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Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
Financial Pacific: The Global monetary analyst (third party), november 29.2010
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Financial Pacific: The Global monetary analyst (third party), november 29.2010

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  • 1. For important disclosures, refer to the Disclosures Section, located at the end of this report. M O R G A N S T A N L E Y R E S E A R C H Global Economics Team: Coordinators of this publication Joachim Fels HJoachim.Fels@morganstanley.comH +44 (0)20 7425 6138 Manoj Pradhan Global November 24, 2010 The Global Monetary Analyst EMflation As the focus in China shifts from the ‘sweet spot’ to managing inflation, a natural question is whether inflation is an EM-wide phenomenon that will draw policy fire and stall EM growth. We surveyed our EM teams on the severity of the inflation problem and the source of inflation concerns. The collective wisdom of our EM teams suggests that the EM world is split fairly evenly into economies that have an inflation problem and ones that don’t. Food inflation is playing a major role in driving inflation, but domestic demand-led inflation is an important factor in the economies of Brazil and to a lesser extent Indonesia. Where domestic demand-led inflation is driving domestic inflation, policy-makers are likely to be more focused on using monetary policy to moderate inflation. Monetary policy, however, is likely to tighten across the EM world as a whole, even though not every country has an inflation problem. Why? In EM economies where policy-makers are fighting inflation, the combination of higher policy rates and FX appreciation will be designed to just about prevent inflation from rising higher, but probably not lead growth lower. In the rest of the EM world, policy rates are likely to rise because central bankers are keen to normalise rates from the very low levels that existed during the Great Recession. In a nutshell, policy tightening should cool down overheating economies, and should continue to provide monetary stimulus (although a little less of it) to the ones who still desire faster growth. p 2 Central Bank Watch US: Fixing Housing: Policy Options p 7 Canada: Tweaking the Rate Path p 8 South Africa: SARB Goes Eazy Once More p 8 South Africa: CPI Passes Inflection Point p 9 Asia-Pacific: Inflation Risks in Asia ex-Japan? p 9 China: 2011: A Year of Reflation p 10 China: PBoC OMOs Monitor p 10 India: CRR Cut a Possibility p 11 Hong Kong: Higher Inflation p 11 Taiwan: Domestic Resilience Continues p 12 Mexico: We Expect No Change in Policy Rate p 12 Manoj.Pradhan@morganstanley.com +44 (0)20 7425 3805 Spyros Andreopoulos Spyros.Andreopoulos@morganstanley.com +44 (0)20 7677 0528 Key Central Bank Risk Events Date Country Event 25 Nov Euro Area Bundesbank’s Weber to speak in Berlin 25 Nov Euro Area ECB’s Constancio to speak in Hamburg 25 Nov Euro Area ECB’s Tumpel-Gugerell speech in Brussels 25 Nov UK MPC members at Treasury Committee Hearing 26 Nov Norway Gov. Gjedrem speeches in Trondheim 26 Nov Russia Rates decision: Expect on-hold 26 Nov Mexico Rates decision: Expect on-hold 29 Nov Hungary Rates decision: Expect on-hold 01 Dec US Beige Book 01 Dec Chile Monetary policy minutes 01 Dec Thailand Rates decision: Expect on-hold 02 Dec Euro Area Rates decision: Expect on-hold 02 Dec Sweden Financial Stability Report 03 Dec Indonesia Rates decision: Expect on-hold Forecast Changes Since Last Week Canada Policy rate: 1, 2% in 4Q10, 4Q11 (prev. 1.25, 2.5%) Poland CPI: 3% in 2011 (prev. 2.7%) Czech Rep. CPI: 2.1% in 2011 (prev. 2.3%) Hungary CPI: 4.8, 3.2% in 2010, 2011 (prev. 5.1, 3.5%) China Policy rate: 6.31, 6.31% in 4Q11, 4Q12 (prev. 6.06, 6.06%) Indonesia CPI: 5.1, 6% in 2010, 2011 (prev. 5.3, 6.2%) Thailand CPI: 3.2, 3.5% in 2010, 2011 (prev. 3.5, 4%)
  • 2. M O R G A N S T A N L E Y R E S E A R C H November 24, 2010 The Global Monetary Analyst EMflation Manoj Pradhan (44 20) 7425 3805  As the focus in China shifts from the ‘sweet spot’ to managing inflation, a natural question is whether inflation is an EM-wide phenomenon that will draw policy fire and stall EM growth. We surveyed our EM teams on the severity of the inflation problem and the source of inflation concerns.  The collective wisdom of our EM teams suggests that the EM world is split fairly evenly into economies that have an inflation problem and ones that don’t. Food inflation is playing a major role in driving inflation, but domestic demand-led inflation is an important factor in the economies of Brazil and to a lesser extent Indonesia. Where domestic demand-led inflation is driving domestic inflation, policy-makers are likely to be more focused on using monetary policy to moderate inflation.  Monetary policy, however, is likely to tighten across the EM world as a whole, even though not every country has an inflation problem. Why? In EM economies where policy-makers are fighting inflation, the combination of higher policy rates and FX appreciation will be designed to just about prevent inflation from rising higher, but probably not lead growth lower. In the rest of the EM world, policy rates are likely to rise because central bankers are keen to normalise rates from the very low levels that existed during the Great Recession.  In a nutshell, policy tightening should cool down overheating economies, and should continue to provide monetary stimulus (although a little less of it) to the ones who still desire faster growth. The passing of the ‘sweet spot’ in China almost had a slow inevitability about it, given its recession-defying growth performance and stimulatory policy environment. Policy focus in China now appears to have shifted rapidly from a narrow campaign to curb property speculation last year to a much broader mandate to quell inflation in 2011 (see China Economics: 2011: A Year of Reflation, November 21, 2010). Inevitably, extrapolation is rampant. Will the rest of EM go the China way? Is the sweet spot for EM growth behind us? Just as inevitably, there is no single answer for the entire EM world. Surveying our EM economics team suggests that inflation is not a universal problem in EM, nor is policy tightening likely to be severe enough to derail growth. In economies where inflation is already a concern for policy- makers, commodity prices have played a role in more cases than domestic demand-led inflation. For these countries, appropriate policy tightening is necessary and is likely to have a salutary effect on growth dynamics. In many other EM economies, however, inflation is not a problem (at least not yet). In a few cases, there is enough slack in the economy for policy-makers to focus mostly on growth for now. EM monetary policy-makers are likely to keep tightening policy, but policy rate hikes probably constitute more of a normalisation of the monetary policy stance rather than a move to an outright restrictive position. Tapping the expertise of our EM teams: Is inflation a problem? Where it is a problem, what are the main drivers of inflation: food and/or energy prices, or domestic demand? Has the slack in the economy dwindled enough to kindle inflationary pressures? What actions will policy-makers take as part of the tightening process? These are the questions we asked our economics teams in order to understand where inflationary tensions lie and what the likely policy response is. Is inflation a problem? The EM world appears to be split fairly evenly on this issue (see Exhibit 1). Inflation is already a concern in many AXJ economies, notably in India, where the central bank has raised rates by 150bp in 2010 to ward off inflation. To a lesser extent, other AXJ economies (with the exception of Taiwan, Thailand and Malaysia) are wary of inflation and central banks have moved to take policy rates off the low levels that were in place during the Great Recession. The exception to this rule is Indonesia, where inflation risk is moderate but relatively higher than the rest of the AXJ region. Outside the AXJ region, the economies of Brazil and Peru in Latin America and Poland, Hungary and Romania in the CEEMEA region are grappling with an inflation problem as well. Exhibit 1 Less Slack, but Very Little Overheating as Well Output gap-inflation mix Output gap Inflation concerns No concerns Large and negative Hungary, Russia Mexico Small but still negative Indonesia Chile, Czech Rep., Israel, Malaysia, S. Africa, Thailand, Turkey, UAE Closed Brazil, India, Poland Taiwan Positive China, Korea, Singapore Source: Morgan Stanley Research EM Economics teams 2
