of the year, the markets have not
fullypricedinthisstep.
Sterlingislikelytoremainunderpressureintonextyear,sinceitappearsovervalued,
given the size of the country’s current account deficit and its higher inflation rate.
Moreover,inautumntheBankofEnglandwillagainhavetheleewaytocutratesina
climateofeasinginflation,whereaswedonotenvisagetheECBloweringratesagain
beforesummer2008.Weexpectanexchangerateof£0.70totheeuroand$1.89to
thepoundin12months’time.

Yen: Boosted by greater aversion to risk

Theyenhasexperiencedaphaseofcorrectionintandemwiththeglobalequitymar-
kets.  It was at its weakest in mid-February, at 122 to the dollar, but had rallied to
115.5bythebeginningofMarch.Thecorrectionwastriggeredbyinvestorsbecoming
moreriskaverse.It’sonlyworthborrowingyenwhilethecurrencyisnotonthead-
vance, and the lower the yen, the greater the risk of it appreciating.  This is exactly
whathappened:Investorstriedtolimittheirlossesandruningoodtime,whichstead-
ilypushedtheyendown.Itsextremeundervaluationhasnowbeencorrected.Ifany-
thing, the spread between Japanese yields and yields in high-interest countries as
Australia has increased in recent weeks.  This is supporting a counter-movement at
present,butthecurrencyshouldnotlosetoomuchgroundtothedollar,asinvestors
havegrownmorecautious.
We expect the Japanese economy to pick up again after the first-half dent, and the
BankofJapanwillcontinuetosteerinterestratesbacktoamorenormallevel.Con-
sequently,theyenwillagainbeanattractiveinvestmentoption.Wedonotenvisage
anotherratehikebeforeAugust,though,butitwillalsobreathenewlifeintothecur-
rency.Wepredictanexchangerateof110tothedollarin12months’time,withfur-
thergainsoverthecourseof2008astheeconomycontinuestopickupspeed.

CHART19: Pound will initially move sideways  CHART20:Appreciation of the Yen likely
Poundpereuro,month-endfigures,forecastasofApril2007 Yenperdollar,month-endfigures,forecastasofApril2007


0.72 125

120
0.70
115
0.68
110
0.66
105

0.64 100
2003 2004 2005 2006 2007 2008 2003 2004 2005 2006 2007 2008

 
Sources: Global Insight, Commerzbank Economic Research  Sources: Global Insight, Commerzbank Economic Research

18  2 April 2007

 ECONOMIC RESEARCH

Growth and inflation

TABLE9
Gross Domestic product Consumer prices
at constant prices, percentage change on percentage change on year
year
2006 2007 2008 2006 2007 2008
Germany 2.7 1.7 1.8 1.7 1.4 1.0
France 2.1 2.0 2.0 1.7 1.5 1.8
Italy 2.0 1.8 1.5 2.1 1.8 2.0
Spain 3.8 3.3 2.3 3.5 2.1 2.3
Netherlands 2.9 2.8 2.3 1.2 1.5 1.8
Belgium 3.0 2.8 2.3 1.8 1.9 2.0
Austria 3.2 2.8 2.3 1.5 1.4 1.8
Greece 4.2 3.8 3.8 3.2 2.5 3.0
Finland 5.8 4.5 3.0 1.6 2.1 1.5
Portugal 1.2 1.5 1.8 3.1 2.1 2.5
Ireland 6.1 5.0 4.3 3.9 4.2 3.0
Eurozone 2.7 2.4 1.9 2.2 1.7 1.7
  
UnitedKingdom 2.7 2.8 2.6 2.3 2.4 1.9
Sweden 4.7 3.5 2.8 1.4 1.8 2.0
Denmark 3.3 2.5 2.3 1.9 1.8 2.0
Switzerland 2.8 2.0 1.8 1.0 0.8 1.3
Norway 2.9 2.8 2.5 2.3 0.5 2.0
  
USA 3.3 1.8 2.3 3.2 1.6 1.8
Canada 2.7 2.3 2.6 2.0 1.8 2.1
Japan 2.2 1.8 1.9 0.2 -0.1 0.5
Australia 2.7 2.7 3.0 3.5 2.5 2.5
Industrial countries (total) 3.0 2.0 2.3 2.5 1.5 1.5
  
Poland 5.8 5.8 5.5 1.0 2.2 2.5
Hungary 3.9 2.4 2.5 3.9 7.4 3.0
CzechRepublic 6.1 5.5 5.0 2.5 2.3 3.5
Slovakia 8.2 8.6 6.0 4.3 1.9 2.2
      
China 10.7 9.5 9.0 1.5 2.5 2.5
SouthAfrica 5.0 4.8 5.0 4.7 5.2 4.4
Source: Global Insight, Commerzbank Economic Research

2 April 2007  19

ECONOMIC RESEARCH

Interest rates
TABLE10:in per cent p.a. 1)
 Forecast horizon
Land 02.04.07 Jun 07 Sep 07 Dec 07 Mar 08 Jun 08
      
Eurozone 10years2) 4.05 3.95 3.85 4.00 4.00 3.80
3months 3.93 4.15 4.10 4.10 4.05 3.85
Minimumbidrate 3.75 4.00 4.00 4.00 4.00 3.75
 
United Kingdom 10years 4.97 4.90 4.80 4.80 4.70 4.50
3months 5.62 5.75 5.65 5.40 5.35 5.10
Reporate 5.25 5.50 5.50 5.25 5.25 5.00
 
