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Mexico
Banco de Mexico’s April Surprise May 01, 2007 By Gray Newman and Luis Arcentales | New York, New York It’s been a tough year for January’s dilemma Banco de Mexico’s dilemma was two-fold. First, a hike in January would have come with no advance warning or preparation for the market. Indeed, up until the new year, the market had been working with a benign inflation path much as set out by Banco de Mexico on November 24 and reaffirmed in its communiqué on December 8. Second, a move by the central bank might have actually contributed to additional political noise and price pressures. If the central bank was willing to hike, then wage setters might have argued that it was evidence that inflation was on the rise and hence union calls for ‘emergency’ wage increases were warranted. Instead, Banco de Mexico decided to take a first step by closing the door to any possibility of a reduction in rates. It also decided to use new, more forceful language that it was ready to take the necessary action if the supply shocks seen in January began to have a negative effect on a trio of variables: a broader group of prices (beyond sugar and tortillas), medium-term inflation expectations and wages. February’s ultimatum By February, Banco de Mexico began to realize that the surge at the beginning of the year was likely to keep headline inflation higher for longer. Headline inflation would like remain above 4% and at times closer to 4.5% beyond the first half of the year and into the third quarter. Meanwhile, the specter of higher corn and other grain prices spiralling into a broader surge of food prices and inflation was getting locals nervous. A number of analysts began to call for Banco de Mexico to hike interest rates to reassert its commitment to its 3% target. And within the central bank there was new concern over the central bank’s credibility. The argument went as follows: the longer that inflation remained this far from the target — it was now moving well above the upper band of 4% — the greater the risk that it would begin to contaminate expectations or wages. The central bank shouldn’t wait until such contamination takes place; indeed, it could prove much more costly to do so. The fact that wages or expectations hadn’t moved was a sign of credibility that had been gained from past actions and which the central bank should jealously guard (see “ The problem, however, was in communicating this new willingness to act in a pre-emptive stance. The board produced an unfortunate communiqué, which seemed to reduce monetary policy to a rigid rule that narrowly focused on whether there was an improvement in March core year-over-year and monthly inflation. The February 23 communiqué threw down the wrong gauntlet by arguing that the central bank would act if March’s core numbers did not show an improvement. All but missed by most in the market was the central bank’s other statement in the communiqué that while its carefully monitored trio (other prices, expectations and wages) had not been contaminated, the fact that inflation would remain “elevated for various months” increased the “risk” of just such a contamination. What the central bank was trying to convey was that it would not necessarily wait until one of the trio were contaminated to act with a hike in interest rates (see “Mexico: No Hike, Comfort”, Global Economic Forum, March 20, 2007). Unfortunately, while the central bank was trying to avoid rigid rule limiting when it could hike rates, it set itself up with a much more rigid precept that if read literally was even more constraining. March’s balance By unveiling the new “balance of risk” focus but at the same time declining to hike interest rates, April’s surprise Two events appeared to have triggered Banco de Mexico’s April move: falling market interest rates and the spillover of higher grain prices into consumer food products. Even as headline prices were moving higher and the path of core prices was uncertain, the market was pushing interest rates lower across the curve. While the central bank expected inflation to fall by the end of the year, there were risks to that forecast: risks that were hard to see in the direction of interest rates. Indeed, on the eve of the April decision some market participants argued that if Banco de Mexico even so much as cited signs that the economy was softening, such a statement could spark another rally. The market, from the vantage point of the central bank, was ready to party: a risky attitude should the inflation environment once again turn out to surprise the central bank with more negative news this time from processed foods where grains are used as inputs. What’s next? We still forecast inflation to reach 3.6% by year-end, although our ‘current conditions’ model suggests that that may be ambitious and highlights additional risks in 2008. Bottom line Nonetheless, we expect Banco de Mexico to act again in order to signal to economic agents that it will work to ensure that the current grains-to-food adjustment in relative prices does not spawn a new round of unrelated price hikes. We had wrongly argued that this would be the year of ‘no hikes, but no comfort’. What Banco de Mexico discovered was that without a hike, no amount of warnings in the monthly communiqués was enough to leave
Thailand
Current Account Surplus Amid Weak Domestic Demand May 01, 2007 By Chetan Ahya and Tanvee Gupta and Deyi Tan | Mumbai, Mumbai, Singapore Current account rose to US$2.3 billion in March: The current account came in at US$2.3 billion (versus +US$1.7 billion in February). The net services and transfers balance fell to US$0.1 billion (versus US$0.5 billion in February). The narrowing in net services and transfers is in line with the seasonal trend. The trade balance, which came in at US$2.2 billion, was bolstered by high export growth of 19.0% YoY (versus 18.4% YoY in February), while weak domestic demand crimped imports (+0.5% YoY versus +6.3% YoY in February) even though the stronger baht improved purchasing power. Disconnect in trade data in US$ terms and Bht terms persisted: The disconnect between trade data in US$ terms and baht terms continued, highlighting that the strong currency might be weakening exporters’ revenue in baht. Exports rose 7.1% YoY (custom basis, Bht terms), versus +7.9% YoY in February). In terms of the product breakdown, machinery (+8.7% YoY & 4.0%-pt) and manufactured goods (+19.7% YoY & 2.5%-pt) were the stronger segments.
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