  • 3. M O R G A N S T A N L E Y R E S E A R C H November 24, 2010 The Global Monetary Analyst Our China economics team expects inflation to become the macro focus in 2011 because of cyclical as well as structural factors (see again China Economics: 2011: A Year of Reflation). Cyclically, the lagged effects of ultra-expansionary monetary policy are expected to drive inflation higher. Structurally, the shift in production from the tradable to the non-tradable sector will lower overall productivity, leading to higher inflation. Policy-makers will be keen to push inflation expectations lower, possibly through a combination of some constraints on domestic credit expansion and/or constraints on money growth, some currency appreciation and policy rate hikes. In other EM economies, inflation is not an immediate problem: In some cases (see Exhibit 1), overall inflation is not high and the metric that matters for policy-makers, core inflation, has remained well behaved (e.g., in Malaysia and Thailand). In other economies like Mexico, Russia and the UAE, the slack in the economy is large enough that the risk of inflation rising sharply seems to be a small one. Where inflation is a problem, what are its main drivers? Inflation being a concern for policy-makers is a necessary but not a sufficient concern for an aggressive tightening of policy. It is very important to identify the drivers of inflation. Is inflation driven by food or energy or other commodity prices? Or is stronger domestic demand responsible for inflation concerns? If it is the former, policy reaction is likely to be muted. However, central banks will be more likely to take action to quell domestic demand if it is pushing inflation higher. Food and energy inflation as drivers of inflation: If headline numbers are driven by internationally traded commodity prices, EM central banks are likely to adopt an approach similar to the one they had in 2007. Then, EM central banks resisted tightening as international commodity prices were driven by strong global demand and central banks were individually incapable of lowering international prices through tighter monetary policy. Clearly, collective action would have helped, but the difficulties of creating such a like- minded group and the difficulties of sustaining commitment in this monetary policy cartel would have proved formidable – and this when growth was exceptionally strong globally without a strong hint of the oncoming global recession. Today, a similar consensus appears to exist among EM central bankers, but for very different reasons. EM economies now appear to be growing sustainably, providing a bid for food, energy and other commodity prices. At the same time, ultra- loose monetary policies from the major central banks have pumped enough liquidity into the system to drive up asset and commodity prices. Getting EM central banks to collectively hike rates by enough to offset liquidity injections from the major central banks appears to be close to impossible, given that this would almost certainly put domestic growth in the EM economies in question at risk. And indeed, food inflation appears to be the main driver (or the joint main driver) of inflation in a large number of EM economies (see Exhibit 2). The big risk, naturally, is one of second-round effects of food price inflation on core inflation. This is particularly true where food inflation is high, domestic demand is strong but domestic demand-led core inflation has not yet picked up. The ideal example in this category is Indonesia, where food inflation has been a problem for a while and where domestic demand has been strong as well. The risk of a pass-through from food to more general inflation is therefore a worry. Turkey shares similar concerns but food prices are expected to normalise there, cutting down the risk of a pass-through into more general inflation. Exhibit 2 What Is Driving Inflation? Inflationary pressure source Inflation concerns No concerns Food and/or energy China, Hungary, India, Korea, Poland, Russia Chile, Czech Rep., Malaysia+, Mexico, Taiwan, Thailand+, Turkey, UAE Domestic demand Brazil, Indonesia*, S. Arabia Israel, S. Africa** Notes: *In Indonesia, domestic demand-led and food inflation are both important; **In S. Africa, domestic demand-led, food and energy inflation are all important; +In Malaysia and Thailand, tradable goods inflation is most important. Source: Morgan Stanley Research EM Economics teams Domestic demand-led inflation: In a handful of economies (Brazil, Indonesia, Israel, South Africa and Saudi Arabia – see Exhibit 2), however, domestic demand-led inflation is the most important concern (though Israel really has only a housing price inflation worry). Of these economies, Indonesia has been pointed out as the economy that has moderate risk both from domestic demand pressures as well as the risk of pass- through from food prices to overall inflation. Brazil and Israel have both used rate hikes so far, partly to address inflation concerns. Both central banks are expected to further raise policy rates in order to bring inflation under control as needed. Is slack so little now that inflation is likely to be a problem in the near future? A surprisingly large number of economies report that economic slack is still present, but that the output gap is not very wide. In some economies, the output gap is closed, indicating that a continuation of rapid growth may start putting upward pressure on inflation going forward (see Exhibit 1). In some cases, the 3
  • 4. M O R G A N S T A N L E Y R E S E A R C H 4 November 24, 2010 The Global Monetary Analyst output gap is still negative and quite large. Prominent in this category is the Russian economy, where the output gap has narrowed but still remains quite large. It is not surprising, then, to note that Russian policy-makers appear to be giving much more support to pro-growth policies than to anti-inflation ones. The South African economy is the other economy where the output gap is large enough for policy-makers to ignore inflation concerns for the moment. Two rate cuts of 50bp each recently delivered by the SARB provide strong evidence of this. What is the policy response likely to be? In light of the above, it may appear somewhat surprising, at first blush, to note that monetary tightening seems to be almost universal in the EM universe that we cover (see Exhibit 3). However, monetary tightening becomes easier to understand when we differentiate between normalisation of rates and moving to an outright restrictive monetary policy stance. Many of the policy rate hikes, particularly in the case where the output gap is still negative and inflation is not a problem, represent normalisation of policy to a stance that is a little less expansionary. Even in the economies where inflation is a problem and the output gap has either closed or is very narrow, we don’t expect policy rates to be hiked to an extent where they will begin to hurt growth. Even for the outperforming AXJ economies, policy tightening is likely to be calibrated to just keep growth from rising further rather than pushing it lower. Policy actions are thus unlikely to derail growth in the EM economies. Exhibit 3 Monetary Tightening Through Higher Rates and FX Appreciation Will policy-makers allow: Higher policy rates FX appreciation Highly unlikely HK, Mexico, UAE Brazil, HK Unlikely Indonesia, S. Arabia Hungary, India, Thailand Balanced risk Malaysia, S. Africa Chile, Czech Rep., Indonesia, Poland, Russia Likely Brazil, Czech Rep., Hungary, India, Poland, Russia, Thailand Israel, Korea, Malaysia, Mexico, S. Arabia, Singapore, S. Africa, Taiwan, Turkey, UAE Highly likely Chile, China, Israel, Korea, Taiwan, Turkey China Source: Morgan Stanley Research EM Economics teams Constrained by the trilemma: Even if monetary policy- makers wanted to be aggressive, they would be bound by the constraints of the trilemma (monetary policy-makers can achieve only two out of the trinity of unconstrained capital flows, a stable exchange rate and independent monetary policy). At a time when capital inflows into EM economies have been aggravated by the Fed’s QE2 salvo, avoiding currency appreciation will severely limit the amount of monetary tightening central banks can attempt. Of course, central banks may choose to break the flow of capital into the domestic economy through the use of capital controls, but to do that, they would have to rival the extensive controls that China has in place. In our view, the kind of capital controls we have seen so far (taxes on capital inflows into domestic fixed income markets) are more likely to change the composition of inflows towards equity flows, but not change the overall level of capital inflows. Which monetary policy tools? Contrary to their developed market peers, EM central bankers are not reluctant to use the many tools at their disposal, including policy rates, the exchange rate, liquidity constraints, capital controls and even strong moral suasion to banks regarding lending activities. Focusing on a narrow set of tools, however, interest rates and exchange rates appear to be heading higher going forward, except for India, Thailand, Hungary and Brazil, where there appears to be limited scope for further currency appreciation (see Exhibit 3, and also page 16 for our quarterly policy rate forecasts through end-2012). In many cases, policy-makers may prefer to have less currency appreciation but may not be successful in warding off capital inflows and the resulting upward pressure on their currency. In any event, EM economies appear to be set for a gradual appreciation of their currencies, probably thanks to a combination of tighter monetary policy and steady capital inflows in line with the constraints of the trilemma. In summary: The policy response to inflation in overheating economies is likely to lead to a salutary slowdown in these economies rather than a hard landing. Where inflation is not a problem, policy rates may be hiked, but this will likely be more for the purposes of normalisation of policy rates than for creating a restrictive monetary policy stance. If successful, these dual strategies should allow solid growth to persist in the EM world. The key risk remains that the combination of relatively easy domestic monetary policy in EM countries and even more easy money imported from the leading economies will push inflation higher. The policy response then would have to be stronger if EM central banks wish to protect medium-term growth by keeping inflation under control.
