28 July 2022

NEWS AND ANALYSIS CREDIT IN DEPTH

Corporates » Significant US growth slowdown ahead, but recession 12
» Mercer's acquisition of Holzindustrie is credit positive 2 could still be avoided
» Acquisition of Ewellix Group will strengthen Schaeffler's 4 We lowered our US real GDP growth forecast to 2.2% this year and
business profile to 1.6% in 2023.
Banks
» Rising tracker mortgage rates will benefit Irish banks, 5 » Growth in Europe's largest economies will sharply 13
RMBS and covered bonds decelerate as energy crisis persists

» Bank of Cyprus' early retirement scheme will generate 6 We lowered our baseline 2022-23 GDP growth forecasts for major
substantial cost savings, a credit positive euro area countries, and also reduced our 2023 UK growth forecast.
Sovereigns
» Wildfires and droughts will intensify inflation and
increase government spending, a credit negative
8 RECENTLY IN CREDIT OUTLOOK
» Articles in last Monday's Credit Outlook 14
Sub-Sovereigns
» Heatwave-fuelled wildfires in Spain and France increase 10
regional and local governments’ spending » Go to last Monday's Credit Outlook

MOODYS.COM
 NEWS AND ANALYSIS CORPORATES

Mercer's acquisition of Holzindustrie is credit positive

Originally published on 25 July 2022

On 22 July, Mercer International Inc. (Ba2 stable) announced it has an agreement to acquire Holzindustrie Torgau (HIT) for a total
enterprise value of €270 million (about $275 million). The acquisition is credit positive because it expands Mercer's wood product
business segment while keeping financial leverage steady.

HIT, a producer of wood pallets, bio fuel, and garden products, will expand Mercer's wood products footprint in Germany and increases
its scale. Pro forma for the acquisition, Mercer will have a combined annual lumber capacity of about 960 million board feet, an
increase of about 75%. Mercer will become Germany's largest pallet producer, and the acquisition will increase the company's
electricity generation capacity to about 432 megawatts (MW).

We believe the acquisition is strategically sound given the proximity (about 200 KM) of HIT's Torgau facility to Mercer's Friesau
sawmill and its product offerings. Mercer will be able to leverage HIT's integrated facilities to diversify its lumber offerings through the
production of wood pallets, use of HIT's wood chips in its pulp mills, and expand its environmentally sustainable biofuel products such
as pellets and briquettes. We expect this to lead to economies of scale, operational synergies and revenue diversification.

Pro forma for HIT's run rate EBITDA and announced synergies, Mercer's leverage (debt/EBITDA) will be 2.0x-2.2x, versus 2.3x for the last
12 months to March 2022 (see exhibit). The pro forma leverage reflects the potential for using all or a portion of the incremental €100
million availability under the current revolving credit facility in combination with cash at hand (about $411 million at March 2022).

Mercer's pro forma leverage whould remain flat

Debt / EBITDA Leverage Range
7.0x

6.0x

5.0x

4.0x

3.0x

2.0x

1.0x

0.0x
Dec-17 Dec-18 Dec-19 Dec-20 Dec-21 LTM PF Leverage
(Mar-22)

Includes announces synergies and run rate EBITDA

Source: Moody's Financial Metrics

Pending customary closing conditions and regulatory approvals, Mercer expects the transaction to close in the third or early fourth
quarter of this year.

Incorporated in the State of Washington and headquartered in Vancouver, British Columbia, Mercer International, Inc. is a leading
producer of northern bleached softwood kraft pulp (approximately 2 million tonnes) and 300 thousand tonnes of northern bleached
hardwood kraft. The company also has about 550 million board feet of lumber capacity. Mercer is a public company with revenue of
about $2 billion for the 12 months to March 2022. Pro forma for the HIT acquisition, revenue increases to about $2.2 billion.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the issuer/deal page on https://ratings.moodys.com for the
most updated credit rating action information and rating history.

