Market Outlook - BNP PARIBAS - Investment Services India

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UK: Top Of The Hill• The September reading of UK consumerprice inflation showed it surging to 5.2%, upfrom 4.5% in August.• But we and the MPC expect it to fall sharplynext year.• Indeed, the risks are on the downside andthe MPC will need to consider more QE byFebruary.The September reading of UK consumer priceinflation showed it surging to 5.2% y/y, up from 4.5%in August. That represents the highest annual rate ofCPI inflation since September 2008.Of the 0.7pp rise in inflation, 0.45pp was accountedfor by higher utility bills. That was in line with our ownexpectations. But on top of this effect, transportprices also contributed to a higher reading. Betweenthis August and September transport prices declinedby 2.1%, compared with 3.4% a year ago. That wasdue to a smaller fall in air fares this September thanlast year, as well as in sea fares. Overall, transportadded 0.2pp to the annual CPI inflation rate. Thesmaller jump in the RPI annual rate, from 5.2% to5.6%, partly reflects lower weights for air and seafares in the index.We expect inflation to remain above 5% in October,though declining to 5.1%. RPI inflation should movedown to 5.5% next month. Despite the high currentrate, the Bank of England’s Monetary PolicyCommittee remains quite convinced that inflation willdrop sharply next year and we would broadly agreewith that.There are a number of reasons why we can beconfident of a sharp fall back. For one, the rate ofVAT rose by 2.5pp in January 2011 and this will dropout of the twelve-month inflation calculation over thefirst quarter of 2012 (assuming some gradual passthroughof the rise). That alone should see at least1pp off the annual inflation rate. But on top of thisimpact, many of the upside commodity induced risesin inflation look to have peaked. For example, globalfood prices appear to have flattened off, while UKwholesale energy prices have done likewise.In the bigger picture, since 2008 UK consumer priceshave increased by around 7.5% more than in theeurozone and the US. As the Bank of England isfond of pointing out, virtually all of that difference canbe accounted for by the impact of the fall in the valueof sterling and the subsequent rise in import prices.13012512011511010510095908580Chart 1: UK, US and Eurozone CPI Since 2008Jan 2008 Jul 2008 Jan 2009 Jul 2009 Jan 2010 Jul 2010 Jan 2011 Jul 2011Source BloombergUK CPIUS CPIEurozone CPIUK Import pricesSince 2008 import prices excluding energy haverisen by around 25%. Once allowance is also madefor the rise in VAT, that can account for thedifference in CPI performance.In the medium term, as these effects wash out thedata, UK consumer price inflation should begin tobetter reflect underlining domestically generatedinflation. And here evidence suggests inflationarypressure is very restrained, with annualised unitlabour growth in the second quarter of 1.1%.This week’s MPC minutes to the October meetingunderlined the Committee’s belief that inflation willfall sharply next year. Indeed, the growing downsiderisks facing UK demand growth were described ashaving increased “significantly” since the AugustInflation Report. That reflects the Committee’sconcern about the weakening in the UK’s mainexport markets, as well as the impact that financialmarket tensions may have on credit conditions. Infact, the MPC now think it is more likely that inflationwill undershoot the 2% target in the medium term,and the available indicators suggested that growth inQ4 would be “close to zero”. The Committee,therefore, found the case for an extension of QE“compelling”.We believe the risks are to the downside of theCommittee’s view that GDP will be flat in Q4, withrecent surveys suggesting a contraction is morelikely. Moreover the shock to household incomesfrom higher utility bills will also knock spendingvolumes in due course. It therefore remains likelythat the macroeconomic backdrop to theCommittee’s meetings early in the new year will notbe auspicious, and we look for it to agree anotherextension to quantitative easing by February.David Tinsley 20 October 2011Market Mover10www.GlobalMarkets.bnpparibas.com
