HOUSE_OVERSIGHT_014577.jpg

Exhibit 43: Japan Consumer Prices Core inflation and inflation expectations remain low. % YoY 3.0 5 Core Inflation* “---- Expectations of Average Inflation Over Following 10 Years** BOJ Inflation Target 10 - 2011 2012 2013 2014 2015 2016 Data through November 2016. Source: Investment Strategy Group, Datastream, QUICK Bond Investors Survey. * Core inflation excludes fresh food and VAT impact. ** Based on the QUICK Bond Investors Survey. United Kingdom: A Fork in the Road Much like the Eurozone, the UK economy is notable for its resilience, evident in 15 consecutive quarters of positive quarterly growth averaging 2.5% annualized. This streak is even more impressive considering last year’s Brexit vote and the resulting consensus view that the UK was destined for recession. Although the 20% decline in the trade-weighted sterling and rapid easing by the Bank of England were no doubt pivotal in avoiding that fate, the immediate impact of the Brexit referendum has been far less destructive than feared. But as we begin 2017, the UK is rapidly approaching a fork in the road. The government must choose which path Brexit will take once it triggers Article 50 of the Lisbon Treaty, which formally sets the process of the UK exit in motion. Here, the government’s current objectives—limiting freedom of movement into the UK while retaining full access to the European Union’s single market— UK authorities will have little room to cushion a downturn given today’s large fiscal deficits and already highly accommodative central bank. seem mutually exclusive and likely to engender a politically charged negotiation process. This road is made all the more dangerous by the fact that UK authorities will have little room to cushion a downturn given today’s large fiscal deficits and already highly accommodative central bank. Of course, a softer stance on the issues is also a possible path, one that could elongate the effective transitional period beyond two years and lead toa far more benign outcome for the UK. The uncertainty around the government’s ultimate choices significantly increases the range of GDP outcomes in the medium term. Our current base case assumes GDP will expand by 0.5-1.5% in 2017. This notable slowdown from last year’s 2% pace reflects the likelihood that both hiring and investment activity will become more cautious once the Brexit negotiations start. Even worse, this slowdown arrives just as consumer price inflation is accelerating from past sterling depreciation, creating a lower growth/higher inflation backdrop that is set to erode real income growth. For these reasons, the risks to our central case are skewed to the downside. That said, the fate of the UK economy is not preordained, even after the government chooses its path. As with any other negotiation, the result will ultimately reflect the reasonableness of the parties, the concessions of both parties and how the discussions evolve over time. Or in the words of golf legend Arnold Palmer: “The road to success is always under construction.” 14 Japan: Same Battle, Different Year For Japan, the decades-long battle against deflation never seems to end. Despite two years of above- trend GDP growth, including last year’s 1% gain, core inflation remains negative, having fallen 0.4% in 2016 (see Exhibit 43). This comes despite a tight labor market and record profits that should have encouraged companies to increase base wages. These already muted inflationary pressures were exacerbated by low energy prices and the appreciation of the yen, once again pushing the Bank of Japan’s (BOJ’s) 2% inflation target further into the future. But far from waving the white flag, Japan’s policymakers responded with a range of bold measures, including a 44 | Goldman Sachs | JANUARY 2017 HOUSE_OVERSIGHT_014577