U.S. Housing Starts: The Downward Correction Continues: Rge Alert 21.7.2010 1
U.S. Housing Starts: The Downward Correction Continues: Rge Alert 21.7.2010 1
U.S. Housing Starts: The Downward Correction Continues: Rge Alert 21.7.2010 1
2010
1.
• RGE View (Jul 15, 2010): Aside from a brief uptick in Q2 2010 driven by the
homebuyer tax credit, which “stole” home demand from the future, housing
construction will resume a sluggish recovery until housing inventories are reduced
to sustainable levels. This will be a slow and painful process, with demand for
housing still severely impaired. We expect housing starts to remain around the
650,000 mark in 2010.
• Housing starts fell 5% m/m (-5.8% y/y) in June 2010 to a seasonally adjusted
annual rate (SAAR) of 549,000, following a downward revised collapse of 14.8%
in May. The decline in June was was driven by volatile multifamily housing
starts, which fell 19.3% m/m in June to reach 88,000 SAAR after rising 4.8% in
May. In the single-family segment, starts fell 0.7% m/m to 454,000. In June,
single-family housing completions soared by 31.3%. (This is reflective of the fact
that to claim the homebuyer tax credit, buyers had to sign a contract by April 30,
but the contract could go to settlement by June 30. This has now been extended to
September 30.) Meanwhile, building permits, an indicator of future construction,
signaled further declines ahead for single-family starts and completions. Total
permits rose 2% m/m June, however, single-family permits fell 3.4% m/m to
421,000 SAAR after falling 10.3% in both May and April, according to a July 20,
2010 release from the U.S. Census Bureau.
• The decline in single-family starts in June 2010 was led by a 11.3% collapse in
starts in the Midwest after a 14% decline in May. Starts in the Northeast fell 8.9%
in June after falling 1.7% in May. Starts in the West rose 3% after falling 5% in
May, while starts in the South rose 3.6% after a massive 28% collapse in May.
Single family permits rose 2.7% in the Midwest, 2% in the Northeast, were flat in
the West and fell 7.6% in the South, according to the July 2010 U.S. Census
Bureau data release.
• In July, the NAHB HMI for the Northeast rose seven points to 23, while the
Midwest index posted a one-point gain to reach 15. (The Northeast is prone to
greater monthly volatility.) The South and West each posted five-point declines
to 14 and nine, respectively. According to NAHB Chief Economist David Crowe,
"This month's lower HMI reflects a number of underlying market conditions that
builders are seeing, including hesitant home buyers, tight consumer credit, and
continuing competition from foreclosed and distressed properties that are priced
below the cost of construction." He also noted that the slowdown in sales
following the expiration of the homebuyer tax credit on April 30 had been "longer
than anticipated due to the sluggish pace of improvement in the rest of the
economy."
• Single-family starts collapsed by over 80% over a span of three years beginning
January 2006. By September 2009, single-family starts had recovered by 42%
from the low of February 2009, due to an increase in housing demand fueled by a
tax credit for first-time homebuyers. After a predictable second surge in
starts before the end-April deadline of the extended homebuyer tax
credit, starts have fallen back agai, and underlying fundamentals are showing few
signs of a robust recovery in the near term. Meanwhile, even in the multi-family
segment, starts have shown no signs of stabilization, due to the excess level of
inventories.
• Mark Vitner and Adam G. York, Wells Fargo Securities: Single-family starts are
expected to climb 16.3% in 2010 and multi-family will rise 23%. "Both gains
come off severely depressed levels, and we still do not see housing starts
returning to a 1.0 million unit pace, which is usually the low hit during the depths
of a severe recession, until 2012." Analysis Wells Fargo Securities Mark Vitner
and Adam G. York Feb 12, 2010 Housing Chartbook, February 2010: What
Happens After the Stimulus Ends?
2.
The IMF and EU suspended their review of Hungary’s IMF loan program on Saturday,
July 17 amid disagreement over budget deficit targets and fiscal austerity measures. The
breakdown of talks with the IMF could be very problematic for Hungary, as the program
was seen as an external policy anchor and as Hungary was hoping to extend the
agreement to December and then sign up for a new two-year deal. As local elections
loom in October, the government appears more focused on near-term political concerns
than economic stability.
This is the latest flashpoint in a series of incidents that underscores the growing risks in
Hungary, which RGE has been highlighting over the past several months. In early June,
several ruling Fidesz party officials riled markets with comments suggesting Hungary
was facing a Greek-style fiscal crisis. Meanwhile, the government has gone on the attack
against the central bank governor. RGE was one of the first to express caution after the
new government’s victory in April (see related Analysis) and continues to believe the
government is playing with fire in its disregard for the market implications of its actions.
Market Reaction
Figure 1: Hungarian Forint Against the Swiss Franc, Euro (Jan 1, 2009 = 100)
Source: Oanda
Figure 2: Hungary’s Sovereign Yield Curve
Source: Bloomberg
Rollover Risk?