  • 5. M O R G A N S T A N L E Y R E S E A R C H November 24, 2010 The Global Monetary Analyst Inflation Target Monitor & Next Rate Move Global Economics Team. Contact: Manoj.Pradhan@morganstanley.com 12M MSInflation Latest target month fcast Next rate decision Current rate Market expects (bp) MS expects (bp) Risks to our call US 1.5-2.0% PCE Price Index 1.2% 1.5% 04 Dec 0.125 0 0 Political pressure on Fed has been increasing Euro Area < 2% HICP (u) 1.9% 1.6% 02 Dec 1.00 0 0 Tilting towards an earlier hike Japan 0-2% CPI (u) -1.1% -0.2% 21 Dec 0.05 0 0 - UK 2% CPI 3.1% 2.9% 09 Dec 0.50 0 0 QE extension now looks unlikely Canada 1-3% on CPI 2.4% 1.7% 07 Dec 1.00 2 0 If US economy disappoints, BoC may slow tightening Switzerland <2% CPI (u) 0.2% 0.4% 16 Dec 0.25 1 0 - Sweden 2.0% CPI 1.5% 2.3% 15 Dec 1.00 18 0 Downside risk to December 2011 forecast Norway 2.5% CPI 2.0% 1.7% 15 Dec 2.00 5 0 Slight risk of a surprise hike Australia 2-3% over the cycle 2.8% 2.4% 07 Dec 4.75 1 0 A 25bp hike New Zealand 1-3% CPI 1.5% 1.8% 09 Dec 3.00 0 0 Very small chance of a December hike Russia none 7.5% 8.3% 26 Nov 7.75 0 0 - Poland 2.5% (+/- 1%) CPI 3.0% 2.8% 22 Dec 3.50 - 0 - Czech Rep. 3.0% (+/-1%) CPI 2.0% 2.5% 22 Dec 0.75 - 0 - Hungary 3.0% CPI 4.1% 3.5% 29 Nov 5.25 - 0 - Romania 3.5 (+/-1%) CPI 7.9% 4.4% 05 Jan 6.25 - 0 - Turkey 6.5% CPI end ’10 8.6% 5.8% 16 Dec 7.00 0 0 - Israel 1-3% CPI 2.5% 2.6% 27 Dec 2.00 - 0 BoI might hike 25bp UAE - 0.9% 1.5% - 1.00 - - - South Africa 3-6% CPI 3.2% 4.7% 20 Jan 5.50 - 0 - China - 4.4% 4.5% - 5.56 - 0 Balanced risk India NA 8.6% 5.5% 16 Dec 6.25 0 0 Higher inflation and domestic demand Hong Kong - 2.5% 3.8% - 0.50 - 0 Premature US tightening upon global inflation uptick S. Korea 2-4% CPI 4.1% 3.6% 09 Dec 2.50 - 0 Rate hikes possible on rising inflationary pressures Taiwan - 0.6% 2.0% 23 Dec 1.50 - 12.5 Rate hike could be delayed due to external uncertainties Indonesia 5% +/- 1.0% 5.7% 5.1% 03 Dec 6.50 - 0 Evenly balanced Malaysia - 1.8% 1.7% 27 Jan 2.75 - 0 Evenly balanced Thailand 0.5-3.0% core CPI 2.8% 3.2% 01 Dec 1.75 - 0 Evenly balanced Brazil 4.5% +/-2.0% IPCA 5.2% 5.2% 08 Dec 10.75 0 0 - Mexico 3% +/-1% CPI 4.0% 3.9% 26 Nov 4.50 0 0 Tangible signs of a slump in US growth Argentina 15.5-24.2% M2 growth 11.1% 10.3% NA 9.25 - - - Chile 3% +/-1% CPI 2.0% 3.4% 16 Dec 3.00 25 25 Further FX strength leading to pause Peru 2% +/-1% CPI 2.1% 2.5% 09 Dec 3.00 0 0 Policy tightening in response to scorching recovery Colombia 3% +/-1% CPI 2.3% 4.7% 17 Dec 3.00 0 0 CB underestimating inflation risk as recovery proves stronger (u) = unofficial Notes: Inflation numbers in red indicate values above target; MS expectations in red (green) indicate our rate forecasts are above (below) market expectations. Japan policy rate is an interval of 0.00%-0.10%. 0.00% 25.00% 50.00% 75.00% Inflation Relative to Target Expected Policy Rates (end '10) Last Policy Move Actual > Target 12M FCast > Target Higher Lower Hike Cut Source: National Central Banks, Morgan Stanley Research Notes: (u) = unofficial target; Interest rate expectations are implied by overnight indexed swap (OIS) curves and may differ from those implied by other instruments; where adequate OIS data are not available, FRAs, foreign exchange swaps, and/or interbank cash rate futures are used; due to varying risk premia (such as liquidity, basis, credit, term, reserve management, calendar turns, etc.), these figures should be used as estimates only; where such instruments are not available, we have inserted our best guess of what markets expect based on consensus estimates. 5
  • 6. M O R G A N S T A N L E Y R E S E A R C H 6 November 24, 2010 The Global Monetary Analyst Central Bank Balance Sheet Monitor Global Economics Team. Contact: Manoj.Pradhan@morganstanley.com US Japan 0 500 1,000 1,500 2,000 2,500 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Size of B/S Excess Reserves Federal Reserve (Bil.$) 0 20 40 60 80 100 120 140 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Size of B/S Total Reserves Bank of Japan (Tr.¥) Source: Haver Analytics Source: Haver Analytics Europe UK 0 500 1,000 1,500 2,000 2,500 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Size of B/S Total Reserves Eurosystem (Bil.€) 0 50 100 150 200 250 300 350 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Size of B/S Total Reserves Bank of England (Bil.£) Source: Haver Analytics Source: Haver Analytics
  • 7. M O R G A N S T A N L E Y R E S E A R C H Central Bank Watch November 24, 2010 The Global Monetary Analyst What’s New This Week? US: Fixing Housing: Policy Options............................... p 7 Canada: Tweaking the Rate Path ................................. p 8 South Africa: SARB Goes Eazy Once More................. p 8 South Africa: CPI Passes Inflection Point in October.... p 9 Asia-Pacific: Inflation Risks in Asia ex-Japan? ............ p 9 China: 2011: A Year of Reflation ................................. p 10 China: PBoC OMOs Monitor....................................... p 10 India: CRR Cut a Possibility......................................... p 11 Hong Kong: Higher Inflation, but Less than Expected. p 11 Taiwan: Domestic Resilience Continues..................... p 12 Mexico: We Expect No Change in Policy Rate........... p 12 US: Fixing Housing: Policy Options Richard Berner (1 212) 761 3398 Many options, little will: Many policy options are available to fix dysfunctional US housing and mortgage markets. But the political will to deploy them is scarce. Small wonder: None is a panacea, most reward ‘bad’ behaviour, some involve government funds, and none will satisfy all parties. Yet all are better than doing nothing, and a combination of carrots and sticks could create incentives for good behaviour and real results. Dimensioning housing rot: Housing activity and home prices remain at risk despite a deep recession, record declines in home prices and plunging mortgage rates. Credit is scarce, thanks to the shadow inventory of yet-to-be-liquidated homes, the one-in-four borrowers in negative equity, and putbacks. Absent aggressive policy action, we believe that the supply- demand balance won’t correct itself for years. Two groups of remedies: The first group: Mortgage modifications or refinancings reduce monthly payments. They help to mitigate defaults but are far from sufficient to solve the problem. That requires policies from the second group: Write- downs or forgiveness of principal. Only when the cushion of owners’ equity is restored will housing and housing finance begin real recovery. First repair, then reform: The sequencing of policy options is critical: The first priority should be to reduce housing imbalances and restore market functioning. Only then can policy-makers implement reform of mortgage finance – including rules governing underwriting, securitisation, loss- taking and the housing GSEs – critical to assuring longer-term financial and economic stability. US: Mortgage Delinquencies Stabilising but Foreclosure Pipeline Still Rising 0% 2% 4% 6% 8% 10% 12% 14% 16% Jan-06 Aug-06 Mar-07 Oct-07 May-08 Dec-08 Jul-09 Feb-10 Sep-10 % of All Loans Non-Current Delinquent Foreclosure Source: Morgan Stanley Research 7
