Market Outlook June 2007

Morgan Stanley Investment Management

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Market Outlook 31ST MAY 2007

Global Take over activity continued to support global stock markets in May, although trading was often turbulent. Prices wilted mid month after Alan Greenspan, former Federal Reserve Chief, (and once the epitome of economic discretion), voiced his concerns on the Chinese stock market. Rising crude oil prices and worries about economic data also hurt investor sentiment. Interest rate chatter dominated the economic arena. The possibility of a near term cut in US rates diminished following the latest FOMC policy statement that said inflation remains the “predominant” concern of policymakers. Stronger-than-expected economic data over the month also made a shift in policy less likely. In the Euro zone, a string of strong data releases have pretty much secured a rate rise on June 6. Markets are already pricing in a further rate rise from the European Central Bank later this year. In the UK, the Monetary Policy Committee raised rates to the highest level in six years in a universally anticipated decision. On the Asian front, the Bank of Japan kept rates on hold but left the door firmly open for a further rise later this year. Indeed data towards the end of this month, which included a fall in unemployment and a pick up in household spending, will have undoubtedly bolstered the central bank's case for raising interest rates. The People’s Bank of China continued to tighten their monetary policy in further attempts to try and cool down the rapidly expanding economy. The price of Brent crude rose 68 cents to a nine-month high of $71.42 over the month. Prices have been on an upward curve in recent months owing to a range of factors including instability in Nigeria and signs that the dispute over Iran's nuclear ambitions could be entering a new, more troubling phase. Prices were also driven higher by US data showing fuel stockpiles were below average, ahead of the crucial holiday season. In other news, a week of high-level talks in Washington aimed at easing trade tensions between China and the US have ended without any significant agreement. The failure to end their biggest dispute, China’s undervalued currency, raises the risk that Congress will impose policies that could sour the US-China economic relationship going forward.

United States Economics The latest housing reports exposed further mixed signals about the near term outlook of the sector. Purchases of new homes unexpectedly surged in April by the most in 14 years as buyers took advantage of the biggest decline in median prices since 1970. Meanwhile, existing home sales fell to a 4-year low as the supply of homes on the market rose to a 15-year high. In similarly conflicting reports, housing permits plunged 8.9% in April, whilst housing starts surprised rising an unexpected 2.5%. In a speech in Chicago, Federal Reserve Chairman Ben Bernanke admitted that the slowdown in the housing market probably has further to run, but that it was unlikely to have a significant impact on the rest of the economy. In the same speech Mr Bernanke pledged to consider further regulatory action to deal with abuses in the sub prime lending market.

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Other data over the month was broadly positive. Industrial production rose 0.7% in April, suggesting that manufacturing may be turning a corner. Durable goods orders also registered their third straight monthly increase. According to the University of Michigan’s survey, American consumers grew in confidence in May. Inflation data was also generally encouraging with core CPI inflation moderating to 2.3%, the lowest reading in a year. Whilst these figures are likely to offer some support to policy makers it is unlikely that any near-term shift in policy will be implemented. The latest FOMC policy statement released on May 9 said that inflation remains the “predominant” concern of policymakers. Equities US indices registered marginal gains in May. With corporate earnings reports mainly complete, investors concentrated on economic data, which was mixed. The S&P 500 saw a record closing high of 1,527.46, which it topped for the first time in seven years, before falling back in the last week of the month. Stocks retreated as it became apparent from new housing data that the Federal Reserve may not need to cut the interest rate any time soon: the market had been expecting an interest-rate cut to encourage economic growth later in the year. The recent spike in the oil price and former Federal Reserve Chairman Alan Greenspan’s comments that he expects a contraction in China’s markets also impacted stock prices. Bonds Treasuries fell in May, pushing yields on benchmark 10-year notes to the highest level since January. Signs of strength in the housing sector and comments from Federal Reserve policy makers that inflation remains their primary concern were behind the fall in prices. Futures traders pared bets that the central bank will lower interest rates. Summary: US equities: negative US bonds: negative