RGE continues to believe that Hungary is not facing imminent rollover risk, as noted in a
recent Analysis, given the maturity structure of its debt and its significant foreign
currency reserves of almost US$40 billion as of May 2010. As seen in Figure 3 below,
Hungary has a relatively low amount of short-term external debt; a country with a
relatively high international reserves/short-term external debt ratio is considered less
vulnerable to speculative attacks or external shocks due to the availability of foreign
exchange. Nevertheless, the breakdown in talks with the EU/IMF has significantly raised
the risk that Hungary will face debt funding pressures going forward.
As the IMF noted in Hungary’s fifth review, “the availability of Fund resources will help
to provide insurance against the impact of any unforeseen deterioration in external
financing conditions.” If talks with the IMF and EU do not get back on track, Hungary
will be without an important safety net, which will raise the country’s borrowing costs.
This is a dangerous situation for Hungary to be in given the country’s huge public debt
burden—the fourth largest in the EU at almost 80% of GDP at the end of 2009. RGE will
be closely monitoring the country’s weekly debt auctions for signs of waning demand.
If the forint weakness is lasting, banks could come under pressure. More specifically,
Hungarian households have borrowed extensively in Swiss francs (CHF). Given the
large stock of outstanding CHF-denominated loans, banks could see a jump in non-
performing loans. (See Europe Weekly Spotlight – Hungary’s Swissfrancization: Risky
Business.)
Households are facing a double-squeeze: The Hungarian forint (HUF) fell against the
euro (the worst-performing major currency year-to-date) to the lowest point in over a
year. At the same time, the CHF has strengthened 9% against the euro and looks like it
may continue strengthening, as RGE predicted in the latest Cross Asset Monthly. Also
hurting households’ loan-paying ability is the fact that Hungary’s economy continues to
be the laggard of the region. RGE (counter to consensus) is expecting another year of
annual contraction in 2010, which will not be supportive of job and income growth.
Hungarian banks could also come under pressure as a result of a recently proposed tax,
which may have been partly responsible for the breakdown in the government’s
negotiations with the EU/IMF. In the July 17 statement by the IMF mission to Hungary,
it notes the “high financial sector levy, which is likely to adversely affect lending and
growth.” RGE recently questioned the logic of implementing a temporary bank tax aimed
at shoring up public finances and suggested it could end up having the opposite effect.
(See: Europe Weekly Spotlight - Hungary: Banking on the Bank Tax.)
Figure 5: Bank’s Exposure to Hungary (Claims as of Dec 2009; US$ Billion)
Source: BIS
Hungary has the highest nominal policy rate—5.25%—in Central Europe. Up until May,
most analysts expected additional rate cuts this year. However, the rising risk
environment has changed that. If forint weakness is sustained and the risk perception of
Hungary remains elevated, RGE believes rate hikes are likely. Foreign currency
intervention to shore up the forint, if it approaches the 300 per euro level, is also a
possible policy tool.
In a July 19 press release, the monetary policy council noted: "In the current unfavorable
international environment, the risk premia on Hungarian financial assets continue to be
high and volatile, in part reflecting concerns over the domestic fiscal path. The Monetary
Council will make efforts to stem any excessive fluctuations in the forint exchange rate in
the period ahead. The Council has therefore decided to continue the conversion of EU
funds in the domestic market. A sustained increase in risk premia may make it necessary
to raise the central bank base rate." See related Critical Issue: Hungarian Central Bank:
Rise in Risk Perception Could Trigger Rate Hikes
The IMF and EU Get Tough: Broader Implications
IMF behavior in Hungary and Romania seems to suggest a move toward greater
toughness after the lender showed significant flexibility with program targets last year;
e.g. it allowed a widening of budget deficit targets in 2009. (See related Critical Issues on
Hungary and Romania.) A big question mark is whether this newfound IMF/EU
toughness might expand to Greece if and when the time comes—especially if the actual
fiscal numbers fail to impress.
3.
In Brazil, inflation and inflation expectations continue to move lower while the central
bank is expected to debate a 50- or 75-basis-point hike over the next two days. In
Argentina, rampant fiscal spending and sharply negative real rates, together with solid
growth in Brazil, are feeding unsustainable growth levels. In Colombia, domestic demand
continues to recover with consumption being the most dynamic aspect. In Peru, the
central bank raised reserve requirements once again and continues massive interventions
in the local FX market, while the pre-electoral environment is starting to take on an
interesting color as shown by poll results.
Brazil
IPCA headline inflation came in lower than expectations by declining 0.09% m/m
(consensus, 0.08% m/m; RGE, 0.06% m/m), bringing the annual reading down to 4.74%
from 4.84% in June. Once again, a sharp decline in food prices was the main driver, as
seasonal effects that pushed perishables higher at the beginning of the year are
disappearing. At-home food inflation declined 1.55% m/m to 2.9% y/y, after dropping
1.06% m/m to 4.81% y/y in mid-June, while out-of-home inflation eased its pace of
growth 0.64% m/m to 8.32% y/y, after increasing 0.83% m/m to 8.1% y/y in mid-June.
Moreover, dropping transportation costs, on the back of lower vehicle, alcohol (-3.15%
m/m) and gasoline prices (-0.53% m/m), pushed overall costs lower. Food and transport
prices were responsible for 25% of the decrease. Moreover, apparel—end of season sales
—and healthcare benefited from positive seasonal factors, while lower household goods
helped on the downside. Personal expenditures, housing, education and communication
inflation remained relatively stable. Core inflation (ex-food) also cooled off to 0.12%
m/m from 0.37% in June.
