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Israel
Tech Nation February 13, 2007 By Serhan Cevik | from New York Technology-intensive exports are the leading engine of economic growth in A sharp slowdown in export growth is unlikely, but remains a risk for the economy. While becoming more balanced, the levers of growth remain dependent on exports with a skewed geographical distribution. The
Hungary
Near-term Bump(s) in the Road February 13, 2007 By Pasquale Diana | London The debate over the path of Hungarian policy rates has intensified markedly over the recent period, also fuelled by central bank commentary. A near-term inflation spike due to hikes in regulated prices will likely take CPI inflation above 9%. While this is temporary, there are risks of higher headline inflation becoming entrenched into expectations, which justifies higher interest rates. At the same time, activity data have begun to soften significantly, due to the implementation of the government’s fiscal package. This will translate into a growth slowdown and an improvement in both fiscal and external balances, which should reduce It’s all about second-round effects Recent commentary by NBH policymakers (mostly hawks) has shown heightened concerns on inflation, prompting renewed speculation about a near-term rate hike. To be sure, the recent news on regulated price hikes has prompted an upgrade to our CPI forecast as well. Even so, we believe that inflation is set to peak at around 9.5%Y in March, and will neither reach double-digits nor peak in 2Q rather than 1Q. We acknowledge, however, that risks of second-round effects exist and will need careful monitoring. In particular, our sense is that two variables deserve careful monitoring in the coming months: wages and market services inflation. With regard to wages, the latest data make it difficult to distinguish trend from noise. Headline wage growth accelerated markedly in August, to over 10%Y, driven by a large rise in private sector compensation. In the last release (November 2006), wage growth eased back to 6.6%Y. Note however, that the profile of year-on-year wage growth over the second half of 2006 was affected by the timing of bonus payments. In August, companies likely brought forward annual bonus payments ahead of the September hike in wage-related taxes; this was followed by a drop in the year-over-year rate in November, as these bonuses used to be paid towards year-end in previous years. For a clearer picture, we need to look at the headline ‘core’ wage growth number (ex-bonuses), and the trend seems to be upwards. In terms of market services inflation, the NBH is likely to look at this as a measure of whether higher regulated prices are translating into higher inflation expectations and faster price pressures in core, demand-sensitive components. Looking at data up to December, market services inflation has remained well behaved thus far, ending the year at 7.2%Y, on a modest uptrend. We think there are good reasons to expect the 1Q inflation spike to be contained and to not translate into higher inflation expectations. First, historical precedent: in 2004, administered prices rose sharply in the early part of the year and the NBH took no action, on the (correct) assumption that this would prove to be a one-off. Second, and more importantly, domestic demand has already weakened substantially in late 2006 and will continue to weaken going into 2007, due to the fiscal tightening. The latest retail sales data (November), which show the weakest growth in retail spending since 2001, set the consumer up for a very weak end to 2006. And this year, we expect wage growth to average roughly 6.4% for the economy as a whole. With headline inflation averaging 7.5%, overall employment growth likely to turn negative and a higher average tax wedge than in 2006 (due to higher PIT and social security contributions), real disposable income growth will contract by around 4.5% y/y in 2007, bearing down on final demand. With such pronounced weakness on the demand side, it is less likely that retailers will feel inclined to pass on higher costs onto consumers, but will rather take a hit on margins. Politics about to heat up? Thus far, we have focused on a near-term inflation spike as a potential bump in the road. Political tension could prove to be a second bump, potentially causing the markets to reassess the country’s risk outlook. The ruling Socialist Party has lost some ground in the opinion polls, and now trails the right-wing opposition Fidesz party by up to 20 percentage points in the opinion polls. While the Socialist leadership is likely prepared for such a drop, it is less clear that the rank and file of the party are willing to tolerate this slide for much longer, and might press the PM to withdraw from some of the more unpopular measures (such as the healthcare or pension reforms). In addition, public sector union action (announced for end-February) might lead the government to renege on its plan to freeze public sector wages (see above), and opposition demonstrations (likely in mid-March) will likely put the government under renewed pressures, much as they did last September. Our central view is that PM Gyurcsany will survive through this tense period, partly because there is nobody within the Socialist party that looks willing to assume the leadership at this stage. We also note that the reported opinion polls numbers showing the gap between Fidesz and the Socialists