2 Credit Outlook: 28 July 2022

 Aziz Al Sammarai, Analyst Paresh Chari, Associate Managing Director
Moody’s Investors Service Moody’s Investors Service
[email protected] [email protected]
+1.416.214.7862 +1.416.214.3837

3 Credit Outlook: 28 July 2022

 NEWS AND ANALYSIS CORPORATES

Acquisition of Ewellix Group will strengthen Schaeffler's business

profile
Originally published on 26 July 2022

On 24 July, Schaeffler AG (SAG, Ba1 positive) announced that it has entered an agreement to acquire Ewellix Group, a Sweden-
based manufacturer of linear motion and actuation solutions, from investment company Triton for about €582 million, excluding the
assumption of €120 million of Ewellix net debt and transaction costs. Pending customary approvals, the company expects the deal to
close by year-end.

The acquisition will strengthen SAG's business profile, a credit positive. Initially, however, it will modestly increase leverage and lead to
somewhat lower but still-solid cash flow metrics for the Ba1 rating.

Ewellix generated sales of around €216 million equivalent in 2021, accounting for around 6% of sales of SAG's Industrial division.
Although not materially contributing to total sales (1.6% in 2021), the integration of Ewellix into SAG's Industrial division will reduce
the group's exposure to the cyclical automotive industry and environmental risks (e.g., carbon transition) it faces. Ewellix offers mostly
complementary products for use in attractive fast-growing niches that should enable SAG to extract growth opportunities through
cross-selling as well as cost synergies from optimization of manufacturing and combined procurement. Ewellix offers linear actuator
systems and linear motion products used in industrial automation, medical applications, mobile machinery and industrial distribution,
and has a manufacturing footprint mainly across Europe, and in the US and Asia.

The benefits are partly offset by our expectation that the transaction will slightly weaken SAG's credit metrics, other than profitability
since we expect Ewellix's margins to be at least at the level of SAG's Industrial division (12.0% company-adjusted EBIT margin in 2021
versus 9.1% on a group basis). The company has said only that funding the €582 million purchase will be through a mix of “existing
internal and external financing sources.” In an assumed fully debt-funded scenario, SAG's pro forma Moody's-adjusted gross leverage
(debt/EBITDA), including the acquired Ewellix debt, would increase by around 0.3x to 3.1x as of 31 March.

Although pro forma leverage remains close to our defined level for a higher rating of consistently below 3.0x, we expect it will increase
during the remainder of this year because of lower EBITDA amid slowing economic activity and rising energy cost inflation. At the same
time, the group's pro forma Moody's-adjusted net leverage of around 2.6x as of March remains around the 2.7x average for 2017-19,
when SAG was rated Baa3. SAG's pro forma net leverage on a reported basis should increase towards 1.4x from 1.0x as of March-end,
still well in line with its stated long-term target of 1.25x-1.75x.

In a fully debt-funded scenario, SAG's continued very strong liquidity would benefit from €995 million of unrestricted cash on
the balance sheet and the group's fully available €1.8 billion committed revolving credit facility as of 31 March. This is particularly
important in an environment of expected slowing economic growth, high cost inflation and potentially falling consumer confidence
over the next few quarters, combined with heightened geopolitical uncertainty and energy supply risks due to the Russia-Ukraine
conflict.

Goetz Grossmann, CFA, VP-Senior Analyst Christian Hendker, CFA, Associate Managing Director
Moody’s Investors Service Moody’s Investors Service
[email protected] [email protected]
+49.69.70730.728 +49.69.70730.735

4 Credit Outlook: 28 July 2022

 NEWS AND ANALYSIS BANKS

Rising tracker mortgage rates will benefit Irish banks, RMBS and
covered bonds
On 22 July, Permanent tsb p.l.c. (PTSB, Baa2/Baa2 review for downgrade, ba11), Bank of Ireland (BOI, A1/A1 stable, baa1) and KBC Bank
Ireland PLC said they will increase tracker mortgages rates 50 basis points (bp), in line with the European Central Bank's (ECB) 50 bp
rate hike a day earlier. The higher tracker mortgage rates will increase Irish banks' profitability, which aids covered bonds. It will also
protect the excess spread available in Irish residential mortgage-backed securities (RMBS) deals exposed to tracker mortgages.