Sweden 10years 3.91 4.10 4.00 3.90 3.90 4.10
3months 3.45 3.60 3.70 3.85 3.85 3.85
Reporate 3.25 3.50 3.50 3.75 3.75 3.75
 
Switzerland 10years 2.74 3.00 2.80 2.80 2.80 2.80
3months 2.30 2.50 2.75 2.75 2.75 2.75
Targetratefor3mo.Libor 2.25 2.50 2.75 2.75 2.75 2.75
 
 
USA 10years 4.64 4.40 4.30 4.50 4.60 4.60
3month(T-Bills) 5.03 4.90 4.30 4.30 4.30 4.30
3monthEurodollar 5.34 5.30 4.70 4.70 4.70 4.70
Fedfundsrate 5.25 5.25 4.75 4.50 4.50 4.50
 
Canada 10years 4.11 4.20 4.10 4.00 4.00 4.10
3months 4.35 4.10 3.90 3.85 3.80 3.80
Overnightratetarget 4.25 4.00 4.00 3.75 3.75 3.75
 
Japan 10years 1.66 1.70 1.70 1.90 2.00 2.10
3months 0.66 0.65 0.85 1.05 1.35 1.35
Overnightratetarget 0.50 0.50 0.75 1.00 1.25 1.25
 
Australia 10years 5.90 5.60 5.50 5.70 5.70 5.70
3months 6.57 6.40 6.60 6.60 6.60 6.60
Overnightratetarget 6.25 6.25 6.50 6.50 6.50 6.50
      
  
Poland 10years 5.25 5.15 5.05 5.00 4.90 4.80
3months 4.24 4.40 4.60 4.60 4.60 4.50
Interventionrate(7days) 4.00 4.00 4.50 4.50 4.50 4.50
      
Hungary 10years 6.68 6.70 6.60 6.50 6.20 6.10
3months 7.90 7.60 7.20 6.70 6.20 6.00
2weekdepositrate 7.25 7.75 7.25 6.75 6.25 6.00
      
Czech Republic 10years 4.10 4.00 4.00 4.00 3.90 3.90
3months 2.47 2.50 2.85 3.10 3.10 3.10
Reporate(2weeks) 2.25 2.50 2.75 3.00 3.00 3.00
      
Slovakia 10years 4.21 4.15 4.10 4.15 4.10 3.90
3months 3.64 4.20 4.20 4.20 4.20 4.05
Reporate(2weeks) 4.50 4.25 4.25 4.25 4.25 4.25
      
South Africa 10years 7.77 7.60 7.60 7.60 7.60 7.60
3months 9.18 9.15 9.15 9.15 9.15 9.15
Reporate 8.00 9.00 9.00 8.50 8.00 8.00
Source: Bloomberg, Commerzbank Economic Research; 1) 10 years government bond yields; 3 months money market rates; 2) Bunds

20  2 April 2007

 ECONOMIC RESEARCH

Exchange rates
TABLE11
Forecast horizon
Currency 02.04.07 Jun 07 Sep 07 Dec 07 Mar 08 Jun 08
      
Dollar USDperEUR 1.34 1.37 1.36 1.34 1.32 1.31
     
British pound GBPperEUR 0.68 0.68 0.68 0.69 0.70 0.70
USDperGBP 1.97 2.03 2.00 1.94 1.89 1.87
     
Swedish krona SEKperEUR 9.35 9.20 9.15 9.10 9.15 9.15
SEKperUSD 7.00 6.72 6.73 6.79 6.93 6.98
     
Swiss franc CHFperEUR 1.62 1.61 1.59 1.58 1.57 1.56
CHFperUSD 1.21 1.18 1.17 1.18 1.19 1.19
     
Canadian dollar CADperEUR 1.54 1.58 1.55 1.51 1.49 1.48
CADperUSD 1.16 1.15 1.14 1.13 1.13 1.13
     
Australian dollar AUDperEUR 1.64 1.71 1.72 1.72 1.71 1.72
USDperAUD 0.81 0.80 0.79 0.78 0.77 0.76
     
Japanese yen JPYperEUR 157 160 154 149 145 143
JPYperUSD 118 117 113 111 110 109
     
Polish zloty PLNperEUR 3.86 3.82 3.75 3.70 3.65 3.62
PLNperUSD 2.89 2.79 2.76 2.76 2.77 2.76
     
Hungarian forint HUFperEUR 247 250 255 258 255 255
HUFperUSD 185 182 188 193 193 195
     
Czech koruna CZKperEUR 27.98 28.30 28.00 27.80 27.70 27.70
CZKperUSD 20.96 20.66 20.59 20.75 20.98 21.15
     
Slovakian koruna SKKperEUR 33.30 33.40 33.80 33.70 33.70 33.60
SKKperUSD 24.94 24.38 24.85 25.15 25.53 25.65
     
South African rand ZARperEUR 9.69 10.15 10.34 10.38 10.30 10.35
ZARperUSD 7.26 7.41 7.60 7.75 7.80 7.90
     
Chinese Renminbi CNYperEUR 10.33 10.09 10.04 9.90 9.74 9.57
CNYperUSD 7.73 7.59 7.49 7.39 7.32 7.25
Source: Bloomberg, Commerzbank Economic Research

2 April 2007  21

ECONOMIC RESEARCH

Economic Research (E-Mail:vorname.nachname@commerzbank.com)

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