Investment Department

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1 Investment Department June 2012 FINANCIAL MARKETS REPORT MACROECONOMIC DEVELOPMENT Czech Republic In June consumer prices grew by 3.5 percent on a year-on-year basis after the growth by 3.2 percent in May. The inflation development was worse than consensus expectations, but 0.1 percent below CNB s estimate. The increase was driven primarily by growth of food prices, especially of vegetables. On the other hand, prices in transport declined for the second month in row thanks to falling oil prices. On month-on-month basis the consumer prices increased by 0.2 percent. The monetary-policy-relevant inflation grew by 2.2 percent on a year-on-year basis and the core inflation remained in the slightly negative territory. It is apparent based on this data that the growth of prices is given solely by external items; there are practically no demand pressures on the part of consumers. In June, the registered unemployment rate declined to the level of 8.1 percent from 8.2 percent in May. The development of unemployment in June was in line with general expectations. The decline was given, in particular, by seasonal jobs in agriculture and construction. With regard to the upcoming deceleration of the economy, slight improvement of the situation in the labor market is good news, although it is very probable that it is only a short-term effect. Worsening is looming as number of job vacancies declined by 2 percent compared to May. Still relatively high unemployment rate, almost zero growth of real wages, and high uncertainty keep being reflected in the weak growth of the domestic consumption. In May, seasonally-unadjusted retail sales fell by 2.1 percent on a year-on-year basis after the decline by 4.1 percent in April. Only sales of non-food items posted a rise. The data stated confirms the weakness of the domestic consumer demand which, thus, does not create practically any inflation pressures. Surprisingly good performance of industry in April, when the industrial output increased by 2.2 percent on a year-on-year basis, was followed by a substantial deceleration in May. Industrial production in that month fell by 2.4 percent year-on-year, showing the first drop since November As usually the domestic industry remains to be driven primarily by production of motor vehicles which continues to grow nicely. Key for the Czech industry remains to be foreign demand as non-domestic new orders grew by 9.3 percent on a year-on-year basis, while domestic orders fell by 5.3 percent. The big difference between the domestic and foreign demands is reflected in the development of the trade balance very positively. It recorded a surplus of 23.1 billion crowns in May which is by 9.6 billion higher year-on-year. Exports grew by 2.8 percent on a year-on-year basis while imports decreased by 1.1 percent. The decrease in imports was registered for the firs time since December On its monetary-policy meeting in June, the central bank cut its key interest rates by 25 basis points. The 2W REPO rate thus declined to 0.50 percent. 4 out of 7 members of the monetary board voted for the cut, the other 3 preferred no change in rates. CNB expects the total inflation to remain elevated at least till the end of 2012 due to higher taxes. On the other hand, monetary policy relevant inflation should stay close to the target level of 2 percent. All in all, disinflationary pressures prevail in the Czech economy. Hence, further easing of the monetary policy is possible. ING Investment Management (C.R.), a.s. Tel.: Bozděchova 2/344, Praha 5 Fax: Czech Republic

2 Slovak Republic The beginning of the June was not positive at all. The crisis came slowly to Germany too. The unemployment went up, sentiment indexes fall (both IFO as ZEW) and industrial output declined. Moreover, the Moody s rating agency cut rating of Spain to Baa3. It is only one notch above speculative level. Under such circumstances the yields of safe heaven bonds (i.e. German bunds) declined to unprecedent level of 1.13% for 10 year long bond!!! On the other side the yields of countries with huge debt burden rocketed above 7 percent (esp. by Spain and similarly by Italy). The bankruptcy of these large EU countries would cause much huge disaster for Eurozone than bankruptcy of negligible Greece. Fortunately, it came EU-summit where German chancelor Merkel weakened a little her stance regarding mutual help to banking system and EU leaders as well promised not only austerity measures but as well some pro-growth tools. The ECB left its key rate flat a 1 percent, but the vote was not unanimous! As well FED confirmed slower growth than expected and delivered another round of quantitative easening (so called Twist operation). These steps restored some optimism on the markets and risk free interest rates went up, the extreme yields of Spain and Italy bonds declined, equity markets jumped up and the end of month was positive. Fortunately, the Slovakia is treated as relatively safe country within EMU borders and its yields stayed moreless flat over the whole month. It means that risk premium versus German bund decreased, as the German bunds yields went up at the end of month. Over the June we have seen ongoing pressures to ECB to support bonds of distressed countries by EU politician. But the representatives of ECB were resistant and left on the EU-summin to solve the situation. On the other side, here was some move within ECB opinion as the refi-rate stayed flat, but here were as well several votes for cut to help the economy. Because of the macro situation is worse and worse we could expect the cut on the next ECB meeting. Compared to the other countries within the EU, the macroeconomic situation of Slovakia is relatively good but the decelerating growth of the GDP in Europe starts to be seen even here. It is reflected the most on the development of the deficit which was worse than previous year. But the government has published its preliminary austerity package for , creating a buffer, which should help to fulfill year-end deficit plan with some reserves. The package includes 22 measures and is worth EUR2.3bn (3.1% of GDP). Moreover, the growth of Slovakia GDP in Q recently announced was surprising good. It achieved a strongly positive level of 3.0 percent, which was an exceptional figure within the EU. With respect to the macroeconomic data, let us mention, in particular, the industry, which grew by 12 percent on a year-on-year basis. Currently, the harmonized inflation started to decline from relatively high level of 3.7 percent to 3.4 percent. The most negative news may be the unemployment rate which is quite high (currently at the level of 13.2 percent) and retail sales, which are only slightly above zero at +0.6 percent. It did not indicate the willingness of households to spend more. The relatively good growth of the GDP, low indebtedness of Slovakia (43 percent of GDP at the end of 2011) and stable governmental environment make Slovakia and its bonds a relatively safe target. Thus, Slovakia does not belong among the so-called peripheral states which have problems to serve their debt. Another positive factor is that Slovakia is focused on the export to Germany which has been successfully avoiding the crisis so far. The weakness is a low domestic demand.

