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Friday, September 30, 2011
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.
Thursday, September 29, 2011
China Watch: Rebound in China's PMI Triggers No Change in Monetary Policy
China's PMI climbed +0.2 points higher to 50.9 in August. While the data came in slightly higher than market expectations, the detailed report evidenced that the momentum of manufacturing activities has weakened when compared with the same period last year. China's exports sector has also been affected by the headwind faced in advanced economies. The risk of inflation remains as input prices unexpectedly rebounded during the month. Premier Wen Jiabao reiterated yesterday that stabilizing overall price levels remains the top priority task of the government. In light of heightening risks of global economic slowdown, we doubt if the government will roll out more tightening measures. Yet, a reversal of policies implemented also appears unlikely.
The August PMI represented the first rise of the index since March. Despite that, the +0.4% monthly increase was less than that +1% increase the same period last year. Moreover, the level that the index has been hovering over the past 3 months is around 51, lower than 52 the same period last year. This signaled the government's tightening policy since October 2010 has taken effects. We expect growth in China will slow further but the risk of hard landing remains low.
Domestic demand resilient as 'production' index rebounded to 52.3 from 52.1, 'import' index picked up +0.6 points to 49.7 and 'new orders' index stayed unchanged at 51.1. However, external demand has obviously been hurt with 'new export orders' index slipping to 48.3 from 50.4 in July. China's largest trading partners, the US and the Eurozone, have been facing debt and economic problems recently. Fiscal- consolidative plans are expected to hurt the economy of both sides of the Atlantic and this would further impact China's external trade in the future. Note that, the drop in 'new export orders' suggested that domestic new orders actually rose in August from July.
'Input price' index climbed to 57.2 from 56.3. The first increase in 6 month signals that the upstream inflationary pressure has not eased. While we expect moderation in global commodity prices will ease price pressure in coming months, it's yet to early confirm the rebound was only a 'one-off' issue.
Premier Wen Jiabao said yesterday that China will continue to stabilize overall price levels in the economy and 'the direction of economic policy cannot change'. This suggests that the government will focus on controlling inflation although growth outlook both domestically and in overseas has deteriorated. Indeed, we expect the government will hike interest rates once for the rest of the year but it will most likely not reverse the tightening measures implemented.
ECB Coordinates With Other Central Banks To Provide Liquidity Through Year End
The ECB announced that, in coordination with the Fed, the BOE, the BOJ and the SNB, to conduct 3-month USD liquidity operations for 3 times through the year. In addition to the 7-day USD facility announced on May 10, 2010, the new operation aims to ensure sufficient liquidity in banks. The offerings will be carried out at in the form of repo, at fixed rate and with full allotment. Tender dates will be October 12, November 9 and December 7. The move had sent stocks higher on improved sentiment as central bankers attempted to ease liquidity problems associated to Eurozone's sovereign debt crisis. The euro advanced.
After the collapse of Lehman Brothers in October 2008, the ECB launched the USD liquidity facility in order to meet liquidity demand from the stressed banking system. All operations were discontinued in January 2010 as the funding market improved and demand reduced. However, as the Greek debt crisis began in May 2010, the ECB reactivated the 1-week USD liquidity facility and introduced a special 3-month operation as banks turned more reluctant to lend money to each other again.
The 1-week operation had lacked demand since February this year but a single bidder was reported to have borrowed $500M at a fixed rate of 1.1% on August 18. As we mentioned at that time, this signaled intensified stress in the region's money market conditions. Earlier this week, the ECB said that 2 more banks borrowed a total of $575M via the operation, evidencing rapid deterioration in the banking system in the Eurozone.
Yesterday's announcement marked a step forward to inject liquidity to the market. We believe it would give relief in the short-term but would not help solve the problem. Indeed, we view the move as an indication of the seriousness of deterioration in market sentiment in recent months and world central bankers have envisaged further tightening in the region's banking system going forward. Some market participants said the move was a prelude to the Fed's QE3. We expect the Fed, at next week's meeting' will not deliver anything more than so-called 'operation twist' -increasing the average maturity of securities holdings by swapping holdings of lower maturities Treasuries with longer ones.
Wednesday, September 28, 2011
ECB Pauses in September, Sends Dovish Message
The ECB left the main refinancing rate unchanged at 1.5%. While this had been widely anticipated, the accompanying statement turned out to be more dovish than the market forecast. The central bank revised lower growth forecasts and did not signal upside risks to inflation. The tone appeared that the central bank is ready for a rate cut should the economy deteriorate further.
As stated in the post-meeting statement, the pace of economic growth 'decelerated' in 2Q11. Going forward, Eurozone's economy will continue to grow 'moderately, subject to particularly high uncertainty and intensified downside risks'. Factors that are dampening the underlying momentum in the region include 'a moderation in the pace of global growth, related declines in equity prices and in business confidence, and unfavorable effects resulting from ongoing tensions in a number of euro area sovereign debt markets'. The ECB pledged to maintain inflation rates below, but close to, 2% over the medium term.
The ECB revised lower the growth outlook. ECB staff forecast annual real GDP will grow 1.4-1.8% in 2011 and 0.4-2.2% in 2012. The projections were revised lower when compared with June's estimates. The risks to the economic outlook are tilted to the downside. Concerning inflation, policymakers believed near-term risks are 'broadly balanced'. While rises in commodity prices and increases in indirect taxes and administered prices might drive up prices, weaker than expected growth in the Eurozone and globally present some downside risks. Staff projections on inflation stayed unchanged at 2.5-2.7% for 2011 and 1.2- 2.2% for 2012.
The central bank left the policy rate unchanged at 1.5%. Regarding the monetary outlook, Preside Trichet said the committee 'never pre-committed' and stands ready to do 'whatever is necessary'. The ECB downplayed inflationary pressures and reduced growth forecasts. These signaled that interest rates will stay low for some time. Indeed, the central bank might ease monetary policy if the situation weakens further.
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