Yen Claws Back Some Ground; RBNZ Leaves Rates on Hold, RBI Hikes

Highlights

The yen led gains overnight, rebounding from yesterday’s intervention. Still, USD/JPY remained above JPY85, with the pair hitting a low of JPY85.23, before trading around the 50 mark. EUR/JPY dipped back below JPY111. PM Kan said Japan would take more ‘decisive action’ if needed. The New Zealand dollar dropped back after the Reserve Bank left rates unchanged at 3%, and Governor Bollard suggested future hikes would be slower and less than previously expected, particularly after the earthquake. The Reserve Bank of India hiked its benchmark repurchase rate by a quarter point to 6%, and the reverse repurchase rate by a half point to 5%. The Swiss franc edged higher ahead of the Swiss National Bank rate decision later on – they will likely leave rates on hold. UK retail sales will be watched closely following a spate of softer data. EM currencies were making a little headway vs the greenback, led by MYR, IDR and INR. China’s yuan was at yet another record high for the fifth day, set at 6.7330, as US Treasury Secretary Geithner suggested the pace of appreciation was too slow.

Asian stocks slipped back with the MSCI Asia Pacific index down 0.6%. was actually little changed. Chinese banks hurt stocks on the mainland and in Hong Kong amid speculation about tighter capital adequacy rules from regulators. The Shanghai composite plunged 2.4%. Japan’s Nikkei slipped just 0.1% but there were losses of more than 0.5% in Hong Kong, Taiwan, Korea, and Australia. Futures on both the European and US markets are trading lower.

Japanese bonds were steady after a group of DPJ lawmakers called for an increase in bond purchases to help stimulate the economy. 10-year JGB yields added just 1 basis point to 1.035%. European bonds opened a little lower, with Germany’s 10-year bund yield up 2bps to 2.42%, while France’s 10-year yield was up 2bps to 2.76%. Periphery spreads narrowed a little. US Treasuries edged higher, with the 10-year yield down 2 bps to 2.7%, and the 30-year down 2bps to 3.86%.

Currency Markets

The New Zealand dollar led declines among the major currencies after the Reserve Bank left rates on hold and suggested, perhaps more strongly than expected, that further rate hikes will be slower in coming after the earthquake. Governor Alan Bollard said the quake ‘significantly disrupted economic activity and is likely to continue to do so for some time yet.’ The central bank has estimated that the earthquake will cut GDP by 0.3% this quarter. Bollard added that the pace and extent of future rate hikes would likely be ‘more moderate than projected’ three months ago – and perhaps a real pointer to future activity came as the bank cut its prediction for the rise in three-month bill rates to 1.5% by March 2013, down from a rise of 2.8% in June, suggesting ‘several on-hold decisions.’

There has been no further intervention from the Bank of Japan overnight. The yen pared some of yesterday’s losses, though USD/JPY remained above JPY85, amid unsurprising speculation that exporters were taking advantage of the drop to repatriate foreign earnings. Prime Minister Kan asserted today that the authorities would ‘continue to take decisive action if needed.’ Nikkei reported overnight that the intervention also took place in London and New York yesterday, and put the amount involved at around JPY2 trillion ($23.3bln), a record for a single day. The Bank of Japan also refrained from conducting its usual same-day money market operation where it was expected to drain funds from the system – suggesting that yesterday’s intervention remains unsterilized.

India’s central bank hiked its benchmark repurchase rate by a quarter point to 6%, and the reverse repurchase rate by a half point to 5%, the latter more than expected. That was the fifth increase in the benchmark rate this year. The bank said in the accompanying statement that inflation remains their ‘dominant concern’ and that this increase should contain inflation expectations. Eleven of sixteen economists polled by Bloomberg had seen a hike, with the remaining 5 forecasting no change. Though price pressures have eased in recent months, inflation remains elevated – earlier this week data showed wholesale prices climbed 8.5% in August from a year earlier, while the pace of food price gains remains a threat to inflation expectations. Growth remains strong, with GDP rising 8.8% y/y in Q2 vs. 8.6% y/y in Q1. More currently, the government said today that exports climbed 22.5% from a year earlier in August, industrial production numbers earlier this week showed annual growth in output at 13.8% in July, while car sales are booming – Maruti Suzuki sold more cars in August than ever before.

We expect the Swiss National Bank to remain on hold later today at 0.25%. According to a research note published by UBS last week, they suggest that a closing output gap and thus inflationary pressures will force the SNB to raise rates this week. The output gap is a measure of the economy’s strength, which can crudely be inferred by taking the long-term average versus the actual output. Therefore, if the actual output exceeds potential then demand pressures on prices may lead to inflation. Actual y/y GDP growth is nearly twice its 10 year average but that alone does not provide substantial evidence for a rate hike. Indeed, the recent strength of the CHF has acted as an inflation anchor, leading to a contraction in monetary policy. And despite the strength of domestic output, our Taylor Model which uses the output gap framework, in addition to the central banks inflation expectations, suggests current policy is sufficient. In other words inflation has been kept in line with the SNB’s mantra and the current balance between inflation and GDP does not warrant a rate hike, in our view. In addition, of the 19 analysts surveyed by Bloomberg UBS is the only bank that has penciled in a rate hike. Overall, with energy products and other import pricing contracting, expected CHF strength and the weak domestic pass through inflation numbers we agree with the markets call and expect the SNB to remain on hold.

Upcoming Economic Releases

Asia Pacific: Reserve Bank of India decision. Europe/EMEA: Swiss National Bank rate decision, UK retail sales, Eurozone trade balance, Swiss industrial production, Sweden house prices, Netherlands retail sales. Americas: US PPI, current account, TIC flows, initial jobless claims, Philly Fed. Events: BOE’s Governor King speaks, US Treasury’s Collyns in Brussels, Barr at US House Financial Services committee, and Lago at Senate Foreign Relations. BOC Deputy Governor Lane.