3 DEVELOPMENT IN FINANCIAL MARKETS A) FOREIGN EXCHANGE MARKETS Czech Republic The EUR/CZK fx rate was very volatile during the last month as the market remained primarily focused on developments in Europe, especially in Spain. Investors are still very sensitive on any news regarding solution of the debt crisis. Graph of the development of the Czech crown against the euro in the last 3 months: (the growth of the curve means the crown weakens against the euro and vice versa) Graph of the development of the Czech crown against the dollar in the last 3 months: (the growth of the curve means the crown weakens against the dollar and vice versa)

4 Slovak Republic The good results of month-end EU-summit (e.g. approved pro-growth tools or mutual support of banking system) persuaded investors to come back to EUR. The USD weakened after several month of appreciation against EUR. The USD versus EUR moved from 1.24 to the level close to 1.26 USD/EUR. Graph of the development of the foreign exchange rate of the euro against the dollar in the last 6 months: (the growth of the curve means the euro strengthens against the dollar and vice versa) B) MONEY MARKETS Czech Republic Money market rates were stable during June and then dropped by some 20 basis points at very end of the month as the CNB cut the interest rates by 25 basis points. Inflation surprised on the upside mainly due to growth of food prices. Development of a two-weekly repo rate of the CNB, the inflation and the annual market rate PRIBOR in the last 12 months:

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6 Slovak Republic/European Union The ECB stayed in the wait-and-see mode with the refi rate equal to 1 percent, but the bulk of extremely bad information within EU and unanimous vote for flat rates announced to us that ECB will deliver very likely the cut in the time being. It left the money markets yields more-less flat. The annual EURIBOR has already declined to the level of about 1.21 percent. Graph of the development of the so-called refi-rate of the ECB (green), 1M (white) or 12M EURIBOR (red) and 3 years swap rate (yellow) in the last 12M:

7 C) BOND MARKETS Czech Republic Local bonds reacted on CNB s rate cut. Yields declined by some 20 basis point along the whole curve. Local fundamentals are still positive for the fixed-income investments. Graph of a change to the yield curve of the Czech state bonds in the last month: The following graph shows the development of the fortnightly REPO rate along with two-, five- and tenyear swap rates in the Czech crowns. In June, swap rates corrected their significant decrease from previous months, especially on the long end of the curve. Nevertheless, they started to decline again at the beginning of July as the CNB cut the rates.

8 Slovak Republic The after EU-sumit positive mood sent the risk free (German bonds yields) higher after reaching extreme low level at 1.13 percent per 10Y bond. But the risk premias of other countries declined. All-inall the yields of Slovak local bonds stayed relatively unchanged. Graph of the change of the yield curve of Slovak, or German, government bonds in the last month: (the movement of the yield curve upwards is negative for market prices of bonds and vice versa)

9 As the German government bond yields jumped up over the month and Slovak bonds were unaltered the risk premium decreased significantly. The premium of Slovakia over Germany is currently at the level of 190 basis points (-60bps over month), that is, Slovakia has to issue bonds with 1.9 percent higher yield than Germany which is considered as a risk-free investment.

10 D) STOCK MARKETS Global equity markets recovered from this year low, where were pushed by uncertainty coming from Greek election and escalation of Euro zone sovereign debt crisis. The outcome especially from the Greek election and also from the French election was perceived quite positive. Greece is now able create pro-european government and fears about exit of the Greece from Euro-zone and also possible Greek bankruptcy were lifted. Other positive news for equity markets was monetary easing in China, where the central bank decided to cut interest rate by 0,25% and the support package around 100 billion EUR for the Spanish banks. Ta the end of the month positive statement came from EU member summit, where EU leaders approved an economic growth package worth135 billon EUR to support the growth of EU economy. The ventral European markets significantly outperformed the developed markets. The best performing equity markets among the central European stock markets in the local currencies was again the Polish stock market followed by the Hungarian stock market, and the lagging market was the Czech stock market. All three central European stock markets ended up with positive performance in June. Graph shows the monthly balance of the central European index CECE (in EUR, dark) and MSCI World Index (in USD, light)

11 Efficiency of Selected Stock Markets Expressed in the Czech Crown Czech PX index Polish WIG Index Hungarian BUX Index American S&P 500 index West European Eurotop 100 index MSCI World index Month +4,08% +11,16% +12,06% +0,62% +4,28% +1,56% From ,12% +14,85% +12,42% +11,17% -0,72% +7,24% OUTLOOK The key factor which will keep influencing markets in the near future will be the method of dealing with the debt crisis of (not only) the peripheral states of the euro area. Recent macroeconomic indicators show that global economy is weakening significantly. USA will probably avoid falling into recession but also here the recovery is very feeble. Other parts of the developed world are clearly in recession and growth in developing economies, especially China, is decelerating. Under the influence of a significant deterioration of the macroeconomic prospect, it is very probable that central banks will be forced to support the economy further. Solution of the debt crisis can not be expected in the horizon of months ant thus the investors will remain to be very sensitive and cautious, preferring the safest assets. This publication is of the informative nature only and its text is not legally binding. It is not an investment recommendation or an offer or call for the purchase or sale of any investment instrument. Although the text stated above has been prepared with utmost carefulness and based on trustworthy sources, the perfect reliability of the data stated in it cannot be guaranteed. ING Investment Management bears no liability for any loss the reader might incur by relying on the information stated in this publication.