  • 8. M O R G A N S T A N L E Y R E S E A R C H Central Bank Watch November 24, 2010 The Global Monetary Analyst Canada: Tweaking the Rate Path Yilin Nie (1 212) 761 2886 Markets underpricing BoC rate hikes: Admittedly our call for a December hike was too soon, but we sense that markets are still underpricing the probability of a BoC hike next quarter. Currently, there is only a full hike priced in by mid- 2011. We believe that there is a rising risk for the BoC to tighten in 1Q11, especially given the growth upswing the US is seeing in 4Q10. Our forecasts now show one hike per quarter in 2011, followed by a faster pace of tightening in 2012 as the Fed moves closer to an exit strategy. Canadian growth still ahead in the G10 pack: The recovery in Canada is continuing at a healthy pace, and we are on track for our forecast of 3.3% GDP growth in 2010. Domestic demand continues to be the engine of growth, a trend we expect to continue into next year. Net exports is still somewhat of a drag, but given our expectation for the global recovery to continue, demand for Canadian exports should remain underpinned. The ongoing upswing in US growth also bodes well for Canada, in our view. Inflation well behaved for now: Price pressures have moderated in recent months, with core CPI still below the BoC target. This gives the BoC full policy flexibility going forward, although we do not believe that it will stay on pause for too long, given that real rates are still negative in Canada. We estimate neutral rates to be around 3.5-3.75% in Canada, which is a long way from current levels. Risks to our call: There are plenty of global uncertainties in the current environment, with sovereign concerns re-emerging in Europe and more tightening measures in EM economies. If these pressures intensify, especially on the European side, it would augment downside risks for the BoC. That said, Canada is most vulnerable to US-centric problems, which seem to be on the backburner for now. South Africa: SARB Goes Eazy Once More Michael Kafe, CFA (27 11) 587 0806 Andrea Masia (27 11) 587 0807 SARB cuts repo rate 50bp on improved inflation prospects: The MPC reduced the country’s policy repo rate by a further 50bp to 5.5% on November 18. This decision was largely supported by an improved outlook for domestic inflation, as well as concerns about the anaemic pace of the global – and as a corollary, domestic – recovery. The decision was also in line with our qualitative analysis, and the decisive signal generated by our proprietary SARB EazyMeter for this meeting (90% probability of a rate cut). The MPC now expects CPI inflation to average 4.3% in 2011, before rising marginally to 4.8% over 2012. These latest forecasts are lower than the previous indication of 4.8% and some 5.1%, respectively. While the SARB’s 2011 forecast is exactly in line with ours, its 2012 profile is much lower than our forecast of 5.5%. According to the MPC statement, the improved forecasts were based on the combination of downward revisions to administered price expectations, a stronger exchange rate than previously expected, and recent lower-than-expected inflation outcomes which have contributed to a lowering of the starting point of the inflation forecast. We believe that policy rates have bottomed: Looking forward, we believe that this should be the last rate cut in the cycle, for two key reasons. The first is we believe that CPI has bottomed, and should start grinding higher from here: Our forecasts of 3.3%Y for October and 3.5%Y for November compare with the most recent outcome of 3.2%Y. A turnaround in the inflation trajectory should raise the psychological bar for further policy easing, we think. Further, the SARB’s relatively benign CPI outlook for 2012 reduces the scope for further downside revisions going forward, in our view. It is also clear that the decision to cut rates was driven in part by the recent weakness in manufacturing production. The MPC concedes that industrial action was largely to blame for the sharp fall in output. Nevertheless, it decided not to look through the noise. Looking forward, we expect a technical bounce in the October manufacturing production (i.e., once the impact of the strike falls out of the wash). This should help to lift both the October and November annual readings above the 1.4%Y that was printed in September, thereby obviating the need for a further rate cut. Risks to our call are a greater-than-expected appreciation of the currency and a spreading of the problems in peripheral Europe. 8
  • 9. M O R G A N S T A N L E Y R E S E A R C H Central Bank Watch November 24, 2010 The Global Monetary Analyst South Africa: CPI Passes Inflection Point in October Michael Kafe, CFA (27 11) 587 0806 Andrea Masia (27 11) 587 0807 Coming in at 3.4%Y, targeted inflation surprised consensus forecasts to the upside for the first time since July 2009 today: Consensus expectations of 3.3%Y for the October reading were in line with our own estimate. The upside surprise relative to our forecast was concentrated almost entirely in the transportation component, where vehicle prices and public transport tariffs rose at a brisk pace. Looking ahead, we maintain our view that CPI has now passed its cyclical low, and should track broadly sideways over the upcoming quarter or two, before base effects and possible currency weakness drive the annual readings higher in 2H11. Food inflation – the devil’s in the detail: While we welcome the favourable 0.1%M food print this month, compared to our 0.2%M forecast, we’re a little less sanguine about its sustainability. Looking into the food basket, the rally in grain and cereal futures has certainly begun to reflect in the CPI, with bread inflation turning positive (0.5%Y) for the first time since August 2009. Meat products, which rely on grains and cereals as inputs, have continued their upward trend to 1.8%Y – their highest rate since December 2009. At some point, the deflationary impact that vegetables and dairy products are providing will lose momentum, in our view, and with cereals and meat at more than twice the weight of vegetables and dairy, it’s a matter of time before food inflation begins to bite. Inflation outlook: We maintain our view that CPI has bottomed and should rise above the mid-point of the 3-6% target band in 3Q11. Our profile is predicated on a steady closure of the output gap, rising food prices and a weaker ZAR from 2H11 onwards, resulting in annual readings of 4.3% in 2011 and 5.5% in 2012. Monetary policy take-away: Although the SARB’s 2011 CPI forecast is in line with ours, its 2012 forecast of 4.8%Y is much lower than our 5.5% estimate, and may leave very little room (if any) for further downward revisions in the months ahead. More importantly, today’s upside surprise serves as a useful reminder that inflation will not decelerate ad infinitum. In fact, we believe that at some point in 1H11, the SARB’s 2012 inflation estimates may have to be adjusted higher. This, together with a GDP trajectory that is set to trend higher, suggests that we may have already reached the floor in policy rates. The future policy trajectory is contingent on further significant ZAR appreciation and a stabilisation in global macro dynamics. Our baseline view is that policy rates have already bottomed. Asia-Pacific: How Serious Are Inflation Risks in Asia ex-Japan? Chetan Ahya (65) 6834 6738 Sumeet Kariwala (91 22) 2209 7929 Upside risks to headline inflation materialising, thanks to higher food inflation: Headline inflation in the region ex India accelerated to 3.5%Y in September from 2.9% in June and 1.8% in January. Currently, a large part of the rise in headline inflation in the region is being driven by higher food prices. Going forward, we expect a pick-up in core inflation, lifting the pace of rate hikes in 1H11: We believe that capacity slack is definitely likely to be lower in 2011 than in 2010. Moreover, higher global commodity prices, even though they are driven by stronger growth in EM, should begin to increase core inflation pressures. More capital controls likely: If policy-makers face a challenge in lifting rates in the environment of QE2, they may aim to exercise greater control on monetary policy by accompanying tightening with capital controls. Disruptive rate hikes unlikely: Considering that domestic demand is the key source of growth, we believe that policy- makers will be careful not to initiate a disruptive rate hike policy unless developed world growth continues to surprise on the upside. For details, see Asia Pacific Economics: How Serious Are Inflation Risks in Asia ex-Japan? November 22, 2010. Asia-Pacific: Trend in AXJ ex India Inflation -2% 2% 6% 10% 14% 18% Aug-00 Aug-02 Aug-04 Aug-06 Aug-08 Aug-10 AxJ ex India Headline Inflation AxJ ex India Core Inflation AxJ ex India Food Inflation Avg Core Inflation 2004-07 %Y Source: CEIC, Morgan Stanley Research 9