Meanwhile, the second preview of the IGP-M (general price index) continued to show
price deceleration in wholesale, consumer and construction prices, gaining barely 0.3%
m/m from 1.06% m/m last month. Wholesale prices (60% of the index) deflated 0.03%
m/m from the previous 1.06% m/m gain as raw materials plunged to 0.21% m/m from
4.75% m/m thanks to deflation in iron ore prices. Consumer prices (30% of the index)
gained 2 bps to 0.18% m/m deflation from 0.20% m/m in June. Food prices moved higher
to -0.88% m/m from -1.49% m/m, while transport, housing, apparel and healthcare
pushed downward, falling to -0.15% m/m, 0.12% m/m, -0.03% m/m and -0.09% m/m
respectively. Finally, construction prices (10% of the index) also came down to 0.72%
m/m from 2.09% m/m last month thanks to the deceleration in labor costs.
In RGE’s view, the lower-than-expected IPCA 15 for July is in line with our assessment
that seasonal factors are still driving inflation down; however, we expect inflation will
start moving higher in August onward as demand-pull pressures persist, food prices
stabilize and a seasonal upward trend takes effect. We maintain our projection for
headline and core inflation readings to be about 5.6% y/y and 5.5% y/y, respectively, by
the end of 2010, though the risk is increasing toward lower prints. Overall, the current
inflation results, the inflation outlook and the uncertain global backdrop bode well for our
view of a cautious monetary policy actions moving forward. Although we expect
COPOM to raise rates by 75bps to 11% in the July 20-21 meeting, the possibility that the
central bank would opt to hike the SELIC by 50 bps to 10.75% is not negligible. In fact,
the forward curve assigns over 67% probability of the latter occurring
The latest central bank Focus report released on July 19 showed that IPCA inflation
expectations for year-end 2010 declined slightly to 5.432% from 5.45% in the previous
survey, while the year-end 2011 forecast remained stable at 4.8%. For 12 months ahead,
however, inflation expectations increased to 4.96% from 4.9%. Similarly, forecasts for
2010 for the IGP-M, Brazil's broadest inflation index, dropped to 8.79% from 8.89% a
week ago. For 12 months ahead, IGP-M inflation expectations continued dropping to
5.4% from 5.47% a week ago, while forecasts for year-end 2011 increased slightly to
5.04% from 5.01%. GDP growth forecasts for 2010 remains at 7.2%, and those for 2011
stayed at 4.5%. On the local currency, analysts kept their forecast for the end of 2010 at
BRL1.80 per USD and for the end of 2011 at BRL1.85 a week ago.
Expectations for the SELIC monetary policy rate for year-end 2010 continued at 12%,
while those for 2011 stayed at 11.75%. The survey indicates that analysts expect a 75-bps
hike to 11% at this week’s meeting. As of July 20, the markets’ DI futures curve shows
that markets lowered their expectations sharply on the tightening cycle: Markets this
week expected COPOM to raise rates by another 119.28 bp over the rest of 2010, which
would bring rates to around 11.44%, compared to last week’s call for 173.95 bps in hikes
to 11.98%. Markets now assign a 66% probability COPOM will raise rates by 50 bps
rather 75 bps at this week’s meeting (58.56 bps versus 70.18 bps a week ago). Moreover,
the DI curve is assigning a 72% chance of a 25 bps hike in September rather than 50 bps
a week ago, while expected central bank actions in October and December dropped to 14
bps and 14.6 bps, respectively, from 31.63 bps and 20.91 bps a week ago. In Q1 2011, the
markets now assign a 67% probability of a 50-bps increase rather than 25 bps (41.9 bps
versus 22.1 bps a week ago).
The weekly inflation index FIPE remained fairly unchanged from last week, adding 2 bps
to 0.12% m/m from 0.10% m/m. Apparel continued to shrink and fell into the negatives
with a 0.21% m/m contraction. Personal expenses eased to 0.55% m/m from 0.72% m/m
and healthcare costs contributed with a 0.4% m/m gain from 0.52% m/m last week.
Meanwhile, food prices continued to advance although remained in deflation, with a
0.42% m/m contraction from a 0.62% m/m one last week. Housing prices added 5bps to
0.33% m/m and education pushed forward with a 0.25% m/m increase after last week’s
0.09% m/m.
In RGE’s view, the lower-than-expected IPCA inflation result for June released last week
positively affected inflation expectations, while persistent drops in food prices at the
beginning of July are contributing to containing the inflation outlook. Nonetheless,
inflation is still running well above the central point of the target of 4.5% (+/-2%), and
we expect inflation to rise to about 5.6% y/y in H2 2010 as the positive output gap raises
demand-pull pressures. In light of these factors, the central bank in the minutes of the
latest monetary policy meeting expressed concern about the risk of high wholesale prices
passing through to consumer prices as the output gap remains in positive territory. We
expect GDP to expand 7% in 2010 (6.5-7.5% range). We maintain our view that the
central bank will hike the SELIC rate by 75 bps to 11% on July 21 and by another 50 bps
to 11.5% in September. Heightened uncertainty about global growth amid deterioration in
eurozone sovereign and financial conditions portends cautious monetary policy
tightening in Brazil.