having widened include only those voters that have made up their minds. We note that 40-50% of the electorate remains undecided and that the gap between the two main parties is much smaller (around 10%) when one looks at the whole electorate, and does not display a clear widening trend. PM Gyurcsany appears aware of the importance of sticking to his promises. After all, a return to fiscal profligacy during the year would most likely result in credit actions by the rating agencies, a sharp HUF sell-off, higher borrowing rates and higher mortgage payments for Hungarians who have borrowed in FX, all of which could hurt support for the PM even more. That said, increased political noise is likely to create market jitters in the near term. NBH: watch the February Inflation report; composition matters Our central scenario is that the NBH remains on hold throughout the inflation spike. This view will be tested already at the February meeting, the last one that the hawkish Governor Jarai will chair. The test will be especially severe if traditional doves such as Peter Bihari (but possibly also Csaki, Oblath or Nemenyi) decide to temporarily join the hawkish camp (Jarai, Auth, Adamecz, maybe Kadar or Kopits) due to concerns on near-term price stability. The February inflation report will provide an important input for the next rate decision. While higher regulated price hikes are likely to translate into a near-term upgrade to the CPI forecast, we note that the NBH now faces a more benign set of external assumptions. Despite the recent uptick, oil prices are still around 10% lower than assumed in November, and the currency is 5% stronger against the euro. Lower energy prices and a stronger EUR/HUF assumption will likely translate into a downward revision to the medium-term (2008) forecast, as also anticipated by NBH Chief Economist Hamecz. Also note that from the March meeting onward, Jarai will be replaced by another governor, who is almost guaranteed to be more dovish. And in July, two more hawks (Auth and Adamecz) will leave the Council. These changes are likely to result in a board even more dominated by doves. Assuming that the fiscal numbers show the expected improvement and that the 1Q inflation spike is reabsorbed quickly, we see aggressive rate cuts in the second half of the year, taking the base rate to 7% by end-2007.
Japan
G7 Seems Content to Rubberstamp a Weak Yen, but… February 13, 2007 By Takehiro Sato | Tokyo Risks are asymmetrical: The G7 statement from last weekend’s governors and finance ministers meeting in Although we are forecasting healthy 0.9% QoQ growth and annualized growth of 3.8% for October-December GDP, much of this is in reaction to the negative growth in consumption in July-September, and this degree of rebound has already been discounted by the market. Consumption in the current January-March quarter is still not as solid as we’d like, with the mild winter hitting sales of seasonal merchandise. In these circumstances, an impressive GDP figure could simply exacerbate concerns about the sustainability of future growth. Yet if the growth rate disappoints, the markets are likely to switch their focus back to the weakness of There is a good deal of uncertainty about the BoJ’s next monetary policy meeting (MPM), given the lack of visibility on the circumstances that led to deferral of a rate hike in January, and the markets are struggling to weigh up the risks and pick a side, but we view the possibility of a February hike as marginally greater than 50%. However, even if the BoJ does bump up rates by another quarter point and prices subsequently drop back below year-earlier levels, the outlook for monetary policy becomes opaque again. The risk is that if the price outlook is going to be the basis for the decision, the window for a rate hike may only stay open in February and March, and then close for the rest of year. So if the opportunity is by-passed in February, we would expect the policy rate to stay at 0.25% until the end of the year, and to rise no higher than 0.50% even if there is an increase. Under these conditions, any rate hike that did come could be widely seen as the last on the horizon, and any spike in the yen would also likely prove temporary. Since the carry trade essentially targets forex translation profits rather than exploitation of the gap in interest rates, it is a stretch to believe that a mere 0.25% narrowing of the spread between US and Japanese rates would arrest the yen depreciation mentality. Reassessment of the potential strength of This line of reasoning implies no let-up in the yen’s depreciation. Some of our colleagues are actually hearing calls in the market for the yen to sink to ¥125 or ¥130 against the US dollar. I personally take the contrarian position, however. It is a rule of the market that just when everyone is convinced that the yen will weaken and has buried doubts, the turning point will come. For example, when market participants have maximized their short positions in the yen and have no scope to move further, a seemingly minor item of news can spark yen repurchasing. The market will turn when confidence in yen depreciation is at its peak. This happens frequently in equity as well as forex markets. My view is that the prospect of upside risk for For example, even if the BoJ shows no signs of lifting its policy rate within this year, any sign that the growth potential of the economy is outpacing the downbeat consensus view from the start of