Counting on Oil
Sept 28, 2006
Oliver Weeks (London)
The Slovak National Bank’s latest 25bp rate hike, on a 5-3 vote, was above market expectations (no change) and below our expectation (50bp). The National Bank’s statement was relatively cautious, pointing to “strong wage growth”, “weakening productivity growth” and “a further gradual monetary tightening”. With new macro forecasts due in October, a further 25bp hike to 5.0% looks likely then, but with energy prices moving favourably and headline inflation poised to dip sharply in October, the bank may then choose to rest on its fortunately won laurels. Whether this will be enough to make euro entry in 2009 realistic now depends significantly on whether oil price falls continue, in our view.
Core inflation should rise further but headline should fall. Demand pressure on inflation indeed remains significant. Core inflation has continued to creep up, with the National Bank’s core HICP measure excluding energy and unprocessed food reaching 2.6%Y in August. The volatile monthly wage series was revised up in July, with nominal wage growth at 8.3%Y in July and showing signs of adjusting to temporarily high headline inflation. Nevertheless, we think that headline inflation likely peaked in August, less a result of monetary policy than the plunge in world energy prices and the government’s efforts to force energy companies to reduce their margins. The (nominally independent) regulator has said it will decide by the end of this month on October’s gas price hike, but the rise will be less than the 8.7% requested by SPP, already sharply reduced from 15%, and far below the 20.3% rise in October 2005. The government is pushing for no hike at all in October, and cuts in water and energy prices in January. The Hungarian-owned Slovnaft has already cut petrol prices around 12% since early August. A likely cut in VAT on pharmaceuticals in January should also help to massage inflation downwards. We expect headline inflation to dip to around 4.4%Y in October and 3.6%Y in January.
Oil may make Maastricht inflation criterion achievable. More importantly, in the medium term, falling energy prices, if sustained, will significantly reduce the current account deficit. Net energy imports in 1H were 8.0% of GDP (against 5.8% in Hungary, 4.6% in the Czech Republic and 2.2% in Poland) with an average Urals price of US$64. Urals oil is already down 13% on these levels, and a sustained fall in Brent prices to Morgan Stanley’s medium-term US$50 forecast could alone take around 2% of GDP off the Slovak current account deficit. Together with the ongoing pick-up in car exports, this would do much to compensate for slower FDI inflows and cancelled privatisation. Further SKK strength would do much to restrain the rise in core inflation. Meanwhile, falling energy prices would see headline inflation falling below core. The huge imbalance in the weights of energy in the HICP basket between Slovakia and the EU-25 (19.0% and 9.4%, respectively) makes lower energy prices asymmetrically favourable for Slovakia in terms of meeting the Maastricht inflation criterion. This level currently stands at 2.8%Y, and downward pressure from energy may be counterbalanced by the likely acceleration of Polish inflation, currently one of the EU’s bottom three reference rates.
Oil and budget remain risks. Clearly, relying on more oil price falls is a risky strategy for the National Bank. More aggressive rate hikes would still be justified, in our view, given the importance of the euro entry target and the unpredictability of the oil market. However, given the cautious pace of rate rises when Urals was at US$65 and CPI seemed likely to reach 5.5%, it seems hard to expect a more aggressive stance with falling headline CPI. The bank’s most recent medium-term forecasts assume Brent oil averaging US$69.6 in 2006 and US$73.6 in 2007. Equally, fiscal policy remains a risk both to inflation and euro qualification. Details on the 2007 budget remain thin and highly unconvincing, with a wide range of spending increases promised to pensioners, parents, teachers, doctors and farmers, costed by Smer at 1.2% of GDP. The government claims that lower tax thresholds and cuts in administrative spending can still achieve the tightening needed (around 0.9% of GDP, on our estimates). We find this improbable, but with the inflation target looking more achievable, we can no longer exclude the government deciding to tighten fiscal policy further. With oil prices rising, we could see little sense in taking unpopular measures to meet the fiscal criterion when the inflation criterion would exclude Slovakia anyway. If oil falls further, the government could wisely decide to seize an opportunity that may not be repeated for some time — to likely discomfort in Brussels and Frankfurt.
