ONLY A WEAK YEN POINTS TO REAL GROWTH
JANE FOLEY
RESEARCH DIRECTOR,
FOREX.COM
President Obama last week claimed that the US may be seeing the “beginning of the end” of the recession and his words coincided with subtle improvements in the tone of some central banks, whose rhetoric provides a useful gauge as to how the world is moving on in the wake of the financial crisis. Most recently, signs of accelerating growth, and with it early hints from central banks that inflation rises could be on the horizon, appear to be clustered in the Asian region, specifically China, India and Australia.
By contrast, recession is still running its course within most of the G7 but Canada could be the first member to emerge from recession, with the Bank of Canada projecting positive GDP in the third quarter. In the US, a report last week suggested a slower pace of contraction in during early summer. This supports the expectation that there could be a return to growth in the America by year-end. Growth will follow in the UK with the Eurozone and Japan potentially being the laggards.
From the market’s viewpoint, the inflation potential that growth can breed is crucial . The relatively slow growth projections for the US, UK, Eurozone and Japan suggest there is no real need to be worried about inflation, at least for the next couple of years. But after this, the degree to which inflation does emerge will depend a large part on the efficiency of exit strategies from the current very loose monetary policies. Medium/long-term inflation risks appear to be smallest in Japan and the Eurozone.
CURRENCY WEAKNESS
Medium-term inflation worries are moderately more likely in the UK given the current mix of currency weakness and the Bank of England’s (BoE) quantitative easing program. Despite the recession, UK inflation has been fairly stubborn with the consumer price index only moving below the BoE’s 2 per cent inflation target in June. The reluctance of the consumer prices index to soften significantly could be a persuasive factor at this week’s central bank policy meeting. If the Bank decides not to extend its QE plans, then the market is likely to consider that the next move will be a hike.
In Norway, the reluctance of inflation to fall has been even more marked suggesting that the Norges Bank could be the first European central bank to hike rates during this cycle, possibly before the end of 2009.
Comments from Governor Glenn Stevens of the Reserve Bank of Australia (RBA) shook the market last week. In terms of the economic outlook he said: “It is becoming more common for Australians to see the glass as half full than as half empty”. His tone cemented the view that the next move in RBA rates would be a hike, probably before year-end. China was cited as continuing to provide opportunities, which was a clear reference to Australia’s ability to supply industrial commodities.
Clearly commodity prices remain a source of concern with respect to inflation. While the RBA sees the rise in oil and other commodity prices that occurred in the first half of 2008 as having reversed, it refers to the cumulative increase in the preceding five years as having remained in place. Strengthening growth in industrial Asia will keep the RBA on its toes.
MODERATELY EXPANSIONARY
In China growth registered a startling 7.9 per cent in the second quarter. Last week the Chinese central bank warned that inflation might rebound in the second half of 2009, though it later reaffirmed that policy will remain moderately expansionary. The Bank of India (BoI) also raised its inflation forecast last week to “around” 5 per cent from an April forecast of 4 per cent, citing elevated food and commodity prices. Its growth forecast was edged higher to 6 per cent “with an upwards bias”. Following an expansionary budget, it seems likely that the BoI will have to consider withdrawing its expansionary policy, suggesting the possibility of a hike this year.
For the currency market the prospects of returning growth and inflation potential to some part of the globe have been creating renewed interest in some “risky” currencies. The Norwegian krone and the Australian dollar have both benefited from the expectation that interest rates could turn higher and similarly the outlook for the Indian rupee has brightened.
However, with the G7 still struggling to shake off recession there is still reason for investors to remain cautious. The fact that the yen is still strong indicates continued safe-haven demand. Going forward, signs of growing economic momentum – specifically from the US – will be instrumental for the global recovery story to gain integrity and for risk appetite to build. Only when this happens will the Japanese yen finally relinquish its strength.
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