Digest Dec 2015 No8 : The outlook of inflation
Mexico monetary Policy: A pre-emptive hike and two more to follow
- The positive outlook of inflation, combined with downside risks to growth, suggests that Banxico will lag the Fed during its hiking cycle in 2016. Two more hikes of 25bp are expected, at the March and June meetings.
- Banxico decided to hike 25bp on the back of MXN weakness. As widely expected and against the expectation, the board of Banxico decided to set the reference rate at 3.25%. In the press release, the board mentioned that "although the central scenario of inflation in the short and medium term is in line with the consolidation of inflation to target", it had decided to increase the rate in response to the Fed hike to avoid additional exchange rate depreciation and affect inflation and inflation expectations.
- The board believes that a disorderly decompression of the term premia is a threat on the back of the US hiking cycle. Accordingly, it will be necessary to adjust the monetary policy in an adequate manner, in line with the fiscal consolidation that is taking place, as well as implement the structural reforms properly.
- The balance of risks to growth has improved, although no demand pressures are in sight in the coming semesters. The risks to growth are coming from weakness in manufacturing exports and lower oil prices; however, the economy has grown at a higher rate than expected in Q3 15 due to better private consumption.
- The balance of risks to inflation has improved in the short term. In the board's view, annual inflation will likely end 2015 at close to 2% and remain very close to 3% in 2016. Downside risks include additional reductions in telecommunications tariffs and some energy prices.
- It is believed that the domestic conditions suggest a shallow adjustment of monetary policy in 2016. The fact that external demand might remain weak during the year, combined with the absence of public investment and the risk of not having a full recovery in the labor market, should maintain modest growth in a best case scenario. Accordingly, it is believed that Banxico will likely lag the Fed during the second half of the year but that it will deliver two 25bp hikes in the first half. The overnight rate should finish 2016 at 3.75%.
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A pro-market coalition likely in Spain
Latest opinion polls suggest that second place might be occupied by the anti independance party Ciudadanos, way ahead of Podemos.
The new party should be divided and the coalition will prove needed for first time in the country's modern history.
"The likelihood of a pro-market coalition - between the PP and Ciudadanos - is now 75% in our opinion. However, polls point to a very thin majority, hence political instability will remain high", says Societe Generale.
These polls gave a broad range of sear forecasts and a situation same as in Portugal can also happen, like the PSOE might form a coalition and get a majority in Parliament, despite losing election in votes.
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Central Bank of Turkey hikes its rate on FX Reserves and US Fed hike
Central Bank of Turkey has made a rise in its interest rate on FX RRR as the US Fed made a hike this week, the annualised interest rate that CBT pays on Forex required reserves was increased to 0.49%.
This is consistent with the Governor Erdem Basci's guidance prior in this month that this rise could be done imminently consistent with Fed's change, so it was neutral for TRY.
At a broader level, government leaders remarked that there was no need for CBT to hike rates in response to the Fed, which is a familiar rhetoric from the government, noted Commerzbank.
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Canada's external factors the key driver, but also the key risk
The anticipated rotation of Canadian growth, and indeed much of the growth forecast, is reliant on how developments beyond the borders feed into the domestic economy. There are two key risk channels: foreign demand and the interest rate environment. Should export growth come in weak as a result of deficient foreign demand, overall economic growth would likewise disappoint what is already a low bar.
Similarly, a more rapid increase in borrowing costs due to spillover from the U.S. would create an additional headwind to the housing market and consumer spending, both sectors that lack pent-up demand to power through.
"Our forecast is for somewhat weaker growth than anticipated by the Bank of Canada's October outlook. We do not view the difference in outlook as sufficient in size to warrant another cut in the policy rate. But, should the risks identified above materialize, a policy response would likely be warranted, particularly in the case of deficient foreign demand given the high dependence on export-driven growth to the overall picture", says TD Economics.
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Canada’s external factors key to economic rebalancing and growth
Factors beyond Canada's borders remain central to the economic outlook. Low oil prices, diverging growth outlooks and expected interest rate differentials have all pushed the value of the Canadian dollar lower relative to its U.S. counterpart. The result has been improved competitiveness of Canadian goods, and a pick-up in export activity that is expected to persist through 2016, weakness in the more recent monthly data notwithstanding.
A note of caution is warranted: although exports are expected to be a key driver of growth, the pace of their expansion is likely to be less than what the level of the loonie and U.S. demand might imply. There are two main reasons for this: first, other nations have also seen their currencies fall against the greenback, and so have similarly gained competitiveness in the U.S. market. Secondly, exports have become less responsive to the exchange rate, and more sensitive to foreign demand. These factors will serve to restrain export growth relative to past cycles.
Low oil prices tend to benefit some sectors of the economy, such as exports, as foreign incomes (and hence demand) rise and the loonie falls. In contrast, low prices have a significant negative impact on business investment. The benchmark West Texas Intermediate (WTI) oil price has fallen markedly, and is expected to recovery only gradually to just $60 per barrel by the end of 2017.
The continued weakness in WTI is expected to translate into further sharp reductions in oil-related capital spending, with total investment in non-residential structures unlikely to bottom-out until 2016Q2. The continuation of the low oil price environment also means that the investment recovery, when it does occur, is likely to be at a fairly gradual pace rather than the familiar "V-shaped" bounce back of past cycles.
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Canadian economy may have contracted in October
The Canadian economy may have contracted in October. Even if it didn't, the full quarter is probably faced with little to no economic growth. Major data releases right near the festive season are not always so wisely planned. Monthly GDP next Wednesday will inform twothirds of the tracking risk for broad economic growth during the current quarter. The balance of risks facing near-term Canadian economic growth has undeniably once again tilted toward downsides much more than upsides.
Plunging annualized manufacturing sales volumes and sharp declines in export and import volumes - with the latter reflecting a soft domestic economy and a weak currency that raises import costs - are once again plaguing the outlook after a brief improvement in the third quarter that had more to do with one-off effects. Net trade might not suffer so much because of less of an import leakage effect - but as yet it is difficult to gauge how much of the plunge in import volumes is due to a soft domestic economy or trade substitution toward domestically produced products where feasible.
If anything saves the economy from contracting in October it would be a) a weak base effect given that the economy shrank by 0.5% in September; and/or b) one-offs that are difficult to assess through the complex array of other underlying factors. Even removing the large 5% drop in the output of the mining and energy sector in September on the assumption that technical factors temporarily held it back would yield a 0.4% rise in October GDP, all else held constant, but would only improve annualized quarterly growth tracking to about a half percentage point in Q4. Weakness is not just about sector-specific distortions; the sources of renewed weakness are broadly based.
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