BCA Research: Agflation - A risk for emerging markets
"The main risk to emerging markets is not the US recession or credit crunch, but rising agriculture price inflation (agflation).
"Ramifications of agflation are far more important in the emerging world than in the developed economies, given that food makes up a larger share of the consumption basket. In addition to higher inflation and upward pressure on interest rates, rising social tensions could force policymakers to forgo proven market mechanisms, creating distortions that have long-lasting and harmful economic implications. In turn, this can lead to higher risk premiums on asset markets. The negative shock and risk of pass-through from skyrocketing food prices will be greater in the economies with a rigid supply side and low competition. Moreover, countries where the currency has been sliding will feel the effect of rising global food prices much more acutely.
"Bottom line: We are positive on emerging equity markets as a whole, but are concerned about the outlook for South Africa, Argentina, Indonesia, and the Philippines because of the lack of supply side reforms over the past several years and escalating threats from food inflation. Stay underweight these markets."
Source: BCA Research, April 18, 2008.
Financial Times: £50 billion UK offer for mortgage securities
"The housing market will not see a return to the profligate mortgage lending practices of the past few years, the governor of the Bank of England insisted on Monday as he announced a massive operation to support liquidity in British banks.
"Making an almost unlimited offer to acquire UK banks' mortgage-backed securities for up to three years in return for Treasury bills, Mervyn King said the plan would 'take the liquidity issue off the table in a decisive way'. But he warned that the objective of the plan was neither to persuade banks to start lending again nor stand in the way of a housing market correction.
"His stern words contrasted with those of Alistair Darling, the chancellor, who told Parliament he hoped: 'This [scheme] will help alleviate the problems that have seen banks reluctant to lend to each other and in turn support the provision of new mortgage lending.'
"For the next six months, the Bank will offer to acquire asset-backed securities from banks in exchange for Treasury bills. Based on conversations with commercial banks, the Bank expects to swap £50 billion assets in the first couple of months.
"British bankers on Monday agreed that the plan would help to restore confidence to the sector. Stephen Green, chairman of HSBC, said: 'At an industry level, the Bank of England initiative will help ease some of the current market dislocations in the UK.'
"But there was little sign that the Bank's action would kickstart the faltering mortgage or housing markets."
Source: Chris Giles and Peter Thal Larsen, Financial Times, April 21, 2008.
Edmund Conway (Telegraph): Bank of England hawk sees inflation risk if interest rates cut
"Hopes that the Bank of England will slash interest rates have been undermined after a key policymaker hinted that the Bank's rescue plan for credit markets will free it up to use rates to fight inflation.
"The pound closed in on the $2 mark after Tim Besley's hawkish speech in London stirred fears that Britain is heading towards stagflation, with sluggish growth and high inflation striking the economy simultaneously.
"In a further sign of the chaos the financial crisis is causing in the City, the Bank confirmed yesterday that it is postponing its Financial Stability Report for a week - one of the first times since independence that it has been forced to delay a key publication.
"Mr Besley said he was hesitant about cutting borrowing costs too far from their current level of 5% because of the growing risk that inflation picks up. He said: 'Monetary policy can smooth some of the adjustment in response to changes in the real economy. However, it cannot, and should not try to, prevent warranted real economy changes taking place.'
"He welcomed the Bank's move this week to swap more than £50 billion worth of government debt with frozen asset-backed securities, adding that this may help resolve the credit crisis without the Monetary Policy Committee (MPC) having to cut rates dramatically.
"'This should allow the MPC to stay more focused on its task of using monetary policy to target inflation,' he said."
Source: Edmund Conway, Telegraph, April 24, 2008.
BCA Research: China - fast versus good growth
"The Chinese government's ongoing tightening campaign reflects a strategic policy shift from 'growth at all costs' to sustainable and desirable growth.
"The government's ongoing efforts in growth reorientation and optimization have received desirable responses within the economy. For example, policymakers have been working hard to boost domestic consumption and reduce the economy's dependence on exports and capital spending. This strategy has panned out favorably. Investment spending and export growth have moderated significantly in the past several years, while private consumption has continued to accelerate, due to fast income gains and progress in enhancing the social safety net. Strengthening consumption is providing an important offset for slowing investment and exports. This benign adjustment has allowed growth to downshift, but remain robust.
"Bottom line: The trade-off of quality over quantity suggests the authorities are not targeting an across-the-board growth slowdown. Indeed, sectors that had experienced excessive growth have more recently shown pronounced weakness, but the economy has not lost much of its forward momentum."
Source: BCA Research, April 22, 2008.
Financial Times: CPI suggests Japan near end of deflation
"Japanese consumer prices, stripped of energy and fresh food, rose 0.1% on-year in March, the first increase since 1998 and a sign that Japan could be close to shaking off 10 years of deflation.
"The headline core CPI rate, which includes fast-rising energy prices, leapt 1.2% on-year, the highest in 10 years and a better reflection of how consumers perceive price changes.
"Of the 1.2% rise in the headline CPI, 0.73 percentage point was due to energy and 0.41 point from food. In yen terms, oil prices are 50% higher than a year ago. Economists have characterised Japan's rising prices as cost-push inflation.
"Hiroko Ota, economy minister, characterised the rise as the wrong kind of inflation. 'The price rises are being led by upward pressure from higher raw material costs and not by strong demand, so it is not a good pattern,' she said.
"The central bank is faced with a complex set of calculations. The rising headline rate might, in some circumstances, lead it to consider a rate rise. But the difficult international situation in financial markets coupled with the low rate of the so-called 'core-core inflation', excluding energy and food, means it is far more likely to leave rates where they are at 0.5%.
"If the economy deteriorates, bank watchers are not excluding the possibility of a rate cut."
Source: David Pilling, Financial Times, April 25, 2008.