Higher tracker mortgage rates will support the net interest margins (NIM) and profitability of Ireland`s largest banks: Allied Irish Banks,
p.l.c. (AIB, A1 stable, baa1), BOI and PTSB. Tracker mortgages at AIB comprised 21% of its total mortgage portfolio and 10% of total
loans at year-end 2021, and it increased its portfolio in June this year with an additional €5.7 billion of performing tracker mortgages
acquired from Ulster Bank Ireland DAC (A1 stable, a3). At BOI, tracker mortgages comprised 30% of the total mortgage portfolio and
9% of total loans at year-end 2021. At PTSB, €5.7 billion of tracker mortgages comprised 45% of total loans as of June 2022. All the
tracker mortgages will reprice at higher rates.

The banks' improving NIMs and profitability are positive for their covered bonds because it lowers the likelihood that the bank would
default on covered bond payments.2 In addition, the risk of mark-to-market losses caused by interest rate movements upon issuer
default is lower for floating-rate mortgages than for fixed-rate mortgages. As of 30 June, tracker mortgages comprised 22.5% of AIB's
pool balance of covered bonds, and 15.9% at BOI.

RMBS with significant exposure to tracker mortgages benefit from only slim levels of excess spread. Over the past six months, increases
in EURIBOR raised the cost of capital, while the yields on the securitized tracker mortgages remained unchanged, resulting in reduced
levels of excess spread. Higher tracker mortgage rates will mitigate excess spread erosion, which is positive for these deals since excess
spread is the first line of protection against credit losses. The concentration of tracker mortgages in the collateral pools of Moody's-
rated bank-sponsored RMBS ranges from less than 10% to almost 90%.

For years, interest rates for tracker mortgage have been significantly lower than for fixed-rate or standard variable-rate mortgages,
which has been a drag on banks' profitability. Even with the 50 bp increase, the absolute interest charged on tracker loans will remain
comparatively low and have a muted effect on the tracker mortgages' affordability. Whilst a rising interest rate environment puts a
strain on mortgage borrowers' affordability in general, increases in tracker mortgage rates will still leave them more affordable than
fixed-rate and standard variable-rate mortgages. We expect the ECB to raise its policy rate by 1.50%-1.75% over the next 12 months.

Endnotes
1 The ratings shown in this report are the bank’s deposit rating, senior unsecured debt rating (where available) and Baseline Credit Assessment.
2 For covered bonds, bank issuers are the primary source of payments to investors. Investors would only draw payments from the pool of loans backing
covered bonds if the issuer defaulted.

Michal Kuehnel, AVP-Analyst Farooq Khan, Vice President-Senior Analyst

Moody’s Investors Service Moody’s Investors Service
[email protected] [email protected]
+49.69.70730.793 +44.20.7772.1638
Paul Millon, Assistant Vice President - Analyst
Moody’s Investors Service
[email protected]
+44.20.7772.1379

5 Credit Outlook: 28 July 2022

 NEWS AND ANALYSIS BANKS

Bank of Cyprus' early retirement scheme will generate substantial cost

savings, a credit positive
Originally published on 27 July 2022

On 25 July, Bank of Cyprus Public Company Limited (Ba3 positive, b21) announced that it completed a voluntary early retirement
scheme as part of its cost rationalisation efforts. Although the plan's completion will immediately decrease capital and weigh on
profitability this year, it will reduce the workforce by around 16% this year based on March 2022 data and generate substantial future
annual cost savings, a credit positive.

