China Watch: Moderation in Inflation not Strong Enough to Trigger Monetary Easing

Moderation of headline CPI to +6.2% y/y in August from +6.5% in the prior month signaled that inflation in China probably peaked in July. Yet, price levels remained elevated and it would be premature to expect China will abandon tightening or even shift to easing monetary policy. Growth of industrial production and fixed asset investment and retail sales decelerated further in August as a result of government's tightening measures. Yet, the rate of expansion remained resilient despite recent global economic turmoil. We expect to see further slowdown in economic activities in coming months but do not envisage any signs of hard landing.

Headline CPI rose to +6.2% y/y in August, easing from +6.5% in July, as helped by slowdown in food and housing prices. PPI increased +7.3% y/y in August, also down from +7.5% in July. We expect inflation has probably peaked in July and further drops are likely in coming months as oil prices have been pressured recently due to rising uncertainty in global economic outlook while pork prices in China has stabilized. Despite the steady decline, elevated inflation should remain a concern for the government. Note that even if inflation falls more significantly to in coming months, the average inflation for 2011 would remain above government's annual target of 4%. Therefore, policymakers would remain vigilant over price pressures and should maintain tightening monetary stance.

Asian stock markets last week were once boosted by a rumor that China may ease monetary policy over the next several months. We believe such speculation is premature. Indeed, just a week ago, some reports 'leaked' the information that the Chinese government is broadening the scope of reserve ratio hikes by including banks' margin deposits in required reserves. Bloomberg estimated that the move will freeze up to RMB 900B from the banking system. While both rumors were not verified, we believe the PBOC will prefer maintaining a tightening bias in monetary policy and turn to a 'proactive fiscal policy' should the economic outlook deteriorate further.

Industrial production (IP) climbed +13.5% y/y in August, easing from 14.0% and +15.1% in July and June respectively. While the reading also missed market expectations, it suggested growth in China remained resilient despite a series of rate hikes and increases in RRR. Fixed asset investment (FAI) grew +25.0% in the first 8 months of 2011, down from +25.4% in the first 7 months of the year. The deceleration was mainly brought about by the slump in railway investment which plunged +15.5%. Property and manufacturing investments remained resilient, soaring +33.2% and +32.2%, respectively.

We are impressed by retail sales which rose +17.0% y/y in August. Although it represented a dip from +17.2% in July, it continued to gyrate stably within a range of 17-18% over the past 2 quarters.

The set of data suggests that growth in China has moderated after government's persistent efforts to drain liquidity from the market. Further slowdown may be inevitable in coming months as tightening measures continue to show its effects and global economic outlook deteriorates further. However, the set of data also indicates the government's capability of curbing inflation while not hammering growth. Barring a rapid downturn in global economic activities, a hard landing of Chinese economy remains unlikely.

RBA Stands Still As Global Market Uncertainty Increases And Inflation Risks Remains

As expected the RBA left the cash rate unchanged at 4.75% in September. The initial market reaction was a rebound in the Aussie as the post-meeting statement turned out to be less dovish than previously anticipated. The central bank attributed the pause to the growing uncertainty in global economic outlook. Recent developments have damped confidence and tamed inflation. Against some of the market participants' forecasts, the RBA did not hint any signs on rate cut.

Policymakers acknowledged that global financial markets have been 'very unsettled over recent weeks' and the uncertainty and financial volatility is 'reducing confidence' and may result in 'more cautious behavior by firms and households in major countries'. In the near-term, the global growth outlook will look 'somewhat weaker' than what was estimated a few months ago.

Although the RBA reiterated that headline inflation should decline as temporary factors disappear, it remained concerned about the medium-term outlook. According to the statement, 'a key question will be the extent to which softer global and domestic growth will work, in due course, to contain inflation'. We believe inflation is a major consideration for RBA's monetary stance.

The jobless rate rose to 5.1% in July after staying at 4.9% over the past 4 months. The total number of payrolls increased +3K to 11.48K during month as addition in part-time employment offset the decline in full-time positions. The RBA did not show much worry about the employment situation although it noted that 'growth in employment has been moderate this year and the unemployment rate has been little changed, near 5 %, for some time now'. We believe the central bank will hold the same tone unless it sees the jobless rate rise to 5.5%.

Concerning monetary policy, the central bank believed that current levels of interest rates have exerted 'a degree of restrain'. Policymakers will continue to 'assess carefully the evolving outlook for growth and inflation' in future meetings.

SNB Lowers Growth And Inflation Forecasts, Pledges To Maintain Minimum EURCHF Rate

The SNB revised down its growth and inflation forecasts at the September meeting global economic slowdown and strength in Swiss franc are beginning to erode Swiss growth. In the meeting statement, the central bank showed its commitment in defending EURCHF at 1.20 or above. The SNB pledged it has 'utmost determination' and may take 'further measures' to enforce the minimum exchange rate.

Despite healthy growth in the first half, Swiss economic growth is expected to halt in the second half of the year. The SNB forecasts growth will reach 1.5-2% for 2011, down from +% projected previously, mainly driven by strength in the 1H11. The central bank warned of a threat of recession should there be no imposition of measures to curb currency appreciation.

As far as inflation in concerned, the SNB believed that 'in the foreseeable future, there is no risk of inflation in Switzerland'. On the contrary, there are 'downside risks for price stability, should the Swiss franc not weaken further'. The central bank trimmed the country's inflation outlook. Based on Libor at 0.0%, inflation rate will ease to +0.4% in 2011, down from +0.9% estimated previously. CPI will fall to -0.3% in 2012 (previous: +1.0%) before climbing higher to +0.5% in 2013 (previous: +1.7%).

As the SNB continues to intervene the FX market, we expect it will concentrate on euro buying initially. However, as the central bank seeks to diversify its reserves, other currencies including US dollar, the pound, Japanese yen and Canadian dollar will be purchased. If SNB's intervention in 1H11 serves as a guide, Canadian dollar will be bought the most while Australian dollar and Swedish Krona the least.