Argentina
The consumer confidence index increased by 1.1% m/m to 48.2 in July (13.8% y/y).
Consumers’ perceptions about the macroeconomic situation was flat on a month-over-
month basis (0.5% y/y), because expected improvements over the next twelve months
(2.7% m/m and 9.9% y/y) were reversed by worsening expectations over the next three
years (-2% m/m and -5.6% y/y). Meanwhile, consumers feel their personal situations are
worse off today than they were a year ago and will likely deteriorate in the upcoming
year, as evidenced by the relevant indicators falling 1.5% m/m (+5.6% y/y) and 4.1%
m/m (+5.1% m/m), respectively. Consumers’ willingness to acquire durable goods
jumped 8.6% m/m (54.1% y/y), on the back of increases in readiness to buy appliances
(6.8% m/m and 52.1% y/y) and to purchase automobiles and real estate (11.4% m/m and
57.3% y/y).
Last week, the National Statistics Bureau (INDEC) said that industrial production grew
9.8% y/y in June, which was below expectations (consensus, 10.5% y/y; RGE, 11% y/y).
During H1 2010, industrial output increased 9.5%, compared to a 2% y/y contraction in
the same period the previous year. Rapid growth in output of automobiles (47% y/y),
basic metals (27.2% y/y) which include steel, and textiles (21% y/y) drove industrial
production. Meanwhile, food output, which accounts for 21% of the index, continued to
fall in June (-1.2% y/y), along with chemical products (-2.2% y/y) and oil refining (-5.4%
y/y). On a seasonally adjusted basis, industrial production decreased 0.4% m/m in June
from a 0.2% m/m expansion in May on the back of sharp declines in food (-8% m/m),
plastics (-14.2% m/m), oil refining (-5% m/m), basic metals (-8.1% m/m), and metal
mechanical parts (-9.5% m/m). The only sector posting growth was the automotive
industry (6.4% m/m).
Strong growth in Brazil, Argentina’s largest trading partner and market for about 40% of
Argentina’s manufacturing exports, has been driving industrial output; however, we
expect this manufacturing production to slow down in the coming months as Brazil’s
economic activity cools off and global demand growth eases. We expect industrial output
in Argentina to expand around 7% in 2010.
As we've stated on numerous occasions, the reliability of the official data is questionable;
however, reliable sources point to acceleration in economic growth so far this year.
Overall, economic growth is benefiting from highly accommodative macroeconomic
conditions, strong growth in Brazil, sharply undervalued currency and a rebounding
agricultural sector. Barring a sharp deterioration in global economic conditions, we
expect GDP to expand 6.5% y/y in 2010.
Colombia
Industrial production for May was 7.5% y/y—in line with RGE’s 7.6% y/y—but lower
than the consensus 7.9% y/y forecast, little unchanged from last month’s 7.6% y/y and
surpassing the 7% y/y drop in May 2009. This brought industrial output to a 5.3% y/y
expansion through May 2010, compared to a 9% y/y contraction in the same period of
2009. In May, leading industries were chemicals (12.8% y/y), automobiles (44.4% y/y)
and iron and steel industries (19.8% y/y). By economic sector, output of capital (21.4%
y/y), intermediate (10.3% y/y) and consumer goods (4.2% y/y) posted solid growth, while
contraction related output declined 6.1% y/y.
Real retail sales almost doubled from April, gaining 13.1% y/y from 7.9% y/y previously
(-3.5% y/y in May 2009), and surprising markets (8.2% y/y) and RGE (8.5% y/y) to the
upside. Through May, retail sales have increased 8.8% y/y, compared to a decline of
4.9% y/y in the same period of 2009. In May, solid gains in automobiles (50.9% y/y),
office equipment (38.4% y/y) and appliances (28.7% y/y) pushed the most to the upside,
while alcohol and tobacco and pharmaceutical products lost 3.2% y/y and 2.5% y/y
respectively. Retail sales excluding automobiles expanded 7.9% y/y (4% y/y 3MMA),
their strongest since June 2007 (9.4% y/y).
According to Citi’s market survey of July 19, in which RGE participated, average
inflation expectations for July are in line with RGE’s estimates of 3.2% for year-end
2010, while GDP growth forecasts rest at 4.2% y/y (RGE 3.8% y/y). The totality of
participants are expecting the central bank to stay on hold on July’s meeting and leave the
monetary policy rate at 3%, although the average expectation for December 2010 is at
3.26% (RGE 3%). Meanwhile, expectations for the Colombian peso (CLP) lie at
CLP1903 (RGE CLP1950).
Peru
The central bank increased reserve requirements again for domestic and foreign currency
operations, to be effective as of August. According to the central bank's July 18
resolution, reserve requirements on local and foreign currency deposits at the banks will
rise to 8% from 7%, while minimum deposits held at the central bank increased to 2.5%
from 2%. There will also be a marginal requirement of 12% for domestic currency
deposits. Required reserves against foreign currency loans with durations of less than two
years were increased to 50% from 40% (35% in May), and marginal requirements for
foreign currency deposits at the banks to 40% from 35%.