Important Disclosure Information at the end of this Forum
The information and opinions in this report were prepared or are disseminated by Morgan Stanley & Co. Incorporated and/or Morgan Stanley & Co. International Limited and/or Morgan Stanley Japan Securities Co., Ltd. and/or Morgan Stanley Dean Witter Asia Limited and/or Morgan Stanley Dean Witter Asia (Singapore) Pte. (Registration number 199206298Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H) and/or Morgan Stanley & Co. International Limited, Taipei Branch and/or Morgan Stanley & Co International Limited, Seoul Branch, and/or Morgan Stanley Dean Witter Australia Limited (A.B.N. 67 003 734 576, holder of Australian financial services licence No. 233742, which accepts responsibility for its contents), and/or JM Morgan Stanley Securities Private Limited and their affiliates (collectively, "Morgan Stanley").
Conflict Management Policy
This research observes our conflict management policy, available at www.morganstanley.com/institutional/research/conflictpolicies.
This report does not provide individually tailored investment advice. It has been prepared without regard to the circumstances and objectives of those who receive it. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages them to seek a financial adviser's advice. The appropriateness of an investment or strategy will depend on an investor's circumstances and objectives. This report is not an offer to buy or sell any security or to participate in any trading strategy. The value of and income from your investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized.
With the exception of information regarding Morgan Stanley, reports prepared by Morgan Stanley research personnel are based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we do not represent that it is accurate or complete. We have no obligation to tell you when opinions or information in this report change apart from when we intend to discontinue research coverage of a company. Facts and views in this report have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel.
To our readers in Taiwan: This publication is distributed by Morgan Stanley & Co. International Limited, Taipei Branch; it may not be distributed to or quoted or used by the public media without the express written consent of Morgan Stanley. To our readers in Hong Kong: Information is distributed in Hong Kong by and on behalf of, and is attributable to, Morgan Stanley Dean Witter Asia Limited as part of its regulated activities in Hong Kong; if you have any queries concerning it, contact our Hong Kong sales representatives.
This publication is disseminated in Japan by Morgan Stanley Japan Securities Co., Ltd.; in Canada by Morgan Stanley Canada Limited, which has approved of, and has agreed to take responsibility for, the contents of this publication in Canada; in Germany by Morgan Stanley Bank AG, Frankfurt am Main, regulated by Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin); in Spain by Morgan Stanley, S.V., S.A., a Morgan Stanley group company, which is supervised by the Spanish Securities Markets Commission (CNMV) and states that this document has been written and distributed in accordance with the rules of conduct applicable to financial research as established under Spanish regulations; in the United States by Morgan Stanley & Co. Incorporated and Morgan Stanley DW Inc., which accept responsibility for its contents. Morgan Stanley & Co. International Limited, authorized and regulated by Financial Services Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. Private U.K. investors should obtain the advice of their Morgan Stanley & Co. International Limited representative about the investments concerned. In Australia, this report, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act.
Trademarks and service marks herein are their owners' property. Third-party data providers make no warranties or representations of the accuracy, completeness, or timeliness of their data and shall not have liability for any damages relating to such data. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and S&P. Morgan Stanley bases projections, opinions, forecasts and trading strategies regarding the MSCI Country Index Series solely on public information. MSCI has not reviewed, approved or endorsed these projections, opinions, forecasts and trading strategies. Morgan Stanley has no influence on or control over MSCI's index compilation decisions. This report or portions of it may not be reprinted, sold or redistributed without the written consent of Morgan Stanley. Morgan Stanley research is disseminated and available primarily electronically, and, in some cases, in printed form. Additional information on recommended securities is available on request.