1. Economic Outlook
Macroeconomic Research – Itaú Unibanco
June 2014

2. Overview International
The period of global recovery and low inflation will last longer.
Activity is recovering in the U.S (despite the first quarter) without pressuring inflation, allowing interest rates to remain low for a longer time.
Despite a disappointing first quarter in the euro zone, we expect the modest economic recovery to continue. The ECB is carrying out a round of monetary easing.
Chinese economy is likely to stabilize after the government stimulus package.
Positive external environment for emerging markets continues.
Brazil
Activity is still weak and there are downside risks.
BRL is likely to depreciate because of the current-account balance, electoral uncertainty and the U.S. interest rates.
Inflation is still close to the target ceiling.
Amid the slow growth, a more challenging fiscal scenario.
Central bank ended the hiking cycle, expressing heightened concerns about the drop in economic growth.

3. Global Economy Is Recovering
2012
2013
2014
2015
World
5.1
3.2
3.0
3.3
3.6
USA
2.9
2.8
1.9
2.3
3.1
Euro Zone
2.5
-0.6
-0.4
1.1
1.5
Japan
1.4
1.6
1.7
1.3
China
12.1
7.8
7.7
7.2
7.0
Source: Haver Analytics, CEIC, Bloomberg, Itaú Unibanco

4. U.S.: Activity Is Likely to Keep Recovering After a Weak 1Q14…
The first-quarter GDP growth was revised to -1.0% annualized. Due to the surprise, we reduced our 2014 GDP forecast, to 2.3% from 2.5%.
We expect a rebound in the second quarter (3.8% growth saar) following the winter payback, the inventories effect and a better housing investment.
The good performance of the economic indicators in May underpins this positive outlook.
GDP – Real Growth
Seasonally adjusted, annualized change, %
ISM
Higher than 50 indicates expansion
Source: Itaú Unibanco, Institute for Supply Management, Bureau of Economic Analysis

5. ... With Inflation at Moderate Levels
Inflation has been firmer in the last two months, but remains at comfortable levels.
Due to the weaker GDP growth and modest inflation, we lowered our long-run interest rate forecast to 2.9% (from 3.45%) in December 2014.
Average Hourly Earnings & Core CPI
YoY change, %
10-Year Treasury Yield %
Source: Itaú Unibanco, Bloomberg, BLS, Haver Analytics

6. Europe: The Modest Recovery Is Likely to Continue
The first-quarter GDP disappointed, increasing 0.2% qoq.
We lowered our GDP growth projection, from 1.3% to 1.1% this year. Our forecast for remains unchanged at 1.5%.
Second-quarter activity indicators underpin this moderate recovery.
GDP – Real Growth
Seasonally adjusted, annualized change, %
Industrial Production and Retail Sales
YoY growth, %
Source: Itaú Unibanco, Haver Analytics

7. The ECB Eased Its Policies to Counterbalance the Risks of Deflation
The measures are off to a good start in terms of the impact on inflation expectations, but additional measures are possible.
The economic recovery should contribute to a reduction in disinflationary pressures.
Inflation
Annual change, by group of countries, %
Monetary Measures
Lower overnight bank deposits interest rate (from 0% to %)
Reduction of the main bank-lending rate by 0.10%, to 0.15%.
Central bank will lend funds to banks for up to four years at a fixed cost of 0.25%.
The ECB ended the weekly sterilization of its periphery sovereign-bond portfolio.
Central Bank reinforced its forward guidance of low interest rates.
Source: Itaú Unibanco, Eurostat, Haver Analytics

8. China: Signs of Improvement in the Second Quarter
With the recent gains in the PMIs, we are confident that activity is stabilizing.
We maintain our GDP forecast at 7.2% for 2014 and 7.0% for 2015.
The risks, however, remain tilted toward the downside, specially in the property sector.
GDP – Real Growth
Seasonally adjusted, annualized change, %
PMI
Seasonally adjusted, higher than 50 indicates expansion
Source: Itaú Unibanco, CEIC, Haver Analytics

9. Emerging Markets: Positive External Environment Continues
Volatility remains low following the stable interest rates in the U.S..
Despite some recent adjustment, most emerging stock exchanges strengthened and some currencies even appreciated.
The weak growth performance could limit the gains from the global environment.
Stock Exchange
PMI – Emerging Countries
Higher than 50 indicates expansion
**Emerging Asia: China, India, Korea, Indonesia, Vietnam, Singapore and Taiwan
***Latam: Brazil and Mexico.
*EM Stock: Geometrical average of Stock Exchange Index from Mexico, Chile, China, Indonesia, South Korea and Turkey.
Source: Itaú Unibanco, Bloomberg

10. Commodities: Our Projections for the Short Term
Itaú Commodities Index
Source: Itaú Unibanco

11. Latin America: Growth Continues to Disappoint
Peru
Mexico
2013
2014
2015
GDP - %
5.6
5.0
5.9
1.1
2.4
3.8
PEN / USD (Dec)
2.80
2.85
2.95
MXN / USD (Dec)
13.1
13.2
Interest Rate- (Dec) - %
4.00
Interest Rate - (Dec) - %
3.50
3.00
CPI
2.9
3.0
2.5
4.0
3.7
3.2
Colombia
Chile
4.3
4.5
4.1
2.8
COP / USD (Dec)
1930
1950
2000
CLP / USD (Dec)
526
575
600
3.25
4.25
5.00
4.50
1.9
3.1
3.6
Argentina
-2.0
0.0
ARS / USD (Dec)
6.5 10 13
BADLAR - (YE) - %
21.6
35.0
30.0
CPI - % (Private Estimatives)
28.4
37.0
27.0
Source: Itaú Unibanco