The new measures complement the central bank’s interest rate hikes in July, as well as
the increase in the limits allowed to Peruvian pension funds when investing abroad to
28% from 26%, and foreign exchange interventions, which so far in July sum US$ 1.25
billion and year to date US$ 4.4 billion.
These actions are in line with RGE’s expectations of additional removal of excessive
monetary stimulus—given Peru’s aggressive growth dynamics—and government actions
to contain strong appreciative pressures on the local currency (PEN)—given wider
interest rates and growth differentials with the rest of the world. The policies aim to
restrict domestic liquidity by limiting credit growth—in both USD (9.1% y/y in May) and
PEN (16.4% y/y in May)—and bring stability to the currency by managing capital
inflows. As Peru’s economy continues to expand at a robust pace during 2010 (RGE,
6.8% y/y), we expect the monetary authority to control for inflation pressures and tighten
rates to 2.5% or 3% by the end of the year. Meanwhile, the central bank has been
intervening aggressively in the local exchange market and accumulating international
reserves. Year to date to July 16, the central bank has added US$4.75 billion for a total
of US$37.9 billion (27% of GDP); in June alone the central bank bought US$2.5 billion
(1.8% of GDP), which is higher than the US$2.1 billion purchased in 2009.
Meanwhile, the presidential elections in Peru to be held on April 20, 2011 have already
started, yet the specific candidates remain unclear. While the ruling party (APRA) does
not have an official candidate yet, Lima Mayor Luis Castañeda Lossio (of the center-right
National Solidarity party) and former president Alberto Fujimori’s daughter, Keiko
Fujimori (Force 2011), are leading the initial opinion polls. On July 18, a poll conducted
by IPSOS Apoyo gave Keiko Fujimori 22% of the intended vote, placing her in the lead.
However, another poll by the Public Opinion Institute of Lima’s Catholic University on
July 14 gave Castañeda Lossio 31% of the votes.
But the results from IPSOS Apoyo show additional interesting results. Former president
Alejandro Toledo, who so far has denied any official intention to participate in the
elections of 2011, would enjoy enough popularity for a third place and displace leftist
candidate Ollanta Humala to a fourth position. Mercedes Aráoz, current Minister of
Economy and Finance and potential candidate for the ruling APRA, would reach a fifth
position.
According to local political analysts, it is surprising that voters are still ambivalent on
corruption and democracy. While some analysts expect that Castañeda Lossio will keep
on falling in the polls because of a corruption accusation, others argue that having Keiko
Fujimori as one of the preferred candidates demonstrates ambivalent attitudes toward
democracy among the Peruvian population, as she can be seen as an extension of Alberto
Fujimori's political legacy. He is currently serving time in jail for violation of human
rights, abuse of influences and accusations of illicit enrichment.
In RGE’s view, it is still too early to make any meaningful analysis, as political dynamics
tend to be very volatile in Peru, even right up to election day. However, we want to point
out that if former President Alejandro Toledo—who is in large part responsible of Peru’s
economic success—participates in the presidential elections, it would be very welcome
by investors not only because he is a well known figure internationally but also because
he would be able to reduce Humala’s chances. Meanwhile, Ollanta Humala has been
moving toward a more conciliatory stance and appears to be less belligerent that in the
last presidential elections, an overall positive for political dynamics for Peru.
• On July 20, 2010, as expected by markets, the Bank of Canada raised its target
rate by 0.25% to 0.75%. It also raised the bank rate to 1% and the deposit rate to
0.5%. The bank noted that global economic recovery is uneven and that the
European sovereign debt crisis and U.S. slowing private demand pose downside
risks to the pace of global growth as was previously projected by the bank. In
Canada, strong economic activity is driven by the strength of government and
consumer spending and by improved labor conditions. However, going forward,
as the housing market tempers and household spending moderates, the bank
anticipates “the growth to be more gradual” than was previously expected, while
business investment and net exports are expected to make a “relatively larger
contribution to growth.” Thus, the bank downgraded growth to 3.5% from 3.7%
in 2010 and to 2.9% from 3.1% in 2011, while the 2012 growth forecast is revised
up to 2.2% from 1.9%. Analysis Bank of Canada Jul 20, 2010 Bank of Canada
increases overnight rate target to 3/4 per cent
• Core inflation, as tracked by the central bank, has been subdued, falling below the
central bank's 2% target—at 1.8% in May and 1.9% y/y in April. In the bank’s
view, the combination of effects from strong domestic demand, modest wage
growth and accumulated slack in the economy will keep the inflation within the
target range of 2%. The bank expects the economy to reach full capacity by the
end of 2011, two quarters later than was previously estimated. The future pace of
normalization will depend on “domestic and global economic developments”
given the notable uncertainties about the outlook. However, considerable
monetary stimulus still remains.
• Julia Coronado of BNP notes that the Bank’s of Canada move to increase its
target rate to 0.75% was in line with expectations. However, the path of policy
tightening is far from certain owing to “balance sheet repair by households, banks,
and governments in a number of advanced economies" as a key factor holding
back the global recovery. Given downside risk to domestic and global economic
recovery, in Coronado’s view, the bank will first normalize rates to the range of 1-
1.25% before remaining on hold until global recovery takes a stronger hold.