  • 10. M O R G A N S T A N L E Y R E S E A R C H Central Bank Watch November 24, 2010 The Global Monetary Analyst China: 2011: A Year of Reflation Qing Wang (852) 2848 5220 Steven Zhang (86 21) 2326 0029 Ernest Ho (852) 2239 7818 The Chinese economy in 2010 has featured a Goldilocks scenario, as a mix of a normalised policy environment and a tepid G3 recovery has helped to deliver relatively strong growth and modest inflation so far this year. However, the recent flaring in inflation suggests that the Goldilocks scenario is close to running its course. It will be a year of reflation for the Chinese economy in 2011, as the post-crisis economic normalisation and rebalancing carry on. Specifically, the lagged effect of massive monetary expansion in 2009-10 is expected to continue to provide strong tailwinds for inflation in the near term, while the headwinds stemming from weak external demand are letting up. Beyond the near term, China’s economic rebalancing, which features a shift in growth drivers from tradable to non-tradable sectors, also points to a higher future secular inflation rate. We forecast 9.0% GDP growth and 4.5% CPI inflation for 2011, with consumption and investment envisaged to be equally important in terms of contribution to growth. We expect CPI inflation to rise in 1H11 and peak at 5.5%Y by mid-year, and then start to decelerate to the tune of 4.0%Y by year-end. Tackling inflation will be an overarching policy priority, especially in 1H11: The M2 growth target and quota for new bank lending for 2011 will likely be set at 15% and Rmb7 trillion, respectively. And the monetary tightening will be front- loaded. We expect three 25bp interest rate hikes through mid- year and maintain the target for the USD/CNY rate at 6.20 by end-2011. The primary risk to this outlook stems from potential policy missteps: If the Chinese authorities were to mainly rely on administrative controls over monetary aggregates instead of allowing price-based policy instruments such as rate hikes and appreciation of the renminbi to control inflation, the risk of a policy-induced boom (in 2010) and bust (2011) cycle would be on the rise. A continued tepid recovery in G3 economies would make it easier to manage inflation pressures and reduces the policy risk. For details, see China Economics: 2011: A Year of Reflation, November 21, 2010. China: PBoC OMOs Monitor Steven Zhang (86 21) 2326 0029 Qing Wang (852) 2848 5220 Latest developments: After four consecutive weeks of liquidity withdrawal totaling Rmb154 billion, Rmb74 billion of net injection resurfaced last week. The PBoC has continued to act aggressively through open market operations to keep money growth under control. However, it has been accumulating losses through the above operations, given the noticeable gap between cost (reference yields of PBoC bills) and revenue (the yield of foreign reserves). In this context, any further hikes in the reference yields of PBoC bills would escalate the sterilisation cost to an even higher level. On the contrary, the cost of an RRR hike is much lower than that of bill issuance or repo sales. Hence, the operations last week suggest that the PBoC may gradually use RRR to swap high-cost bill issuance (and repo sales) for near-term liquidity management. Except for cost consideration, open market operations are more flexible (easy to reverse) than RRR hikes, given their regular and highly frequent operation. However, in light of the heightened headline inflation and resurgent ‘hot money’ inflow stemming from the aggressive US-led QE, the task of liquidity management may gradually turn into a one-way operation (withdrawal) in the longer term. In this context, the RRR should be superior to bill issuance to lock in a large amount of liquidity for the longer term without redemption pressure. Injection in both bills issuance and repo sales: PBoC bill issuance softened to Rmb26 billion last week, from Rmb57 billion the week before. Given the marginal rise in redemption pressure, Rmb4 billion of net liquidity was withdrawn through bill issuance last week. In the meantime, the PBoC suspended the sales of 90d repo last week, which led to Rmb70 billion of net liquidity injection on the same amount of redemption. The reference yields of 3m, 1y and 3y PBoC bills remain stable at 1.81%, 2.34% and 3% last week after rising from 1.77%, 2.09% and 2.85% in the week before. Short-end SHIBOR jumped: Short-end SHIBOR (below 1m) jumped last week on a liquidity shortage stemming from mega refinancing of ICBC within the week and multiple RRR hikes in the previous week. The long-end rate continued to trend up mildly (6bp for 1m and average 1.5bp for 1m and above). What’s next: Since the recent continued RRR hikes suggest that the PBoC may lean towards RRR hikes for strengthening liquidity management, the liquidity withdrawals from open market operations should be rather modest in the coming weeks, in our view. In addition, the continued RRR hikes also reduce the risk of an imminent hike in the benchmark interest rate in the near term. 10
  • 11. M O R G A N S T A N L E Y R E S E A R C H Central Bank Watch November 24, 2010 The Global Monetary Analyst India: Tightening Inter-Bank Liquidity – CRR Cut A Possibility Chetan Ahya (65) 6834 6738 Tanvee Gupta Jain (91 22) 2209 7927 The net liquidity in the banking system (repo less reverse repo balance) moved to a deficit of US$33 billion as of yesterday compared to the average deficit of US$22 billion month-to- date (MTD) and about US$14 billion deficit in October. Indeed, the inter-bank liquidity balance has been in deficit territory since the second week of September. Note, in the repo operation, banks access funds from the Reserve Bank of India (RBI) and park their holdings of government securities as collateral, and vice versa for the reverse repo process. RBI responded earlier to ease liquidity pressure – but it’s not enough: On November 9, the RBI reintroduced temporary liquidity measures. Banks are allowed to borrow up to 1% of their deposits (net time and demand liabilities, NDTL) as additional liquidity from the central bank on a temporary basis up to December 16. This represents an additional liquidity window of US$11.4 billion for banks. In addition, the RBI announced that it would conduct a special second LAF (SLAF) on a daily basis up to December 16. Why is liquidity tightening? Liquidity conditions are tightening because bank credit growth is at 22%Y and deposit growth is at 15%Y as of the week ended November 5. This has resulted in the credit-deposit ratio moving up to 73%. Note that with the cash reserve ratio requirement of 6% of deposits and statutory liquidity ratio of 24% of deposits (temporary effective rate), there is not much room in the banking system. Over the past few days, outflows on account of IPO issuance, a rise in the government’s surplus with the RBI and high currency in circulation have all resulted in a further tightening of inter-bank liquidity. The centre’s surplus with the RBI has increased to US$18 billion for the week ending November 12 compared to US$14 billion in the previous week as revenue collections outpace expenditure. Bottom line: Inter-bank liquidity continues to be tight. In fact, the net repo balance remains in deficit of more than 1% of NDTL (above US$11.4 billion). We think that the RBI