The Bank of Israel(BOI) left its policy rate unchanged at 2.25% this week after cutting rates by 25bp in June. The rational for this was the deterioration in the fiscal position with government spending forecast to be looser than previously thought. The BOI also voiced concerns over the recent depreciation in the ILS. However, the arguments for further interest rate cuts are still strong. Economic growth indicators have deteriorated over the past month, moreover inflation has eased. We believe policymakers will want to wait for more direction, both at home in relation to fiscal policy and from overseas as central banks act to support their economies. Nevertheless, a further rate cut is expected in the coming months.
The National Bank of Hungary (NBH) also left its base rate unchanged at 7%. We believe that the timing of an interest rate cut is dependent on the successful conclusion of an agreement with the IMF/EU over the extension of a stand-by loan. The first round of formal negotiations ended inconclusively this week. The main stumbling block appears to be policy toward the banking sector, in particular the recent Financial Transaction Tax bill, and the government’s ‘optimistic’ fiscal forecasts. Given recent history we believe that negotiations will be protracted and with this comes the likelihood of delays in cutting interest rates.
The South Korean economy hit another soft patch in Q2, as global uncertainties weighed on investment and consumer spending. Exports also subtracted from growth down 0.6% q/q in Q2, from 1% in Q2. In summary this saw GDP growth moderate to 0.4% q/q (2.4% y/y), from 0.9% in the previous quarter. Although uncertainties over the euro area are likely to linger, we still expect economic growth to pick up in H2, leading to GDP growth of 2.7% for 2012 as a whole. In particular, exports should benefit from stronger Chinese demand and household spending is expected to strengthen reflecting lower inflation and interest rate cuts. We expect the Bank of Korea to cut rates by a further 25bp in September, although if exports remain weak further reductions could be expected in Q4.
THE WEEK AHEAD
The Chinese official PMI manufacturing index is forecast to fall to 49.7 in July, the first time since November 2011 that it has dipped below 50 (contraction), although there is some upside risk to our forecast, given the stronger ‘flash’ HSBC number released earlier this week. We expect output to stay above the crucial 50 line, which we estimate will put industrial production on track to record 9.8% y/y in July, up from 9.5% in June. Despite a range of measures undertaken by the Chinese authorities, including two interest rate cuts in July, the near term outlook for manufacturing is subdued. We expect new orders, notably export orders, remained below 50 in July. Against a backdrop of benign consumer price inflation (2.2% y/y in June its slowest annual rate in 2½ years) we expect the government to announce further measures to support GDP growth including lowering bank reserve ratios by another 100bp and cutting interest rates by an addional 25bp.
While June WPI’s inflation will have provided some comfort for the RBI, slowing by more than expected to 7.25%, from 7.55% in May, we believe the window of opportunity for an interest rate cut is closing rapidly. Concerns are also growing that a potential government price hike on regulated fuels and a poor monsoon will further stoke inflationary pressures in the coming months. We believe that July’s interest rate decision will be a close call. However, given recent commentary that further interest rate cuts at this juncture may only exacerbate inflationary pressures rather than support growth, we are leaning towards interest rates to be left at unchanged at 8%. But ultimately, growth concerns are expected to lead to a 50bp cut this year.
Weak Brazilian industrial activity saw the government recent announce a range of measures to assist production. Tax breaks on motor vehicle loans has already led to a surge in sales and we expect production has started to respond. We expect industrial activity increased by 0.6% m/m (-4.2% y/y) in June, from -0.9% previously. However, another downward surprise in Brazilian industrial production growth could see interest rate cuts beyond our projected 50bp.
The Turkish trade deficit has narrowed over the past six months as imports have fallen and exports have proved surprisingly resilient, as external demand from the Middle East largely offset the impact of sluggish EU demand. We forecast that the deficit narrowed further in June to $8.8bn, from $10.3bn in June 2011. The improved trade position should support a further reduction in the current account deficit, a key vulnerability for Turkey, providing some support for the lira.