Analysis BNP Paribas Julia Coronado Jul 20, 2010 Bank of Canada: Moving
Cautiously Toward Normalization
• Francis Fong of TD notes that despite the increase of its target rate to 0.75%, the
bank's statement is very dovish in tone and cites international developments
forming most of the downside risks. In his opinion, the bank’s role will be to
strike a difficult balance between strong domestic conditions and faltering global
growth. Given the anticipated slowing in consumer expenditure and housing
market in Canada, the central bank revised down its growth forecast. In TD’s
view, domestic factors will play an important role in determining the Bank’s
future decisions, with the target rate reaching 1.25% by the end of 2010 and 2.5%
by the end of 2011. Analysis TD Bank Economics Francis Fong Jul 20, 2010 Data
Release: Bank of Canada Raises Rates with a Cautious Tone
• Avery Shenfeld of CIBC notes that the Bank of Canada’s message remains very
cautious despite raising interest rate to 0.75%. However, in Shenfeld’s view,
despite the dovish language, the bank will increase rates two more times this year
before staying on hold for several months. CIBC projects the Canadian economy
to decelerate more materially in 2010 and 2011 than the central banks forecasts,
thus expecting the BoC to further soften their view on growth by the end of the
year. Analysis CIBC Economics Avery Shenfeld Jul 20, 2010 Bank of Canada:
More to Come
• The economists on the C.D. Howe Institute's monetary policy council continued
to call for a gradual sustained increate in the overnight rate. All 11 members
called for a hike in July, with seven calling for it to be raised to 0.75%, and four
to 1%. All also called for further rate increases in September, members roughly
split between a target of 1% and 1.25%. Looking ahead six months, members
were split along a range of 1.25% and 2%+, with the divergence widening for a
year in the future to 1.75%-3.75%. Despite their different views on the Canadian
and global outlook, all members suggested that the bank of Canada should
continue to signal the importance of existing the emergency policy of the crisis
period. Analysis C.D. Howe Institute July 2010 C.D. Howe Institute’s Monetary
Policy Council Urges Bank of Canada to Raise Overnight Rate to 0.50 Percent,
With Increases to 1.50 in December and 2.50 Percent by May 2011
• The EIU suggests that the signs of economic softening will keep the bank of
Canada on hold for the foreseeable few quarters given that the global risks have
risen since the decision to begin hiking interest rates. Moreover some of the most
recent data points to a softening domestically, particularly in the property market.
Moreover the inflationary outlook remains benign, with core inflation "noticeably
below the central bank’s 2% target rate." Analysis Economist Intelligence Unit
Jul 19, 2010 Canada economy: Signs of growth slowdown
• TD's Eric Lascelles suggests that the Bank will maintain its "hawkish
action/dovish language tag-teaming" to "cast a heavy shadow of doubt over the
more distant future" while gradually hiking rates in the near future. Despite the
April "hiccup" of too strong growth in March, Canada's economy remains
"inordinately strong" and well ahead of the rest of the G7. Core inflation remains
near the BoC target, though tepid wage growth should be a restraint. Moreover
Taylor rules suggest that economic conditions would support a rate of 1%, and
given the gradual absorption of slack in the economy, that might be even higher in
Q3. Analysis TD Bank Economics Eric Lascelles Jul 15, 2010 Canadian
Monetary Policy Monitor: With Wings Unfurled
• BMO expects another hike in July to continue its exit from emergency policies
but suggests that the BoC might pause thereafter to assess conditions in Europe
and the U.S. "soft patch" as the Eurozone crisis dissipates, the BoC "will likely
resume raising rates in halting fashion thereafter." BMO expects rates of 1% at
the end of 2010, 2.5% by the end of 2011 and 3.5% by mid-2012. Analysis BMO
Capital Markets Sal Guatieri Jul 07, 2010 North American Outlook July 2010:
Recovery?
• In its May 2010 Economic Outlook, the OECD recommended that the Bank of
Canada "start normalizing its policy rate without delay and tighten gradually
throughout the projection period." However, OECD policy recommendations
came despite recent market turmoil triggered by the European sovereign debt
crisis, which somewhat lowered the odds of an interest rate hike on the next BoC
announcement date. Analysis OECD Economic Outlook 87 May 26, 2010 Canada
- Economic Outlook
• The BoC cut rates sharply at the beginning of the credit crisis and gradually
reached its effective lower bound of 0.25% in mid-April 2009, where it has
conditionally pledged to remain until at least July 2010. The better credit
conditions in Canada than in the U.S. enabled the BoC to avoid a move into active
quantitative easing and has allowed the central bank to begin unwinding some of
its temporary liquidity facilities.