will want to wait and watch the liquidity situation until December 16 (the next monetary policy review). If the liquidity situation does not improve meaningfully before then, there is a good chance that the RBI will cut the cash reserve ratio (CRR). However, we believe this is not a done deal as headline WPI inflation will still be high at about 7-7.5%Y (our estimate) in November, and the RBI might be mindful of potential negative implications of a reduction in CRR on anchoring inflationary expectations. Hong Kong: Inflation Creeps Up, but Less than Expected Denise Yam, CFA (852) 2848 5301 Ernest Ho (852) 2239 7818 Underlying inflation crept up to 2.3%Y in October: As expected, underlying inflation headed up further in October, to 2.3%Y (+2.2% in September), but the rise was less than our forecast. Headline inflation actually remained unchanged at 2.6%Y, lower than our forecast of 3%, with the upward bias from the phasing out of the electricity bill subsidy diminishing, narrowing the difference between the headline and underlying inflation rates. Inflation lifted by private housing rents, food and transport: The pick-up in underlying inflation in October is attributable to three main components: 1) private housing costs (+1.6%Y in October versus +1.4% in September); 2) food (for home consumption) (+5.7% versus +5.2%); and 3) transport (+2.7% versus +2.1%, led by motor fuel +10.5% versus +2.3%). Downside risk to 2010 inflation forecast… Contrary to the widely felt concern about rising inflation, Hong Kong has been seeing slower gains in prices than in the rest of the region. Hong Kong’s mature consumption structure is heavily weighted in services (75%) as opposed to food (only 10%) and goods (15%), so higher import costs (of food and consumer goods) do not bring as significant and ready an impact on the CPI as many may think. The mild CPI figures in the last few months actually pose downside risk to our current 2010 headline inflation forecast (2.8%); it appears that full- year inflation will likely come in below 2.5%. …but inflation to head further up in 2011: Aside from imported inflation, Hong Kong sees increasing price pressures stemming from the buoyant property market and wage increases ahead, although these generally enter the CPI gradually with a time lag. We have recently lifted our 2011 CPI inflation forecast to 3.8% (from 3%), with half of that derived from housing costs. 11
  • 12. M O R G A N S T A N L E Y R E S E A R C H 12 Central Bank Watch November 24, 2010 The Global Monetary Analyst Taiwan: Domestic Resilience Continues Mexico: We Expect No Change in Policy RateSharon Lam (852) 2848 8927 Jason Liu (852) 2848 6882 Luis Arcentales (1 212) 761 4913 Upward trajectory of annual inflation but remains in central bank’s range: Mexico’s November 1H CPI is expected on November 24. Morgan Stanley forecasts 0.54% 1H/2H while consensus estimates 0.57% 1H/2H. Annual inflation should continue its upward trajectory through the end of the year; though part of this reflects a low comparison base, it has also been driven by some normalisation in food prices. Taiwan’s GDP expanded by 9.8%Y in 3Q, above our and consensus forecasts (Morgan Stanley: 7.9%Y; consensus: 8.3%Y). It was below the 12.9%Y growth in 2Q10 and 13.6%Y in 1Q10 due to a diminishing low base effect. In terms of sequential growth, GDP increased by 0.02%Q (i.e., 0.09% annualised), below the 0.48%Q rate in 2Q. Despite the slower sequential growth, the stronger-than-expected growth in 3Q was a pleasant surprise to us. Upside surprise was particularly evident in private consumption and capex investment. But even if upside surprises on the food front were to materialise in the near term, annual inflation is still likely to remain well within Banco de Mexico’s conservative forecast of 4.25-4.75% on average for 4Q, in our view. We expect further rate normalisation: We think that 3Q GDP data are further confirmation that Taiwan’s GDP is becoming more domestic-driven, with private consumption and capex the key drivers. While the external uncertainty may linger, we think that a stronger domestic sector could give Taiwan more resilience in the face of any likely slowdown of the major economies, like China, Europe and the US. Clearly, consumer and business confidence in Taiwan remain supported, with the improving economic outlook and closer cross-strait ties. The government is more likely to withdraw stimulus spending further going forward. On the monetary policy front, we think that Taiwan will continue to see rate normalisation in the next few quarters, as the liquidity environment in Taiwan remains abundant and inflation could become a downside risk for the economy with the strong domestic demand. An unchanged policy stance expected: Mexico’s monetary policy meeting is scheduled for November 26; we and consensus expect no change to the policy rate of 4.50%. Despite a growing debate among Mexico watchers about potential interest rate cuts, Banco de Mexico is likely to keep its policy stance unchanged in its final meeting of 2010. In its October 27 inflation report, the central bank opened the door to potential rate cuts down the road, in our view; however, we suspect that the authorities would have to see further tightening in monetary conditions – via an appreciation in the exchange rate – before they consider altering their stance (see “Mexico: Banco de Mexico’s Next Move”, This Week in Latin America, November 1, 2010). Mexico: Central Bank’s Inflation Forecast PathTaiwan: GDP Becoming More Domestic-Driven 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% 6.5% 2Q06 4Q06 2Q07 4Q07 2Q08 4Q08 2Q09 4Q09 2Q10 4Q10 2Q11 4Q11 Actual Inflation Forecast Range (Jul 28) Forecast Range (Oct 27*) -15 -10 -5 0 5 10 15 1Q 05 4Q 05 3Q 06 2Q 07 1Q 08 4Q 08 3Q 09 2Q 10 RealGDPGrowth, ppts Private Consumption Public Consumption Private Investment Public Investment Change in Stocks Net Exports Real GDP Growth GDP Growth Contribution in Taiwan *Starting 3Q11, Banxico expects that inflation will converge to levels consistent with the 3% central target, which has a +/-1% tolerance band. Source: Banxico Source: Taiwan Statistics Office, CEIC, Morgan Stanley Research
  • 13. M O R G A N S T A N L E Y R E S E A R C H November 24, 2010 The Global Monetary Analyst Monetary Policy Outlook – Morgan Stanley versus Markets 0 1 2 3 4 5 6 Jan- 06 Jul- 06 Jan- 07 Jul- 07 Jan- 08 Jul- 08 Jan- 09 Jul- 09 Jan- 10 Jul- 10 Jan- 11 MS Forecast Mkt Implied Actual United States  The FOMC does not expect to achieve its dual mandate for five or six years, pointing to many years of easy policy.  We see no Fed exit before 2012. More QE beyond June more likely than an early stop. 0.5 1.5 2.5 3.5 4.5 Jan- 06 Jul- 06 Jan- 07 Jul- 07 Jan- 08 Jul- 08 Jan- 09 Jul- 09 Jan- 10 Jul- 10 Jan- 11 MS Forecast Mkt Implied Actual Euro Area  Markets are starting to price in first hikes for late 2011 – too early, in our view.  In December, the ECB will likely map out the next steps of its non-conventional exit. -0.25 0 0.25 0.5 0.75 Jan- 06 Jul- 06 Jan- 07 Jul- 07 Jan- 08 Jul- 08 Jan- 09 Jul- 09 Jan- 10 Jul- 10 Jan- 11 MS Forecast Mkt Implied Actual Japan  The size of the new fund which the bank has stated its intention to establish is likely to be a kind of new policy target.  If deflation worsens and the yen continues to appreciate, the BoJ is likely to come under renewed pressure to increase the size of asset purchases, including equities and J-REITs. 0 1 2 3 4 5 6 7 Jan- 06 Jul- 06 Jan- 07 Jul- 07 Jan- 08 Jul- 08 Jan- 09 Jul- 09 Jan- 10 Jul- 10 Jan- 11 MS Forecast Mkt Implied Actual United Kingdom  We think that the MPC will start raising rates in mid-2011. Markets are pricing in a later start.  Triggers for an earlier change (more QE or rate rise): GDP contraction or sharply rising inflation expectations/wages. Source: National Central Banks, Morgan Stanley Research Notes: (u) = unofficial target; Interest rate expectations are implied by overnight indexed swap (OIS) curves and may differ from those implied by other instruments; where adequate OIS data are not available, FRAs, foreign exchange swaps, and/or interbank cash rate futures are used; due to varying risk premia (such as liquidity, basis, credit, term, reserve management, calendar turns, etc.), these figures should be used as estimates only; where such instruments are not available, we have inserted our best guess of what markets expect based on consensus estimates. 13