Europe Economics The self-sustaining recovery in Europe continued unabated in May. The latest GDP data, which came in above expectations for the first quarter, led economists to revise up full year forecasts, which could see the region matching last year’s 2.7% annual growth rate. The fastest economic growth in six years is also boosting tax revenue for European governments and helping them bring down budget deficits. Both Germany and Greece avoided expected disciplinary action as their deficits fell below the EU limit. In France, non-farm payrolls rose 93,600 or 0.6% in the first quarter - the best in six years. Meanwhile, in Italy, industrial orders surged 4.6% in March. The latest increase left overall orders 10.8% higher than a year ago. The euro area ran a €7.4 billion trade surplus in March 2007. Its exports were up 1.2% while its imports were down 2.6%. New orders for industrial goods (excluding ships, railway and aerospace equipment) grew by 2.7%.

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The European Central Bank again stressed the need for “strong vigilance” to ensure inflation doesn't accelerate. Risks to the medium-term outlook for price stability remain clearly on the upside. In particular, stronger than currently expected wage developments in a context of ongoing robust growth and high oil prices pose a threat. Another rise in the key interest rate on June 6th has already been factored into the market. In the UK, interest rates hit their highest level in more than six years after the Monetary Policy Committee raised the cost of borrowing to 5.5%. Release of the minutes later in the month showed that the vote to raise rates was unanimous - the first unchallenged decision to raise rates since August 2004 and a very strong signal of intent. The move came as inflation reached its highest level since Bank independence and amid a background of strong underlying growth. Equities European markets hit fresh multi-year records in May as merger & acquisition activity continued to underpin equities. News of potential consolidation in the Dutch mobile market boosted telecoms KPN, Vodafone, Deutche Telekom and France Telecom. Car producers also benefited from takeover speculation, rewarding the German stockmarket in particular. The end of the month saw some markets retreat however as investors began to question the valuations of many shares, especially after recent gains. Bonds Bund yields rose to multi-year highs after Germany's ZEW investor sentiment data reinforced the outlook for strength in the Euro zone economy. Other economic data released over the month was also strong and another rate hike on June 6th has now been factored into prices. Summary: European equities: slightly positive European bonds: negative

Japan Economics The Bank of Japan (BoJ) left its key overnight interest rate unchanged at 0.50% in May. At the press conference, which followed the widely anticipated move, BoJ governor Toshihiko Fukui said they would adjust rates gradually to support economic growth amid price stability. Economic date over the month was mixed. The core consumer price index (CPI), excluding fresh food prices, fell 0.1% in April from a year earlier, the third straight month of year-on-year declines. Japanese GDP grew 0.6% in the first quarter of 2007 compared to expectations for a 0.7% quarter-on-quarter rise. While the headline number only just missed analyst forecasts, the capital expenditure component was down 0.9% quarter-on-quarter. Japan's machinery orders unexpectedly fell 4.5% in March from a month earlier after declining a revised 4.9% in February.

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In a more positive development, the recovery in consumption appeared in tact. Japan's unemployment rate declined to 3.8% from 4%, where it had been stuck since November, and household spending rose a higher-than-expected 1.1%. Equities Japanese stocks were volatile in May. However, stocks rose at month end after reports showed the nation's jobless rate unexpectedly fell to a nine- year low and households increased spending for a fourth month. Banking stocks were the primary beneficiaries on speculation the improving economy will allow the Bank of Japan to lift interest rates, and thus help widen lenders' profit margins. Bonds Japan's five-year notes dropped in price, pushing yields to their highest level since August, after government reports on jobs and consumer demand bolstered the central bank's case for raising interest rates. Two-year note yields reached the highest since 1997 after Bank of Japan Governor Toshihiko Fukui said the bank will “implement monetary policy in a timely manner” if it can be confident about the economy's outlook. Summary: Japanese equities: slightly positive Japanese bonds: negative