12. Brazil: What Do We Expect in the Short Term?
2012
2013
2014
2015
Economic Activity
GDP (%)
1.0
2.5
1.7
Unemployment (%) - December
5.4
5.1
5.3
5.6
Inflation
IPCA (%)
5.8
5.9
6.5
Monetary Policy
Selic Rate (%)
7.25
10.00
11.00
12.00
Fiscal
Primary Surplus (% GDP)
2.4
1.9
1.3
Balance of Payments
Exchange Rate (eop)
2.08
2.36
2.45
2.55
Current Account (% GDP)
-2.4
-3.6
-3.7
-2.9

13. Activity: Outlining a Lower-Growth Scenario
We revised our GDP forecast for 2014 to 1.0% and 1.7% in 2015.
The 1Q14 GDP report showed a deceleration in domestic demand, with the deceleration reaching gross fixed-capital formation (-2.10%) and household expenditures (-0.1%).
The third straight fall in the gross fixed-capital formation.
According to the available 2Q14 data, there was a retreat in industrial activity and a moderation in retail sales.
2014 – First-Quarter GDP
GDP Growth Scenario
Seasonally adjusted change
QoQ change (SA)
GDP
0.2%
Demand
Household expenditure
-0.1%
Government expenditure
0.7%
Gross fixed-capital formation
-2.1%
Exports
-3.3%
Imports
1.4%
Supply
Agriculture
3.6%
Industry
-0.8%
Services
0.4%
Source: Itaú Unibanco, IBGE

14. Recent Data Suggests an Economic Deceleration
While industrial production retreats, retail sales stagnated.
Confidence levels are low, and they are falling at the margin.
Industrial Production and Retail Sales
Seasonally adjusted
Confidence Indexes
Seasonally adjusted, July 2010=100 **
Source: Itaú Unibanco, IBGE, FGV

15. We Forecast a Moderate Rise in Unemployment
Due to the slowing economy, we expect the unemployment rate to be at 5.3% by year-end and 5.6% by the end of 2015.
Formal Job Creation (CAGED)
Thousands, seasonally adjusted
Unemployment Rate
Seasonally adjusted
Source: Itaú Unibanco, IBGE, Caged

16. Electricity Balance: Rationing Risks in 2015 Persist
Reservoir levels started to fall in May, following the seasonal pattern, and should continue to drop slowly until November.
Basic scenario:
Rainfalls slightly above the average for the rest of the year (El Niño).
Intense thermal-power-plant usage. The costs of distribution companies are likely to be BRL 6 billion in addition to the amount already paid in 2014 (BRL 17.4 billion).
High rationing risks in 2015.
Aggregate Reservoir Levels
% of total capacity
Source: Itaú Unibanco, ONS

17. Trade Balance: Exports Are Weakening
The falling prices for exported commodities and resilient imports (which continue to advance despite the weak economic activity) are likely to have negative impact on the trade balance this year.
We revised our trade-balance estimate for 2014 to USD 1.5 billion, from USD 3 billion.
For 2015, we maintain our expectation of a USD 16 billion trade surplus.
Terms of Trade
Price of exports / price of imports, seasonally adjusted
Trade Balance
12-month accumulated, USD in billions
Source: Itaú Unibanco, BCB

18. BRL: Appreciation Is Likely Temporary
The exchange rate has been fluctuating within the range.
The FX intervention program via swap contracts will be extended beyond June.
BRL is set to weaken again due to: the recent worsening of external accounts, the moderate increase in the U.S. Treasury yields and election-related uncertainties.
Exchange Rate
Monthly average
Current-Account Balance
12-month accumulated, USD billions
Source: Itaú Unibanco, BCB

19. Inflation: We Expect a 6.5% IPCA in 2014 and 2015
Our regulated-price estimate was reduced (to 5.4% from 5.6%) after incorporating tariff reductions for landline phones and water and sewage. Our estimate for market-set prices is still at 6.8%.
We expect increases of 7.3% for regulated prices and 6.3% for market-set prices.
IPCA Breakdown YoY change, %
IPCA
3 months
12 months
1Q13
1.94%
6.6%
2Q13
1.18%
6.7%
3Q13
0.62%
5.9%
4Q13
2.04%
1Q14
2.18%
6.2%
2Q14
1.44%
6.4%
3Q14
0.83%
4Q14
6.5%
1Q15
2Q15
1.37%
6.3%
3Q15
1.24%
4Q15
1.74%
Source: Itaú Unibanco, IBGE

20. Fiscal Policy: Difficulties in Achieving the Target
Non-tax revenue (especially dividends) remains high, while tax revenue is growing in line with GDP.
By year-end, we expect a drop in the 12-month cumulative primary surplus to 1.3% of GDP.
Collection of Dividends
BRL in billions, January-April
Public-Sector Primary Surplus
% GDP
Source: Itaú Unibanco, BCB

21. Monetary Policy: End of the Rate Hikes, at the Moment
The COPOM expressed heightened concerns about the drop in economic growth and greater ease with the stability of the exchange rate.
Selic Rate
% p.a
Source: Itaú Unibanco, Bloomberg

22. Conclusion
The period of global recovery and low inflation will last longer.
Positive external environment for emerging markets continues, but activity in these countries is at moderate pace.
Brazilian economy’s growth is still weak and is likely to increase 1.0% this year.
Unemployment should start rising, reversing the recent trend.
Domestic and international factors are likely to pressure the BRL this year.
Inflation is expected to end up close to 6.5% in 2014 and 2015.
It will be difficult to achieve the fiscal target.
We expect the Selic rate to remain at 11.00% this year and reach 12.00% in 2015.

23. Our Economic Analysis Online