The early-retirement scheme will cost Bank of Cyprus around €99 million, which it expects to book in its third-quarter 2022 results,
compared to a net underlying profitability of €27 million in first-quarter 2022. However, it will generate annual cost savings of
approximately €37 million going forward, equivalent to 19% of the bank’s staffing costs, which comprised more than 50% of total
operating expenses in the first quarter of 2022. The immediate 100 basis point before-tax hit to capital is manageable given the
bank’s improved capital buffers (Common Equity Tier 1 (CET1) ratio of 15.2% as of March 2022), pro forma for the bank’s recent
nonperforming exposures sale. The immediate costs will also be mitigated by the adoption of IFRS 17 standard on 1 January 2023,2,
which the bank expects will improve its CET1 ratio by 50 basis points.

With more than 90% of transactions executed digitally as of April 2022, Bank of Cyprus has steadily reduced it number of branches,
closing 25% of its branches so far this year and 40% in the past three years. The bank's workforce has shrunk 30% over the last three
years, mainly because of successive and costly early retirement plans, including the latest one.

Rightsizing the bank will reduce its structurally high cost base and improve its cost-to-income ratio. Over the medium term, the bank
is targeting a 50%-55% cost-to-income ratio, based on core operating expenses and excluding regulatory costs, down from 59% in
first-quarter 2022 (excluding one-time items and regulatory costs). Despite the improvements, we expect Bank of Cyprus’ efficiency
to be weaker than many of its European peers because of structural rigidities (see exhibit), including a bank employee union that
makes the labor environment inflexible, with high fixed annual cost increases for all employees, and inflation-linked salary adjustments
exacerbating costs.
Cypriot banks have the second-weakest efficiency among EU peers
Cost-to-income
90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

Greece: Q4 2021
Source: European Banking Authority Risk Dashboard Q1 2022

6 Credit Outlook: 28 July 2022

 Bank of Cyprus’ cost rationalisation efforts have intensified as its focus moves toward building a sustainable profitability following its
balance sheet derisking and reduction of legacy nonperforming exposures to 6.5% of gross loans as of March 2022, from a peak of
more than 60% in 2015.

Bank of Cyprus' recurring profitability will strengthen from currently weak levels with rising interest rates, in line with its euro area
peers. For Bank of Cyprus, the effect of high and rising interest rates will be pronounced and immediate because of its €9.3 billion
balances as of 30 March at the European Central Bank (ECB). The bulk of Bank of Cyprus' balances with the ECB3 earned a negative
0.5% before the ECB's recent 50 basis points rate hike, which will reprice immediately. Also, a portion of the bank’s variable rate loans
will reprice with a time lag, while higher interest rates will not fully feed through to deposit rates given excess liquidity. As a result, we
expect the bank’s profitability to rebound faster than previously expected with the bank expecting to reach its 2025 target of achieving
a return on tangible equity (i.e., net profits divided by shareholders' equity minus intangible assets) exceeding 10% one year ahead of
plan.

Endnotes
1 The bank ratings shown in this report are the bank's deposit rating and Baseline Credit Assessment
2 The standard affects the phasing of profit recognition for insurance contracts
3 The ECB’s two-tier system exempted part of banks’ excess reserve holdings from negative rates

Christos Theofilou, CFA, VP-Senior Analyst Corina Moustra, Associate Analyst

Moody’s Investors Service Moody’s Investors Service
[email protected] [email protected]
+357.2569.3004 +357.2569.3003

7 Credit Outlook: 28 July 2022

 NEWS AND ANALYSIS SOVEREIGNS

Wildfires and droughts will intensify inflation and increase government

spending, a credit negative
Originally published on 26 July 2022

As of 26 July, wildfires burned in France (Aa2 stable), Spain (Baa1 stable), Portugal (Baa2 stable), Italy (Baa3 stable) and Greece (Ba3
stable) amid intense heat and drought. The credit-negative conditions intensify inflationary pressure and increase sovereign spending, a
credit negative.

The Iberian Peninsula has been hit worst by wildfires, with close to 180,000 hectares of land charred across Spain and Portugal as of 16
July. French authorities report 40,000 hectares of burned land over the same period. Across the European Union (EU, Aaa stable), the
amount of burned land far exceeds previous records for prior years' January-July period (see Exhibit 1).