  • 14. M O R G A N S T A N L E Y R E S E A R C H November 24, 2010 The Global Monetary Analyst Monetary Policy Outlook – Morgan Stanley versus Markets 0 1 2 3 4 5 Jan- 06 Jul- 06 Jan- 07 Jul- 07 Jan- 08 Jul- 08 Jan- 09 Jul- 09 Jan- 10 Jul- 10 Jan- 11 MS Forecast Mkt Implied Actual Canada 0 0.5 1 1.5 2 2.5 3 3.5 Jan- 06 Jul- 06 Jan- 07 Jul- 07 Jan- 08 Jul- 08 Jan- 09 Jul- 09 Jan- 10 Jul- 10 Jan- 11 MS Forecast Mkt Implied Actual Switzerland  The BoC should continue to remove stimulus, albeit at a more gradual pace, given remaining global uncertainties.  SNB starting to prepare stimulus withdrawal – we expect a first rate hike in 1Q11.  The risks lie to both sides. On the upside, the BoC may speed up its tightening if there is further indication that domestic price pressures are heating up. On the downside, the BoC may slow hikes if the US economic recovery slows. 0 1 2 3 4 5 Jan- 06 Jul- 06 Jan- 07 Jul- 07 Jan- 08 Jul- 08 Jan- 09 Jul- 09 Jan- 10 Jul- 10 Jan- 11 MS Forecast Mkt Implied Actual Sweden  Market seems to price in way too much hiking for the December meeting at the moment.  New repo rate forecast by Riksbank could suggest small downside risks to 2011 estimates. 0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 Jan- 06 Jul- 06 Jan- 07 Jul- 07 Jan- 08 Jul- 08 Jan- 09 Jul- 09 Jan- 10 Jul- 10 Jan- 11 Actual MS Forecast Mkt Implied Norway  We have taken out the December hike and now expect Norges Bank to remain on hold until 2Q11.  This is broadly in line with market expectations. Source: National Central Banks, Morgan Stanley Research Notes: (u) = unofficial target; Interest rate expectations are implied by overnight indexed swap (OIS) curves and may differ from those implied by other instruments; where adequate OIS data are not available, FRAs, foreign exchange swaps, and/or interbank cash rate futures are used; due to varying risk premia (such as liquidity, basis, credit, term, reserve management, calendar turns, etc.), these figures should be used as estimates only; where such instruments are not available, we have inserted our best guess of what markets expect based on consensus estimates. 14
  • 15. M O R G A N S T A N L E Y R E S E A R C H November 24, 2010 The Global Monetary Analyst Monetary Policy Outlook – Morgan Stanley versus Markets 2 3 4 5 6 7 8 Jan- 06 Jul- 06 Jan- 07 Jul- 07 Jan- 08 Jul- 08 Jan- 09 Jul- 09 Jan- 10 Jul- 10 Jan- 11 MS Forecast Mkt Implied Actual Australia 1 3 5 7 9 Jan- 06 Jul- 06 Jan- 07 Jul- 07 Jan- 08 Jul- 08 Jan- 09 Jul- 09 Jan- 10 Jul- 10 Jan- 11 MS Forecast Mkt Implied Actual New Zealand  RBA unexpectedly tightened in November, with mortgage rates likely to rise even further.  We’re expecting no more hikes in 2010 due to elevated global risks and a weaker-than-expected recovery profile for NZ. Rate hikes likely to start in 2Q11 as the RBNZ seeks to normalise rates.  With two rate hikes for the price of one, we think that the RBA will now stay on hold until next year.  Markets are also reflecting similar expectations. Source: National Central Banks, Morgan Stanley Research Notes: (u) = unofficial target; Interest rate expectations are implied by overnight indexed swap (OIS) curves and may differ from those implied by other instruments; where adequate OIS data are not available, FRAs, foreign exchange swaps, and/or interbank cash rate futures are used; due to varying risk premia (such as liquidity, basis, credit, term, reserve management, calendar turns, etc.), these figures should be used as estimates only; where such instruments are not available, we have inserted our best guess of what markets expect based on consensus estimates.. 15
  • 16. M O R G A N S T A N L E Y R E S E A R C H 16 November 24, 2010 The Global Monetary Analyst Global Monetary Policy Rate Forecasts Global Economics Team Current 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 Last change (bp) Since peak/ trough (bp) Since Dec 06 (bp) United States 0.125 0.125 0.125 0.125 0.125 0.13 0.50 1.25 2.00 2.50 -87.5 (16/12/08) -512.5 -512.5 Euro Area 1.00 1.00 1.00 1.00 1.00 1.00 1.25 1.50 1.75 2.00 -25 (07/05/09) -325 -200 Japan 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05 -5 (05/10/10) -45 -45 United Kingdom 0.50 0.50 0.50 0.75 1.25 1.50 2.00 2.25 2.50 2.50 -50 (5/3/09) -525 -450 Canada 1.00 1.00 1.25 1.50 1.75 2.00 2.25 2.75 3.25 3.50 +25 (8/09/10) +75 -325 Switzerland 0.25 0.25 0.50 1.00 1.25 1.50 1.50 1.50 1.50 1.50 -50 (11/12/08) -250 -175 Sweden 1.00 1.00 1.25 1.75 2.00 2.25 2.50 2.75 3.00 3.25 +25 (26/10/10) 75 -200 Norway 2.00 2.00 2.00 2.25 2.25 2.50 2.75 3.00 3.25 3.50 +25 (05/05/10) 75 -75 Australia 4.75 4.75 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 +25 (2/11/10) 175 -150 New Zealand 3.00 3.00 3.00 3.25 3.50 3.75 4.00 4.25 4.50 4.50 +25 (29/07/10) -525 -425 Russia 7.75 7.75 8.00 8.25 8.50 8.50 8.50 8.50 8.50 8.50 -25 (31/05/10) -525 -325 Poland 3.50 3.50 4.00 4.25 4.50 4.50 4.75 4.75 5.00 5.00 -25 (24/06/09) -250 -50 Czech Republic 0.75 0.75 0.75 1.00 1.25 1.50 1.75 2.00 2.00 2.00 -25 (06/05/10) -300 -175 Hungary 5.25 5.25 5.50 5.75 6.00 6.25 6.50 6.75 7.00 7.00 -25 (26/04/10) -625 -275 Romania 6.25 6.25 6.25 6.25 6.50 6.75 6.75 7.00 7.00 7.25 -25 (05/05/10) -400 -250 Turkey 7.00 7.00 7.00 7.00 7.00 8.50 8.75 9.00 9.25 9.50 -25 (19/11/09) -1,100 -1,100 Israel 2.00 2.00 2.25 2.50 3.00 3.50 3.50 3.50 3.50 3.50 +25 (27/09/10) 150 -250 UAE 1.00 1.00 1.00 1.00 1.00 1.25 1.50 1.75 2.00 2.25 -50 (28/01/09) -425 -425 South Africa 5.50 5.50 5.50 5.50 6.00 6.50 6.50 6.50 6.50 6.50 -50 (18/11/10) -650 -350 China 5.56 5.56 5.56 5.81 6.06 6.31 6.31 6.31 6.31 6.31 +25 (19/10/10) -191 -56 India 6.00 6.25 6.50 6.75 7.00 7.25 7.25 7.50 7.50 7.50 +25 (02/11/10) -275 -100 Hong Kong 0.50 0.50 0.50 0.50 0.50 1.00 1.50 2.00 2.50 3.00 -100 (17/12/08) -625 -625 S. Korea 2.50 2.50 2.50 3.00 3.25 3.50 3.75 3.75 3.75 3.75 +25 (16/11/10) -275 -200 Taiwan 1.50 1.63 1.75 1.88 2.00 2.13 2.25 2.38 2.38 2.38 +12.5 (30/09/10) -213 -125 Indonesia 6.50 6.50 7.00 7.50 7.50 7.50 7.00 7.00 7.00 7.00 -25 (03/08/09) -300 -325 Malaysia 2.75 2.75 2.75 2.75 2.75 2.75 2.75 2.75 2.75 2.75 +25 (08/07/10) 75 -75 Thailand 1.75 1.75 2.00 2.50 2.75 2.75 2.75 2.75 2.75 2.75 +25 (25/08/10) 50 -325 Brazil 10.75 10.75 10.75 11.75 12.50 12.50 12.50 12.50 12.50 12.50 +50 (21/07/10) 200 -300 Mexico 4.50 4.50 4.50 4.50 4.50 4.50 4.75 5.50 6.00 6.00 -25 (17/07/09) -375 -250 Chile 3.00 3.25 4.00 4.75 5.50 5.50 5.50 5.50 5.50 5.50 +25 (14/10/10) 250 -225 Peru 3.00 3.00 3.00 3.50 3.75 4.00 4.00 4.00 4.00 4.00 +50 (09/09/10) 175 -350 Colombia 3.00 3.00 3.00 3.00 4.50 6.00 6.00 6.00 6.00 4.50 -50 (30/04/10) -700 -600 Global Policy Rate 2.3 2.3 2.3 2.5 2.6 2.7 2.9 3.1 3.4 3.5 std. deviation 2.7 2.7 2.7 2.8 2.9 2.9 2.9 2.8 2.8 2.7 # countries above 18 17 17 19 19 19 17 17 17 16 # countries below 14 15 15 13 13 13 15 15 15 16 G10 Policy Rate 0.6 0.6 0.6 0.6 0.7 0.7 1.0 1.4 1.9 2.2 std. deviation 1.5 1.5 1.5 1.5 1.5 1.5 1.4 1.4 1.4 1.4 # countries above 5 5 5 7 7 7 7 7 6 6 # countries below 4 4 4 2 2 2 2 2 3 3 Source: National Central Banks, Morgan Stanley Research Note: Global policy rates are GDP weighted averages of national policy rates. Japan policy rate is an interval of 0.00-0.10%.
