8 December 2015 World Outlook 2016: Managing with less liquidity easing moves of the cycle. The outlook for economic recovery is not strong, but modestly above-trend economic growth means a gradual narrowing of the output gap and hence a gradual normalisation of core inflation. We expect that roughly a year from now the ECB will have to think about whether to extend QE again or to taper in 2017. It may be slightly more marginal after what happened on 3 December, but the balance of probabilities suggests that a tapering discussion is likely to take place. On current expectations, core inflation will have risen to within a couple of tenths of Its historical average in H2 2016 and be on course for a further correction upwards in 2017 and 2018. The ECB has tended to announce new unconventional policy measures when the two-year ahead consensus headline inflation forecast is 1.6% or lower and tighten policy when it is 1.9% or higher. If our forecasts for cons and non-core inflation are correct in particular ow expectation for rise in oil prices in 2017 — headline inflation ought to satisfy the criterion for tightening policy. Mario Draghi is likely to be cautious. A sustainable correction in inflation is the objective - this means more than just reaching the inflation target for one year. The ECB will be nervous of creating its own 'taper tantrum'. We expect the ECB to taper its QE purchases, meaning that purchases will continue after the current scheduled end date of March 2017 at a declining rate. A decision to taper is the first step towards exit and that is likely to result in a euro fixed income market correction/normalisation later in 2016, tightening financial conditions. We see the first ECB policy rate hike only at the end of 2018. The risk is that oil prices continue to decline in the near term and weigh on headline inflation. If this weakens medium-term inflation expectations, the late- 2016 tapering risk will dissipate and the pressure for further ECB easing will grow. Political risks to rise into 2017 In Spain we think the tail risk of a radical party having a position of influence within the new government is low. Beyond that, however, the euro area is dotted with potential risks. Portugal's minority Socialist government looks unlikely to survive a major test, particularly if it requires more austerity and reform. The Catalan independence bid is a source of uncertainty. Ireland's outgoing coalition has a tailwind from strong GDP growth but is short of majority on current polls. Italy is the peripheral with the largest proportion of votes going to eurosceptic and populist parties. The risk is that the 2018 Italian election is brought forward one year. Opinion polls leave the UK referendum on EU membership — possibly in late 2016 — too close to call for now. The areatest political tests for Europe next year come from the refugee and terror crises. The conservative backlash in Germany against Merkel's initial welcoming is very gradually narrowing differences across countries on how best to address the refugee wave. The new terror dimension to the iefugee crisis we believe will more likely than not lead Europe to a more unified stance. Germany may be more willing to compromise on otherwise more divisive issues like Greece debt and fiscal easing to secure a better deal for refugees, for example, or more funds to deal with the crisis 'at source'. However, we do not expect any real progress on euro area integration — greater fiscal autonomy as a compromise for Catalonia would be the opposite of what a stronger euro area requires — nor do we expect the unified stance to last into 2017. The closer we get to the German, French and Dutch elections in 2017. the more disharmonious Europe is likely to sound. Political uncertainty will likely be another hurdle to growth in 2017 while elections create reasons for further delays to structural reforms. Page 26 Figure 8: Balance of probabilities points to initial ECB tapering discussion in late 2016 22 20 Is I6 1.2 3044 07.03 lc 39030 ..404. I ?I lxanraawNN00W0 ,ro ..1/kniaar by n: x.ris I I Eat Curlew 34 Profte0200 Forecnton Ivene•r 0400 costm44114401ne I 0 ... 7.394 .... _ ...... .... . ... 2000 2002 NS 2003 2006 2010 2012 2014 2016 San* 0701•00 &At 4n • 20111 Figure 9: Fiscal risk get more worse in 2016; it is political risk we need to focus on 10 09 OS 07 CEO 06 04 03 02 01 00 Ea0/warning erdlcatce fiscal sub- em 4433 (047 "'"' -..Mc Coma.< • • • • as .3/4 • • 2006 2007 2000 S 2011 2013 2016 0.34400 ,w al M. cariecnoto 0474/ M. can ovstbad 044 r 0 inkinasal ea *boa nts• axis Mres.414 Sow. Df40.010.11*..~111. Figure 10: Other indicators & financial forecasts: Euro area M30t.w.%pl 00 Pow 40044 We 0OP OuOb. debt I40 OOP Immo Yltt. 1401 bn 0034 belenc41/0 CCP 2.4 tutors /eta IUSI14 3.56 Cu0541160:000.1401004 24 ;th lz.t. ai 011441 001 000 000 091 YA at* .011 .013 .015 415 yold OM 005 0/0 110 U1000 SYR 100 IM OS/ 010 JW PerEUR 134 129 124 115 • mw FUR 072 577 071 071 7074 23:4 17 47 -TO 94* 9411 34111 32110 12 no 30 334r AS 940 200 20 27 177,0 32 'I. 020 a.3 23 AI 3 23 Senor. Ataceel n COtexis tat Sweat% es of Otanede 07 Deutsche Dank AG/London CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e) CONFIDENTIAL SDNY_GM_00265317 DB-SDNY-0119133 EFTA01458963