Exhibit 1
The number of wildfires reported in the EU this year is historically high
Total burnt areas (hectares, thousands)
Min 2006-2011 Max 2006-2011 2022 Average 2006-2021
500

450

400

350

300

250

200

150

100

50

0
1-Jan 15-Jan 29-Jan 12-Feb 26-Feb 12-Mar 26-Mar 9-Apr 23-Apr 7-May 21-May 4-Jun 18-Jun 2-Jul 16-Jul

The gray-shaded area is the 2006-21 minimum and maximum

Sources: European Forest Fire Information System and Moody's Investors Service

Drought is also leading to severe water shortages, particularly in southern Europe. According to the European Commission (EC), close
to one half of the EU territory is at risk of drought. Italy in particular is having its worst drought in 70 years. Its longest river, the Po,
is currently several meters below its normal level, while the Brenta river, also located in northern Italy, has been completely dry since
the beginning of July. France’s ministry of ecology recently declared a state of water “crisis” in 20 departments, including in northern
regions where the Rhine is running at historically low levels.

In the short term, these conditions will weaken agricultural output. The European Commission forecasts that cereal production
in the EU will be 2.5% lower this season than during the 2021-22 period, despite efforts to increase domestic supply. The Italian
Confederation of Direct Farmers (Coldiretti) has warned that the droughts will cost Italy's agricultural sector €3 billion (0.15% of
nominal GDP); at least 30% of Italy's total rice harvest has been wiped out and yields of fruits and vegetables in the Po Valley have
fallen by more than 30%. France’s soft wheat production is expected to be 7.2% below last year’s level. The agricultural sector
represents a small share of gross value added in most countries (1.85% in France, 2.18% in Italy, 2.54% in Portugal, 3.02% in Spain, and
4.46% in Greece as of 2021), but the decline in output will pressure food prices.

Amid an energy crisis triggered by Russia's invasion of Ukraine (Caa3 negative), droughts have also reduced hydropower production in
Portugal, Spain and Italy by over 20% compared to the 2015-21 mean for July,1 and forced nuclear energy plants that require cooling
water to slow production. Although estimates are difficult at this stage, a heatwave in 2003 caused France's annual nuclear electricity
production fall 1.5%. France's drought and the fact that more than half of its nuclear reactors are currently out-of-service have forced

8 Credit Outlook: 28 July 2022

 it to import electricity for the first time since 1980. Higher energy and food prices will pressure inflation and erode discretionary
spending, which in turn will slow economic growth.

Governments will also incur additional costs to extinguish fires and replant trees. Last year’s wildfires in Greece for example cost the
government €500 million (0.3% of nominal GDP). The EU has also said it is in talks to buy more firefighting planes. Governments are
also likely to need to extend support measures to the most affected territories. For example, the Italian government recently adopted a
€36.5 million (0.002% of nominal GDP) relief package to help regions suffering from droughts.

While these costs remain manageable in the short term, the expected increase in number, intensity and duration of droughts and
wildfires in the coming years will likely have a longer-term credit-negative effects. In a study published in July 2022, the European
Commission said an intensification of extreme events under a standard 1.5°C scenario will present additional annual fiscal costs of
4.5% of GDP in Spain, 2.1% in Portugal, 1.7% in Italy and 1.2% in France. Droughts and wildfires would have major consequences for
tourism, which represents more than 20% of GDP in Greece, 18% in Portugal, 15% in Spain, 13% in Italy, and 9% in France. Therefore,
increased exposure to physical climate risks is likely to contribute to an erosion in their fiscal and economic strength.

Rising temperatures are also likely to trigger social risks through their effects on human health. Spain and Portugal recorded over 1,000
heat-related deaths as of 19 July and wildfires across Southern Europe are polluting the air, with severe health effects. We reflect these
vulnerabilities in the “moderately negative” environmental issuer profile scores (IPS) and “moderately negative” to “highly negative”
social IPS we assign to Spain, Greece and Portugal. Scores from Moody’s ESG Solutions show a broad set of elevated climate risks in
southern Europe, but heat, water scarcity, and wildfires are key drivers (see Exhibit 2).