• Mark Carney, the governor of the BoC, noted that core inflation has been
“slightly firmer than projected, the result of both transitory factors and the higher
level of economic activity.” He also claimed that the interest rate decision “is
expressly conditional on the outlook for inflation.” This statement, coupled with
the emphasis on the bank’s commitment to price stability might signal an interest
rate increase within the next couple of months. Analysis Bank of Canada Mark
Carney Mar 24, 2010 The Virtue of Productivity in a Wicked World
• Stephen Gordon argues that Canadian and U.S. economic trajectories have
diverged, so monetary policy should also do so, meaning that the BoC should hike
interest rates before the U.S. Federal Reserve. Although the Canadian economy
still has a fair amount of slack, it has much less than the U.S.; therefore, the BoC
should start to gradually remove stimulus now as the economy is recovering
rather than have to tighten sharply before the recession is fully over, he says.
• David Rosenberg worried in March that the BoC may have moved too soon in
starting to signal to the markets that a rate hike could come soon given that it has
not been able to move significantly ahead of the U.S. Fed in the past. In 2002, the
Bank of Canada began raising interest rates after one quarter of 5% GDP growth
q/q annualized, only to have to begin easing again in 2004 in line with Fed cuts in
2003. Opinions Globe and Mail David Rosenberg Mar 17, 2010 Bank of Canada
ignores Fed at its peril
5.
• RGE View (Jul 12, 2010): RGE has always said that the UK needs a credible
medium-term fiscal strategy. In our view, the plan will enhance confidence in the
UK’s public finances and will reduce pressure on its triple-A rating. According to
the budget, the biggest contribution to the fiscal consolidation will come from
spending reductions (which will account for 59% and 57% of the total
consolidation in 2010-11 and 2011-12, respectively) rather than tax increases.
This approach should promote growth over time by boosting confidence. Analysis
Roubini Global Economics Parul Walia Jul 19, 2010 United Kingdom: Q3 2010
Outlook
• The HM Treasury: “The UK is forecast to have the largest deficit in the G7 this
year and is borrowing one pound for every four it spends. The figures for June
demonstrate the urgent priority tackling the deficit represents, with borrowing
higher than last June despite higher tax receipts." News FT Jul 20, 2010 UK June
budget deficit higher than forecast
• Public Finances: In June 2010, the public sector deficit was at £13.3 billion—
larger than expectations—compared with £12.1 billion in June 2009. Public sector
net borrowing (excluding financial interventions) was at £15.2 billion,
compared with net borrowing of £14.9 billion the previous year. Public sector net
debt (excluding financial intervention) as a percentage of GDP was at 56.1% at
the end of June 2010, compared to 47.7% at the end of June 2009. Tax receipts,
on which the performance of public finances is highly dependent, increased by
approximately 4% compared with a year ago. Receipts rose by around 10% or
more in the previous three months on the year before. The budget forecast for the
whole of 2010-11 is for receipts to rise by more than 6%. Analysis Office for
National Statistics Jul 20, 2010 UK: Public sector finances-June 2010
• S&P: On July 12, S&P reaffirmed the UK’s AAA rating, but maintained its
negative outlook. According to S&P, “a number of large and politically
challenging spending decisions are still to be made, and Standard & Poor’s
medium-term economic forecasts for the UK are less optimistic than the
assumptions underlying the budget. We therefore believe there is still a material
risk that the UK’s net general government debt burden may approach a level
incompatible with the ‘AAA’ rating. As a consequence, we have maintained the
negative outlook on the long-term rating on the UK.” Analysis S&P Jul 12, 2010
United Kingdom 'AAA/A-1+' Sovereign Ratings Affirmed; Outlook Remains
Negative Blogs FT Alphaville Jul 12, 2010 Carry on cutting
Emergency Budget
• Chancellor George Osborne's first budget, introduced on June 22, 2010, included
drastic cuts to government departments of 25%, except for those with "protected
budgets," such as the NHS and overseas aid, as well as an increase in the VAT
from 17.5% to 20% (effective January 2011). The budget implies more rapid
fiscal consolidation than that planned by the outgoing Labour government.
Osborne said, "This emergency budget deals decisively with our country’s record
debt." News Financial Times Chris Giles and Daniel Pimlott Jun 22, 2010
Osborne presents ‘unavoidable’ Budget
• Key Facts: 1) The budget expects GDP growth of 1.2% y/y in 2010 and 2.3% y/y
in 2011. 2) The VAT will be increased to 20% from 17.5% on January 4, 2011. 3)
A banking levy will be introduced in January 2011; Tier 1 assets will be exempt
from the levy, which is expected to raise £2 billion. 4) The corporation tax will be
cut by one point per year over the next four years, taking it to a rate of 24% by
2014-15. 5) The UK’s structural budget deficit should be in balance by 2015-16.
6) Unemployment is forecast to be 8% this year, falling to 6.1% by 2015-16.