  • 17. M O R G A N S T A N L E Y R E S E A R C H November 24, 2010 The Global Monetary Analyst Global GDP and Inflation Forecasts GDP CPI 2010E 2011E 20122009A 2009A 2010E 2011E 2012 GLOBAL -0.8 4.7 4.2 4.4 2.0 3.3 3.2 3.2 G10 -3.4 2.6 2.1 2.4 0.0 1.5 1.8 1.8 United States -2.6 2.8 2.9 3.2 -0.3 1.7 2.1 2.2 Euro Area -4.0 1.7 1.4 1.7 0.3 1.7 1.8 1.9 Germany -4.9 3.4 1.7 2.0 0.3 1.1 1.4 1.7 France -2.5 1.6 1.8 2.0 0.1 1.6 1.8 1.8 Italy -5.1 1.2 1.4 1.6 0.8 1.5 1.7 1.8 Spain -3.7 -0.3 1.0 1.5 -0.3 1.7 1.8 1.7 Japan -5.2 3.7 1.0 1.7 -1.3 -1.0 -0.3 -0.2 United Kingdom -5.0 1.8 1.6 2.0 2.2 3.2 2.8 2.1 Canada -2.5 3.3 2.9 2.3 0.3 1.5 1.7 1.8 Sweden -5.3 4.6 3.4 3.2 -0.3 1.2 1.9 2.5 Australia 1.3 3.3 2.7 2.6 1.8 2.8 2.4 2.5 Emerging Markets 2.3 7.4 6.5 6.5 4.3 5.4 4.8 4.6 CEEMEA -4.8 3.7 3.7 3.8 7.7 5.7 6.0 5.9 Russia -7.9 4.2 4.3 4.0 11.7 6.7 8.5 8.5 Poland 1.7 3.3 4.4 3.8 3.5 2.6 3.0 2.4 Czech Republic -4.1 1.9 2.4 3.4 1.0 1.4 2.1 2.5 Hungary -6.3 1.2 2.8 2.7 4.2 4.8 3.2 3.5 Romania -7.1 -2.9 -1.7 1.6 5.6 5.8 5.3 4.7 Ukraine -15.1 4.8 4.0 4.5 16.0 10.0 10.0 9.0 Turkey -4.7 7.0 4.2 4.0 6.3 8.7 6.3 5.8 Israel 0.7 4.0 3.8 3.5 3.3 2.7 2.9 2.5 UAE -3.5 0.8 2.3 3.3 0.5 -0.7 0.7 1.8 Saudi Arabia 0.1 3.0 3.7 4.3 5.1 5.5 5.1 4.3 South Africa -1.8 3.0 3.5 3.5 7.2 4.3 4.3 5.5 Asia ex Japan 6.2 9.0 8.2 8.0 2.4 4.9 3.9 3.6 China 9.1 10.2 9.0 9.0 -0.7 3.1 4.5 3.0 India 6.7 8.5 8.7 9.0 10.8 12.0 6.5 5.6 Hong Kong -2.8 6.8 5.0 4.0 0.5 2.8 3.8 3.0 Korea 0.2 6.0 4.5 4.0 2.8 2.8 3.2 2.9 Taiwan -1.9 7.0 3.8 4.2 -0.9 1.4 1.5 1.7 Singapore -1.3 16.0 6.0 6.5 0.6 2.6 2.8 2.7 Indonesia 4.6 6.0 6.5 6.5 4.8 5.1 6.0 5.5 Malaysia -1.7 7.2 5.0 5.5 0.6 1.7 2.3 2.2 Thailand -2.3 8.0 4.8 5.3 -0.9 3.2 3.5 3.5 Latin America -2.0 6.3 4.1 4.4 6.3 6.6 6.9 6.7 Brazil -0.2 7.9 4.0 5.0 4.9 4.9 5.1 5.2 Mexico -6.5 5.2 3.9 4.1 5.3 4.3 3.8 3.6 Chile -1.5 5.0 5.6 4.8 1.5 1.5 3.1 3.0 Peru 0.9 7.9 5.5 5.9 2.9 1.8 3.1 2.4 Colombia 0.4 5.0 5.1 4.1 4.2 2.4 4.3 3.9 Argentina 0.9 9.7 5.9 4.0 7.7 10.5 10.7 11.3 Venezuela -3.3 -3.4 -0.7 1.6 25.1 33.0 35.5 33.0 Source: Company data, Morgan Stanley Research Note: Figures in parenthesis indicate the country’s or region’s weight (in %) in global GDP, using PPPs. 17
  • 18. M O R G A N S T A N L E Y R E S E A R C H 18 November 24, 2010 The Global Monetary Analyst Global Economics Team Richard Berner & Joachim Fels, Co-heads of Global Economics Global Fixed Income Economics Joachim Fels Global Joachim.Fels@morganstanley.com +44 (0)20 7425 6138 Alan Taylor Global/Senior Advisor Alan.Taylor@morganstanley.com +1 212 761 5478 Arnaud Marès Global Arnaud.Mares@morganstanley.com +44 (0)20 7677 6302 Manoj Pradhan Global Manoj.Pradhan@morganstanley.com +44 (0)20 7425 3805 Spyros Andreopoulos Global Spyros.Andreopoulos@morganstanley.com +44 (0)20 7677 0528 Americas Richard Berner US Richard.Berner@morganstanley.com +1 212 761 3398 David Greenlaw US David.Greenlaw@morganstanley.com +1 212 761 7157 Ted Wieseman US Ted.Wieseman@morganstanley.com +1 212 761 3407 David Cho US David.Cho@morganstanley.com +1 212 761 0908 Gray Newman Latam, Brazil Gray.Newman@morganstanley.com +1 212 761 6510 Luis Arcentales Chile, Mexico Luis.Arcentales@morganstanley.com +1 212 761 4913 Daniel Volberg Argentina Daniel.Volberg@morganstanley.com +1 212 761 0124 Europe & South Africa Elga Bartsch Euro Area, ECB, Germany Elga.Bartsch@morganstanley.com +44 (0)20 7425 5434 Daniele Antonucci Italy, Spain Daniele.Antonucci@morganstanley.com +44 (0)20 7425 8943 Melanie Baker UK Melanie.Baker@morganstanley.com +44 (0)20 7425 8607 Cath Sleeman UK Cath.Sleeman@morganstanley.com +44 (0)20 7425 1820 Tevfik Aksoy Turkey, Israel, MENA Tevfik.Aksoy@morganstanley.com +44 (0)20 7677 6917 Mohamed Jaber MENA Mohamed.Jaber@morganstanley.com +44 (0)20 7677 8189 Pasquale Diana Poland, Hungary, Czech, Romania Pasquale.Diana@morganstanley.com +44 (0)20 7677 4183 Michael Kafe South Africa, Nigeria Michael.Kafe@morganstanley.com +27 11 587 0806 Andrea Masia South Africa Andrea.Masia@morganstanley.com +27 11 587 0807 Alina Slyusarchuk Russia, Kazakhstan, Ukraine, Baltics Alina.Slyusarchuk@morganstanley.com +44 (0)20 7677 6869 Asia Robert Feldman Japan Robert.Tokyo.Feldman@morganstanleymufg.com +81 3 5424 5385 Takehiro Sato Japan Takehiro.Sato@morganstanleymufg.com +81 3 5424 5367 Takeshi Yamaguchi Japan Takeshi.Yamaguchi@morganstanleymufg.com +81 3 5424 5387 Qing Wang Greater China Qing.Wang@morganstanley.com +852 2848 5220 Denise Yam China, Hong Kong Denise.Yam@morganstanley.com +852 2848 5301 Sharon Lam Korea, Taiwan Sharon.Lam@morganstanley.com +852 2848 8927 Steven Zhang China, Hong Kong Steven.Zhang@morganstanley.com +86 21 2326 0015 Ernest Ho China, Hong Kong Ernest.Ho@morganstanely.com +852 2239 7818 Jason Liu Korea, Taiwan Jason.JL.Liu@morganstanley.com +852 2848 6882 Chetan Ahya Asia ex-Japan, India Chetan.Ahya@morganstanley.com +65 6834 6738 Deyi Tan Singapore, Malaysia Deyi.Tan@morganstanley.com +65 6834 6703 Shweta Singh ASEAN Shweta.Singh@morganstanley.com +65 6834 6739 Tanvee Gupta Jain India Tanvee.Gupta@morganstanley.com +91 22 2209 7927 Morgan Stanley entities: London/South Africa – Morgan Stanley & Co. International plc; New York – Morgan Stanley & Co. Incorporated.; Hong Kong/Shanghai – Morgan Stanley Asia Limited.; Singapore – Morgan Stanley Asia (Singapore) Pte.; Japan – Morgan Stanley MUFG Securities Co., Ltd.; Dubai – Morgan Stanley & Co International plc (DIFC Branch); India – Morgan Stanley India Company Private Limited.
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