Exhibit 2
Southern European sovereigns have elevated ESG scores for exposure to physical climate risks
Sovereign climate risks scores (over 100)

100

80 Heat Stress
Water Stress
60
Floods
40 Sea Level Rise

20 Wildfires
Overall Score
0
Italy (E-2) Spain (E-3) Greece (E-3) France (E-2) Portugal (E-3)

Source: Moody's Investors Service

Endnotes
1 Reservoirs have declined 52% year-on-year in Portugal, 29% in Spain, and 25% in Italy.

Steffen Dyck, Senior Vice President Olivier Chemla, VP-Senior Analyst

Moody’s Investors Service Moody’s Investors Service
[email protected] [email protected]
+49.69.70730.942 +49.69.70730.956
Sarah Carlson, CFA, Senior Vice President Dietmar Hornung, Associate Managing Director
Moody’s Investors Service Moody’s Investors Service
[email protected] [email protected]
+33.1.5330.3353 +49.69.70730.790

9 Credit Outlook: 28 July 2022

 NEWS AND ANALYSIS SUB-SOVEREIGNS

Heatwave-fuelled wildfires in Spain and France increase regional and

local governments’ spending
Originally published on 27 July 2022

As of 26 July, heatwave-fuelled wildfires that began in mid-July in France (Aa2 stable) and mid-June in Spain (Baa1 stable) continued to
rage, tragically costing lives and leaving a swath of economic losses and environmental damage in France's Nouvelle Aquitaine region
and Spain's Extremadura (Baa2 stable), Andalucia (Baa2 stable), Castilla y Leon (Baa1 stable) and Galicia (Baa1 stable) regions.

Affected regional and local governments (RLG) face increased costs related to fire management and health and safety, while damaged
local economies will diminish the RLGs' revenue, a credit negative. Economic disruptions are likely to reduce RLGs' tax and other
revenue but the impact is likely to be greater on the expenditure side.

Strong financial support to the RLGs from Spain and France's central governments will mitigate the costs of these events, as will
the practical support provided by the EU's (Aaa stable) Civil Protection Mechanism for disasters. Additionally, insurance coverage in
the housing, tourism and agricultural sectors will mitigate losses and support the recovery of these sectors in the RLGs' economies.
The heatwave and wildfires, however, could weaken tourism and its contribution to regional GDPs, which amounts to about 7% in
Andalucia and 8% in Nouvelle Aquitaine, as well as damage agriculture.

RLGs in both countries are instituting measures to boost resilience to physical climate risks, including heat stress and wildfires. In
France, the central government covers much of the costs related to fire and heat stress management because health is a national
competency. Indeed, after a serious heatwave in 2003, the government began implementing a national heatwave plan to prevent
adverse health consequences especially among the elderly and to protect health facilities from being overburdened.

For wildfires, France's local governments (départements) must finance firefighters, but in emergencies, a national crisis department
sends additional fire units if needed, as is now the case in Nouvelle Aquitaine. According to the 2020 EU Commission report on forest
fires, French RLGs partially fund surveillance and alert operations for 36,000 man-days per year in the Mediterranean region and fully
fund information campaigns. The EU funds investment in field equipment, which was around €1.7 million in 2020.

Similarly, Spain is implementing climate-change adaptation measures based on its 2004 National Excessive Temperatures Prevention
Plan. Each region is responsible for implementing the plan in its respective territories, including measures to protect the health of more
vulnerable groups, such as the elderly, and prevent pressure on health services. The regions are also responsible for coordinating with
affected administrations and territories. Spanish regions' environment management and protection and healthcare costs comprised an
average of 40% of their budget in 2021.