the year could make the market nervous about yen selling. We in the At this point, the consensus view of Based on the above, I believe that the emergence of upside risk for Where the risks lie Views on the Japanese economy could become more bearish, bucking the above scenario. For example, there is the risk — as we have highlighted previously — that the prospect of a drop back into negative growth for the core CPI could reignite deflationary concerns and make overseas investors leery of Japan’s economy. That said, the case that such a drop in consumer prices would be the result simply of lower oil price, and not necessarily bad news for However, the US Treasury Secretary remarked before the G7 meeting that yen trading is dictated by a competitive market and tacitly suggested that the current level can be deemed tolerable. This means that yen weakness may be consistent with fundamentals, but signifies that the
United States
Bernanke in the Spotlight February 13, 2007 By David Greenlaw and Ted Wieseman | New York, New York The message delivered by Fed Chairman Bernanke at this week’s Monetary Policy Report to Congress is expected to reinforce a stable policy outlook. For some time now, through official FOMC statements and numerous speeches, Fed officials have indicated that they expect a period of below-trend growth to help ease the “high level of resource utilization” and allow inflation to continue to gradually moderate toward their comfort zone. As the headwinds tied to the housing and auto recessions gradually abate, they see growth returning to a pace close to the sustainable trend of around 3% later in the year. While there are identifiable upside and downside risks to this baseline forecast, the predominant concern is seen to be higher inflation. Indeed, remarks from a number of Fed officials over the past week have had a hawkish tilt, and it seems likely that the Chairman’s testimony will reflect a similar theme — especially in the wake of a stronger-than-expected 4Q GDP outcome (note: although we now expect the initial 4Q reading of +3.5% to be revised lower, this is almost solely attributable to new inventory data, and whatever adjustment is made to 4Q should be recouped in 1Q07). Our assessment of the message that is likely to be delivered by Bernanke appears to be broadly consistent with overall market expectations. While we doubt that the Chairman’s testimony will break any important new ground this week, there is a chance that Bernanke may take another small step toward validating a somewhat higher inflation objective than had been perceived in the past. Back in May, in a response to questions from members of the Joint Economic Committee of Congress, Bernanke referenced a Fed study that indicated that the bias in the CPI amounted to around 0.9 percentage point per year. At his appearance before the Senate Budget Committee last month, Bernanke reiterated this view. He has also indicated that the PCE appears to suffer from upside statistical bias. Of course, this follows on the heels of the indication in the July 2006 Monetary Policy Report that the FOMC’s central tendency forecast for the core PCE inflation rate at the end of 2007 was 2-2.25% — slightly above the top end of the perceived long-run objective of 1-2%. Since the Fed’s economic estimates for one year ahead had always been considered more of a goal than an outright forecast, this raised some eyebrows. All of this is consistent with murmurs from inside the beltway that Bernanke and a few of his colleagues may be looking for a public opportunity to formally adjust the Fed’s inflation objective a bit higher — from 1-2% to something like 1-3%. This would reflect the fact that an implied goal of 1.5% for core PCE may be too low if there is a half-point or more of statistical bias embedded in the figure. It might also reflect a reassessment of the costs associated with an outbreak of deflation. While Bernanke has argued that the Fed has tools at its disposal to address such a threat, the risk/reward trade-off appears to have shifted. Once upon a time, bond market vigilantes extracted a price for any hint of a lack of resolve in the battle against inflation. Today, the yield curve is flat, term premiums have collapsed, and inflation expectations remain contained, even though the core PCE price index has been consistently at or above the upper end of the presumed tolerance band for nearly three full years. In this environment, the Fed could come clean on its true inflation objective, create a bit of a cushion, and continue the trend toward greater transparency — paying little price in the process. Still, while we believe that such a shift could occur at some point in the not too distant future, there is no explicit indication that Bernanke is prepared to do so this week — it merely represents a potential source of event risk that could lead to a bit of curve steepening. On another front, we suspect that much of the Q&A session will focus on issues related to income inequality. Bernanke recently delivered a provocative speech on this topic and, as a result, Committee members are sure to try to draw him into the debate on matters like tax policy and foreign trade — especially on the House side. Finally, the economic forecast of FOMC members for 2007 is expected to show a central tendency of +2.75-3% for real GDP and around +2% for the core PCE price index (note: these figures are 4Q/4Q).
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