• Fitch called the budget a "strong statement of intent by the new UK government
to accelerate the path of deficit reduction and stabilize and reduce the public debt
burden." According to David Riley, head of sovereign ratings, "Fitch's
preliminary assessment of today's Budget is that it sets out an ambitious deficit
reduction path that, if delivered upon, will materially strengthen confidence in UK
public finances and its 'AAA' status. However, securing the reductions in
'unprotected' departmental and welfare spending will be very challenging and the
Spending Review announced for October 20, 2010, will be important in detailing
and enhancing the credibility of today's Budget announcements." Opinions Fitch
Ratings Jun 22, 2010 Fitch: UK Budget is Strong Statement of Intent
• FT Alphaville: Cost of bank levy on banks, 2010 and 2011 (gross figures): 1)
Barclays, £200 million + £330 million (2% + 3% PBT); 2) LLOYDS, £150
million + £240 million (3% and 2% PBT); 3) RBS, £250 million + £375 million
(6% and 5% PBT); 4) HSBC, US$350 million and US$600 million (1% and 2%
PBT); 5) Standard Chartered, US$85 million and US$170 million (1% and 2%
PBT). Blogs FT Alphaville Jun 22, 2010 [UK Austerity Budget] The bank-
friendly chancellor
• In May 2010, the public sector deficit was at £14.1 billion, compared with £15.7
billion in May 2009. Public sector deficits have been recorded since 2002-03.
Public sector net borrowing was at £16 billion, compared with net borrowing of
the previous year. Consensus was at £18 billion. Public sector net debt as a
percentage of GDP was at 62.2% at the end of May 2010, which compares with
55.4% at the end of May 2009. Net debt was at £903 billion at the end of May
2010, compared with £774 billion a year earlier. Analysis Office for National
Statistics Jun 18, 2010 Public sector finances: May 2010
• Public sector net borrowing was at a revised £8.3 billion for April
2010, compared with £8.8 billion in April 2009. Analysts had expected net
borrowings to the tune of £11 billion. On May 20, 2010, new Prime Minister
and Conservative Party leader David Cameron and Deputy Prime Minister and
Liberal Democrat leader Nick Clegg said that the coalition government is
united in its aim of cutting the deficit—which was at a post-war high of 11.1% of
GDP for the fiscal year ending March 2010. The OBR, headed by Alan Budd, a
former Bank of England policy maker, was detailed to produce new estimates for
the deficit before the coalition's June emergency budget. News Bloomberg May
21, 2010 U.K. Posts Record April Deficit as Budget Looms Analysis Office for
National Statistics May 21, 2010 Public sector finances April 2010
• For the financial year 2009-10, public sector net borrowing was £152.8 billion, up
by £65.9 billion from 2008-09 when net borrowing was £86.9 billion.The
government forecast was £156 billion for 2009-10. Net borrowing excluding
financial intervention was £163.4 billion compared with £96.5 billion in 2008-09,
up £66.9 billion. The Treasury’s forecast was for £167 billion for 2009-10. The
public sector reported a budget deficit of £14.8 billion in March 2010, compared
with a deficit of £12.0 billion in March 2009. Public sector net borrowing was at
£23.5 billion in March 2010 compared with £20.1 billion in March 2009. The
forecast for net borrowing for 2010/11 is £156 billion. Public sector net debt as a
percentage of GDP was 62% at the end of March 2010, up from 52.9% at the end
of March 2009. Analysis Office for National Statistics Apr 22, 2010 United
Kingdom: Public sector finances :March 2010
• “The scale of the UK’s fiscal challenge is formidable and warrants a faster pace of
medium-term deficit reduction than set out in the April 2010 Budget. The rise in
public debt ratios since 2008 is faster than for any other ‘AAA’-rated sovereign
and the primary balance adjustment required to stabilize debt is amongst the
highest of advanced countries. The primary deficit is nearly twice as large as that
seen in previous episodes of fiscal deterioration in the UK in the 1970s and early
1990s.” Analysis Fitch Ratings Jun 08, 2010 The UK’s Fiscal Challenge: A
Formidable Task
• Standard & Poor’s and Moody’s said that an absence of a clear election result
would not put the UK’s AAA credit rating at risk. S&P in a statement said that the
"complexion of the new government is not, in itself, a rating factor for
us...Instead, our focus is on whether the government’s fiscal consolidation plan to
be unveiled in due course is likely or not, in our view, to put the UK government
debt burden on a secure downward trajectory over the medium-term.” The rating
agency is to make a decision on the UK’s credit rating by the end of 2010 after
assessing the country’s medium-term fiscal agenda. News Bloomberg May 07,
2010 U.K. Aaa Rating Isn’t at Risk From Election, Say Moody’s, S&P
• S&P said in a statement that the "outlook on the United Kingdom remains
negative...In the absence of a strong fiscal consolidation plan, the UK’s net
general government debt burden may approach a level incompatible with a
‘AAA’ rating." Blogs FT Alphaville Mar 29, 2010 S&P still negative on the
outlook for the UK’s triple-A rating
Commentary
• Martin Wolf on structural fiscal consolidation: “What is needed, instead, is to
match higher desired savings with higher investment. One advantage of doing so
is that it should minimize any growth collapse. Another advantage is that it would
make deficits credibly temporary: investment incentives are quite easy to
withdraw.” News FT Feb 25, 2010 How unruly economists can agree
• Vince Cable MP (now secretary of state for business, innovation and skills in the
coalition government), October 19, 2009: The central issue emerging now in the
UK—and the one which will dominate politics for the next few years—is the size
of the UK government's budget borrowing and deficits, and government debt. The
stark reality is that much of the deficit does not represent either automatic
stabilizers or a deliberate fiscal stimulus; it is “structural” in character and will not
be reversed on recovery.