Consumer price inflation is expected to moderate to 5.6% y/y in June

DATA REVIEW

• Bank of Korea surprised markets by reducing its benchmark interest rate by 25bp to 3%, in what the Governor described as a ‘pre-emptive’ move. The long-standing reference to ‘high inflation expectations’ was notably absent from the accompanying statement and with emphasis on the deteriorating outlook we now expect one more 25bp rate cut in Q3.

• Indian industrial production rose by a stronger than forecast 2.4% y/y, from a downward revised -0.9% y/y in April (previously 0.1%). However, the series is very volatile and the three month average still points to very modest trend growth reflecting continued weakness in mining and capital good manufacturing. The RBI did not cut rates in June but we believe that growth concerns will lead to a 50bp cut in rates in the coming months, although this is dependent on the NR showing signs of stabilising.

• As expected Bank Indonesia held its benchmark interest rate at 5.75%. Although the economic outlook faces a number of external headwinds, domestic demand remains solid. Against a backdrop of accelerating consumer price inflation along with the IDR facing significant selling pressure we do not look for any additional rate cuts in this cycle.

• Disappointing monthly retail sales and industrial production growth and consumer inflation falling below 5% for the first time in nearly two years meant that it came as no surprise that the central bank of Brazil cut the Selic interest rate by 50bp to 8% - a record low. We look for a further 50bp cut in August.

THE WEEK AHEAD

• Today’s Chinese national accounts data showed GDP growth slowed to 7.6% y/y in Q2 2012, from 8.1% in Q1 the weakest growth rate since Q1 2009. This slowdown against a weak global economic backdrop has already led to the Chinese authorities easing monetary conditions and providing support for investment and there are some tentative signs that these initiatives are feeding through to the economy. Credit conditions have improved which have contributed to an increase in infrastructure investment and although retail sales were largely unchanged at 13.7% y/y in June, when combined with an easing in consumer price inflation in June (down to 2.2% y/y its slowest annual rate in 2½ years), but means that in volume terms sales rose by 11.5% y/y – the strongest annual rate since March. Although industrial production remained weak rising 9.5% y/y in June from 9.6% in the previous month, on balance, this array of data suggests that domestic demand was not as weak as June’s trade figures had suggested. We continue to believe that Q2 GDP growth marks the bottom of the current cycle and so we have maintained our 2012 growth forecast of 8.2%.

• Against a backdrop of weak external demand, we expect Russian industrial production remained subdued in June increasing 2.6% y/y from 3.7% in May. In contrast data out next week will likely show that domestic demand remains firm, at least for now. Solid gains in real wages over the past six months, as well as credit growth are underpinning consumer demand. We expect retail sales rose by 6.5% y/y in June, from 6.8% in May. Meanwhile, investment is forecast to grow 7.1% y/y in June, from 7.7%. However, although fundamentals remain solid, households and businesses face a number of external headwinds, which could derail the 2012 GDP outlook.

• Food prices and lower fuel costs have driven consumer price inflation back within the SARB’s 3-6% target band. We have correspondingly lowered our inflation projection for South Africa for this year. Consumer price inflation is expected to moderate to 5.6% y/y in June, from 5.7% in May. We expect inflation will continue to hover around the top end of the band for the remainder of the year, although the recent increase in global food commodity prices plus a 10% depreciation in the rand since early March both pose an upside risk to the inflation outlook. This is likely to see the SARB refrain from cutting interest rates and we expect rates to remain on hold at 5.5% after Thursday’s MPC meeting.

• The Central Bank of Turkey is forecast to keep the repo rate unchanged at 5.75% but they may decide to lower the interest rate ceiling (currently at 11.5%). We do not see such a move as negative for the TRY, particularly given the improved inflation and current account outlook. There is also a high probability that the CBT will once again increase in the share of bank reserve ratios that can be held in fx.

• Mexico’s central bank is forecast to keep interest rates unchanged at 4.5% at Friday‘s MPC meeting. In the absence of a sharp deterioration to US or domestic economic growth, we forecast rates to remain on hold until at least Q2 2013.