According to Risk Management Solutions, a Moody's Analytics company, Spain attributed 360 deaths to the heatwave between 10
July and 15 July, with latest estimates at over 1,040 deaths. Castilla y Leon and Galicia are the regions with the highest percentage of
populations over 65 years old, which is significant because people aged over 74 accounted for 90% of heatwave-related deaths in 2021,
according to Informe MoMo and Instituto de Salud Carlos III. In 2021, Castilla y Leon and Galicia were the most heatwave-affected
regions in Spain, accounting for around 1,300, or 75%, of heatwave casualties, which increased healthcare spending and put pressure
on their respective budgets.

Extremadura and Andalucia are among the Spanish regions most exposed to the physical climate risks of heat (Exhibit 1) and wildfires
(Exhibit 2). Rising temperatures, wildfires and droughts threaten the agricultural sector, which contributed 9% to Extremadura's 2020
GDP and 7% of Andalucia's, compared with 3% at the national level.

10 Credit Outlook: 28 July 2022

 Exhibit 1 Exhibit 2
Regions in Spain and Southwestern France generally face medium Regions in Spain and southwestern France have medium to high
to high exposure to heat stress risk exposure to wildfire risk
Heat stress risk by region Wildfires by region

Source: Moody´s ESG Solutions Source: Moody´s ESG Solutions

Exposure to physical climate risks from heat stress and wildfires and their associated costs are captured in Extremadura and Andalucia's
“highly negative” (E-4) environmental issuer profile scores. Water stress, wildfires and heat stress are “high” physical climate risks in
the southern regions of France and Spain. The increasing frequency and severity of extreme weather events will likely have a longer-
term credit-negative effects and necessitate more adaptation and prevention measures to boost climate resilience for vulnerable RLGs,
though the effectiveness of many adaptation strategies has yet to be widely tested.

Mathilde Bonvin, Associate Analyst Stefan Ritzka, Associate Analyst

Moody’s Investors Service Moody’s Investors Service
[email protected] [email protected]
+33.1.5330.1036 +49.69.707.30947
Jennifer A. Wong, CFA, VP-Sr Credit Officer Marisol Blazquez, AVP-Analyst
Moody’s Investors Service Moody’s Investors Service
[email protected] [email protected]
+44.20.7772.5333 +34.91.768.8213

11 Credit Outlook: 28 July 2022

 CREDIT IN DEPTH

Significant US growth slowdown ahead, but recession could still be

avoided
Originally published on 25 July 2022

We have lowered our 2022-23 economic growth forecasts the US (Aaa stable) to incorporate the effect of Federal Reserve monetary
policy becoming increasingly restrictive to tame surging inflation. The US macroeconomic cycle is at an inflection point with a
downshift in growth clearly ahead, and much will depend on factors beyond the Fed's control, such as supply issues and energy prices.

» US real GDP growth is set to slow. We now expect US real GDP growth of 2.1% in 2022 and 1.3% in 2023, down from our May
forecasts of 2.8% in 2022 and 2.3% in 2023. Stubbornly high inflation is being met with tighter monetary and financial conditions,
and economic growth will weaken. We expect the unemployment rate to rise to slightly above 4.0% in 2023 from the current low
rate of 3.6%, owing to a combination of slower hiring and rising labor force participation as more workers seek re-employment.

» Policy decisions are made more challenging by lags in economic data and policy transmission. It will be tricky to navigate
to an equilibrium where inflation falls but economic activity does not slip into recession. The US economy remains fundamentally
strong currently, but macroeconomic volatility will persist for at least another year, injecting large swings in key macroeconomic
indicators, complicating the assessment of economic conditions.

» Inflation will remain elevated this year and into next year. Our forecasts assume that tighter financial conditions, combined
with the ongoing inflationary shock, will limit additional consumer spending and interest-sensitive investment activity over the next
year. Inflation will remain above targets this year, but softening demand and some improvements on the supply side will steadily
drive inflation lower by end 2023.

» Downside risks are high but prolonged stagflation can be avoided. There are two main differences that set the current US
economic environment apart from that of the 1970s: (1) the unemployment rate today remains at record lows and economic
activity is far from stagnant; and (2) there has been a paradigm shift since the 1970s in understanding the optimal monetary
policy response to tackle business cycle fluctuations. Lessons learned from the 1970s are the reason why today's monetary policy
framework is credible and effective, and why the Fed is tightening aggressively.