Asia, ex-Japan Economics China continued to tighten monetary policy in May. The People’s Bank of China raised the interest rate on one-year savings deposits by 0.27%, to 3.06%, and the one-year lending rate by 0.18%, to 6.57%. Banks' reserve requirements were raised for the eighth time in a year. The move came amid continuing strong economic data and heightened concerns for the overall health of the economy. Meanwhile, two days of closed-door talks between the United States and China on economic issues produced deals on international aviation and opening up China's financial industry but made little progress on reforming China's foreign exchange policy. Thailand's central bank cut its key interest rate from 4% to 3.5%, its fourth cut this year. The Thai economy has yet to recover from the political upheaval of September's coup. Malaysia's central bank kept its benchmark interest rate unchanged for a ninth straight meeting, refraining from a cut in borrowing costs on expectations of a pickup in economic growth. Elsewhere Asian economies continued to exhibit strength. In Taiwan, industrial production grew by 2.6% in the year to April, compared with just 0.4% in the year to March. Singapore’s trade-driven economy grew faster than expected on the back of a property and services sector boom, prompting the government to raise its 2007 GDP growth forecast to 5.0-7.0%, from 4.5-6.5 %. Surging Chinese exports and growing demand for foreign goods in the mainland boosted shipments through Hong Kong in April.

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Equities The majority of Asian markets registered strong gains in May. Indices in South Korea and China hit record highs. China’s market continued to benefit from domestic households shifting funds into the stock market and in South Korea shares soared after analysts raised their end-year forecasts for the benchmark KOSPI. Asian shares also rallied on speculation that global demand for commodities and higher raw-material prices may fuel more takeovers. Reports in Japan that showed an unexpected drop in unemployment and a rise in household spending also boosted investor sentiment. Summary: Asian equities: positive

Latin America Economics The Brazilian Real rallied in May as Latin America’s largest economy continued to get its fiscal and monetary house in order. A government report showed the trade surplus jumped to $1.3 billion, boosting the flow of dollars into the country. Brazil has netted dollar-based investors a return of more than 1,000 % in less than five years. Brazil's credit rating was raised to BB+ by Fitch Ratings, leaving the South American country on the cusp of investment grade. In Mexico, the central bank opted to keep its lending rate unchanged but signaled that it was ready to raise rates to rein in inflation if necessary. Other news showed Mexico’s current account deficit widened to $2.8 billion in the first quarter and the country’s unemployment rate fell to 3.6% in April from 4.01% in March. Elsewhere, Chiles’s economy expanded at its fastest pace in almost two years in the first quarter, powered by higher exports, investments and industrial output. Equities Benchmark indices across the region were volatile in May although most recorded modest gains. Comments by former US Federal Reserve Chairman Alan Greenspan that Chinese stock gains weren't sustainable rekindled concern that markets may face a replay of the February 27 sell-off. Brazilian stocks ended the month higher amid speculation metal prices will remain high as Chinese growth pushes up demand. In Mexico, earlier losses were mitigated by the Central Bank’s decision to leave interest rates on hold. In Peru shares fell as investors bet shares were expensive relative to earnings after a strong rally earlier this year. Summary: Latin American equities: positive This document represents the views of the Global Asset Allocation Group at Morgan Stanley Investment Management (MSIM). It does not reflect the opinions of all portfolio managers at MSIM and may not be reflected in the strategies and products that the Firm offers. The document has been prepared as information for investors and it is not a recommendation to buy or sell any particular security or to adopt any investment strategy. Investors should consult their professional advisers for any advice on whether a course of action is suitable. The author's views are subject to change without notice to the recipients of this document. The document has been prepared for institutional and professional investors only. Issued by Morgan Stanley Investment Management Limited, 25 Cabot Square, Canary Wharf, London E14 4QA, United Kingdom. Authorized and Regulated by the Financial Services Authority