Norway: Increased Uncertainty• The Norges Bank left the policy rateunchanged at 2.25%, in line with marketexpectations.• Downward revisions to inflation forecastsand increased uncertainty regarding theeconomic outlook led to a lowering of the policyrate profile.• The Bank now intends to deliver the nextrate hike in Q3 2012. We believe it will comeearlier in Q1 2012.Rates on holdIn line with our and market expectations, the NorgesBank kept its policy rate unchanged at 2.25% at itsOctober meeting. The accompanying policystatement was dovish. The biggest change was thatthe Bank now intends to deliver the next rate hike “ina year’s time”. Although “growth in the Norwegianeconomy remains robust”, the Bank noted that“turbulence and weaker prospects abroad are alsoaffecting the outlook for the Norwegian economy”.So, if tensions in the financial markets intensify andthe outlook for growth and inflation weakens further,the Bank left the door open for policy rate cuts.Norges Bank’s latest forecastsLooking at the forecasts in the new Monetary PolicyReport, the Norges Bank now expects mainland GDPto grow by 2.75% in 2011, down from its previousprojection of 3.00%. Meanwhile, the 2012 and 2013mainland GDP growth forecasts were left unchanged(Table 1).CPI forecasts were revised down for the period 2011-2013. For CPI-ATE, the Bank kept its 2011 forecastof 1.00% unchanged, but revised 2012 and 2013forecasts 0.25pp lower to 1.75% and 2.25%. This isin line with our forecast that a stronger domesticcurrency and moderation in external price pressuresshould lead to some downward revisions to CPI andCPI-ATE forecasts. But, as we highlighted before,this did not change the Bank’s profile that CPI-ATEinflation is to reach a trough this year and annualCPI-ATE inflation is to print higher next year,compared with this year.Policy outlookIn terms of policy going forward, these downwardrevisions to inflation forecasts and an “unusually highlevel of uncertainty surrounding developmentsahead” led to a downward revision to the Bank’spolicy rate profile. The new quarterly policy rateprojections suggest the Bank intends to deliver thenext rate hike in Q3 2012, in August at the earliest.Table 1: Norges Bank’s Forecasts (% y/y)*CPICPI-ATEGDPMainlandGDP2011 2012 2013 20141½(1¾)1(1)1½(1¾)2¾(3)1½(1¾)1¾(2)3(2¾)3¾(3¾)2(2½)2¼(2½)2½(2¼)3¼(3¼)2¼(2½)2¼(2½)2¼(2)3(2¾)Key Policy 2.25 2.41 3.23 4.01Rate (avg.for Q4) (2.65) (3.87) (4.68) (4.79)Source: The Norges Bank, Monetary Policy Report, 3/11, OctoberNote: *Forecasts in Monetary Policy Report, 2/11, June in parenthesisClearly the Bank is giving weight to uncertaintyregarding the developments ahead, in particular inEurope. The adverse external developmentsstemming from the eurozone are having spillovereffects on the Norwegian export sector and leadingto higher money market spreads.We agree with the Bank’s assessment that the policyrate should be left unchanged for some time to come,given broad expectations that the major advancedcountry central banks are to keep their policy rateslow for a while. From the Bank’s assessment, it isclear that a stronger krone is a source of concern forthe Bank. In particular, it noted that “an appreciablyfaster rise in the interest rate at home than abroadwould increase the risk of a krone appreciation,resulting in inflation that is too low”.But we believe the next rate hike is to come earlier inQ1 2012, in March. As we highlighted before,although there are some signs that economic growthis to moderate over the period ahead, mainly due tothe impact of external developments on Norway,domestic economic conditions are to remainrelatively robust. Consumer spending is stillsupported by high house prices, robust growth incredit to households, high real personal disposableincomes and a tight labour market. Furthermore, oiland housing investment are to provide a boost to theeconomy overall. In particular on housing, therelatively low level of interest rates and high demandcontinues to push housing starts higher.The risk to this forecast is that the Bank will keep thepolicy rate unchanged for longer than we assume, ifthe negative spillover effects of externaldevelopments on Norway are larger than we expect,inflation surprises the Bank to the downside and thekrone appreciates significantly.Gizem Kara 20 October 2011Market Mover11www.GlobalMarkets.bnpparibas.com
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