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12 Credit Outlook: 28 July 2022

 CREDIT IN DEPTH

Growth in Europe's largest economies will sharply decelerate as energy

crisis persists
Originally published on 25 July 2022

We have lowered our baseline 2022-23 GDP growth forecasts for the major euro area countries, and have also reduced our 2023
growth forecasts for the UK. The main factors driving the lower growth projections are: (1) gas supply interruptions and uncertainty that
will require adjustment on the demand side; (2) high inflation, which is denting consumer spending; (3) withdrawal of monetary policy
support by the European Central Bank (ECB); (4) tighter global liquidity; and (5) subdued external demand.

The steadily worsening energy crisis in Europe has inhibited the economic recovery from the pandemic shock. In our baseline, for the
euro area as a whole, we now expect real GDP to grow 2.2% in 2022, followed by 0.9% in 2023, down from our May forecasts of 2.5%
and 2.3%, respectively (see Exhibit 1). The inflation rate hit a record 8.6% in June from a year earlier, and we expect inflation to remain
elevated this year.

There are substantial risks to our forecasts in the event of a complete shutoff of gas flows from Russia to Europe. Such an energy supply
shock that would be severely disruptive and inflationary, and forms the basis of the alternative downside economic scenario that we
discuss in more detail below.

Exhibit 1
Economic growth will decelerate in 2022 and 2023
Baseline scenario forecasts for major euro area countries and the UK

Baseline
Real GDP growth Inflation (Dec-to-Dec, %) Unemployment rate
scenario
Economies 2021 2022F 2023F 2021 2022F 2023F 2021 2022F 2023F
Euro area* 5.0 2.2 0.9
Germany 2.9 1.4 0.5 5.7 7.6 ↑ 3.1 ↑ 3.6 3.3 3.8
France 7.0 2.1 1.0 3.4 5.7 ↑ 2.4 ↑ 7.9 7.0 7.3
Italy 6.6 2.2 0.8 4.1 7.5 ↑ 3.3 ↑ 9.5 8.4 8.5
UK 7.4 3.0 0.9 5.4 11.0 ↑ 3.8 ↑ 4.5 4.0 4.2
*Euro area real GDP growth is based on aggregate growth of six euro area economies: Germany, France, Italy, Spain, Portugal and the Netherlands.
Source: Moody's Investors Service

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13 Credit Outlook: 28 July 2022

 RECENTLY IN CREDIT OUTLOOK

Articles in last Monday's Credit Outlook

FIRST READS
» ECB rate hikes and bond buying program are positive for euro area banks

» ECB's rate hike will push money market fund yields into positive territory

NEWS & ANALYSIS

Corporates

» Liquidity stress and defaults are reshaping the Asian high-yield market

Infrastructure

» Technical fault at Neelum Jhelum is credit negative for Pakistan Water and Power Development Authority

Sovereigns

» Collapse of coalition government heightens Italy's economic, policy and fiscal risks

» Ukraine's proposed deferral of bond payments will not fully alleviate debt-sustainability risks

» Indonesia temporarily scraps palm oil export levy to improve trade balance and reduce inventory

Accounting

» FASB approves sought-after supplier finance disclosures, a credit positive

CREDIT IN DEPTH
» Mexico's sluggish growth constrains credit prospects across sectors

» FAQ on the unintended consequences of El Salvador's Bitcoin gambit

MOODY'S MACRO MONDAY

» ECB delivers a 50-basis-point rate hike and unveils anti-fragmentation tool

Click here for last Monday's Credit Outlook.

14 Credit Outlook: 28 July 2022

 Editors
Jay Sherman, Elisa Herr, Andrew Bullard, Julian Halliburton and Phil Macdonald

15 Credit Outlook: 28 July 2022

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16 Credit Outlook: 28 July 2022