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Economics
Greater China, Korea
• KR: The Bank of Korea lifted the benchmark 7-day repo rate by 25bps to 2.75%
yesterday, against market consensus but in line with our forecast. This rate move is
clearly aimed at curbing the rise in inflation and inflation expectations. Oil and
food prices have increased markedly in tandem with the global uptrend. Core
inflation is picking up gradually and continuously as a result of the sustained
recovery in aggregate demand in the domestic economy. Housing prices have also
resumed the upward trend since the government relaxed mortgage lending
controls late last year. CPI inflation (3.5% YoY as of Dec10) is expected to stay
elevated at around 3.7% in 1Q11 and 4% in 2Q11, topping the BOK’s policy target
of 2-4%. Core inflation is also likely to approach 3% by the end of this year. We
have revised the full-year inflation forecast to 3.7% for 2011, up from the previous
estimate of 3.4%.
Obviously inflation management is becoming a priority for policymakers. During
the central bank’s policy statement yesterday, the BOK emphasized that monetary
policy will be conducted in a way to “firmly” maintain price stability while the
economy continues solid growth. Meanwhile, the government also announced a
package of price stabilization measures yesterday including freezing public utility
charges temporarily in 1H, cutting tariffs on certain food imports and tightening the
monitoring of pricing practices.
We maintain our view that higher inflation pressures will push the BOK to accelerate
the process of interest rate normalization this year. We continue to expect the 7-day
repo rate to go up to 3.25% by June, which implies another two 25bps hikes within
six months (probably in March and May respectively).
Southeast Asia, India
• TH: We have lifted our 2011 inflation forecast to 4.0% (from 3.6% earlier) and
added one more 25bps hike to the rates trajectory this year.
Like in many Asian economies, inflation has picked up in recent months in Thailand.
Over the last two months of 2010, the price level (adjusted for seasonal vagaries) has
increased by a total of 1.5% – half as much as one might expect in an entire year. To
be sure, the price increase is for now largely driven by supply-side factors. Higher
food and fuel prices have pushed overall inflation higher while non-food and nonfuel inflation remains low. However, there are signs that the price rise is broadening
to other items. Core inflation rose by 5% (MoM, saar) in December. Even if prepared
food is excluded from core inflation, the resulting core-ex food inflation rose by 4%
(MoM, saar) in December. Likewise, we find that under the housing costs
component, rentals and textile inflation has increased even as electricity and fuel
component have been artificially held down by the government. Clearly,
underlying inflation pressures too are starting to increase though it is still early days.
The rise in inflation should not come as a surprise. After all, output has returned to
pre-crisis levels but interest rates have not. Even after the 25bps rate hike to 2.25%
this week, policy rates are below the inflation rate (3% YoY in December). In fact,
policy rates are also below the long-term inflation rate average (3% to 3.5%), a
proxy for inflation expectations. As such, we continue to think rates need to be
lifted higher swiftly to normalize policy. This is why we expect a total of 100bps of
rate hikes just in the first half of this year with a 25bps hike at each meeting (of
which we saw the first one this week). We have already flagged that rates may not
peak at 3.25% where we had forecasted policy rates to end the year and one or two
more hikes may be needed. Accordingly, we now add one more 25bps rate hike to
the rate trajectory in the second half of 2011 and expect a 25bps hike in 3Q and in
4Q. This means policy rates should rise to 3.50% by end-Dec 2011 (non-consensus
view). Since rates are merely being normalized, we don’t expect this to lead to
slower-than-trend growth this year or the next.
• IN: Inflation (Dec, today) will be keenly watched given the surge in weekly inflation
data for primary and fuel prices in the past few weeks. We estimate from weekly
inflation data that primary product prices rose by 6% (MoM, sa) and fuel prices rose
by 3% (MoM, sa) in December – a staggering amount be it due to vagaries of
weather or not. With growth momentum still strong in our view and excess
capacity diminishing, core price pressures, for which manufacturing WPI is a proxy,
should also be on the rise. Such underlying price pressures coupled with higher
manufactured food prices should push overall manufacturing WPI inflation to 8%
(MoM, saar) in December, higher than RBI comfort level of 5%. As a result, overall
WPI too should push higher to 8.5% (YoY) or 30% (MoM, saar) rise, higher than
November’s 7.5% (YoY). While the headline inflation rate (in YoY terms) should
moderate ahead due to basis effects as well as easing of one-off supply disruptions,
inflation does look to be higher in 2011/12 than generally anticipated. As such,
whether December inflation comes in slightly higher or lower than expectations,
the prognosis will not be comforting. It is not conceivable that abnormal weather
alone pushed inflation sharply higher. The central bank itself concedes that higher
food prices are a reflection of improved living standards among lower income
groups that is translating into a greater demand for protein-rich food products.
Besides, as we have argued before, as long as food price rise is not transient and as
long as the lagging supply response is enduring, food price inflation too will
endure and that will translate into greater wage demands and hence pose a risk of
wage-price spiral. Therefore, the RBI and the government can ill afford to ignore or
excessively downplay the demand-side pressures inherent in the higher food
inflation. Following the inflation release today, we will finalize the upward
revisions to our inflation and rates forecast flagged before in this space (as argued
in yesterday’s publication, we don’t think this will push growth below-trend).
G3
• US: US retail sales (Dec) are on tap today. As mentioned yesterday, sales growth
(always reported in nominal terms) is running at a ten-year high of 8% YoY.
Considering the fact that core inflation is at a 20-year low, though, sales are even
stronger than it appears on the surface. In real (inflation adjusted) terms, retail sales
growth is running faster than at anytime since 1992. Little wonder 4Q consumption
reported in the GDP accounts in a couple weeks will be around 4.5%, well above
the 3% long-run average.
Alas, consumption growth won’t likely stay this fast for long – we still think there is
a fair amount of deleveraging to go in the household sector – but growth risks are
plainly biased to the upside now, which only goes to underscore the point that
weak GDP growth in mid-2010 (recall double dip worries and 2Q GDP growth of
1.7% QoQ, saar) was never a problem of weak demand (as everyone feared), rather
that what was in fact surprisingly strong domestic demand was being satisfied by
foreign suppliers, i.e., a rising trade deficit. Plainly, US demand continues to run
strong but now the trade swings are starting to settle down – GDP growth will look
considerably stronger this year than last.
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