Firmer Inflation Lifts Sterling; Chinese Stocks Stumble

Firmer Inflation Lifts Sterling; Chinese Stocks Stumble

  • Firmer UK inflation has helped sterling recover from yesterday’s decline
  • The Australian and Canadian dollars are under pressure but the New Zealand dollar is faring better
  • The yuan’s stability today contrasts with the biggest drop in Chinese shares in three weeks
  • In Europe, the focus is on the German parliament vote on the Greek aid package tomorrow
  • We expect no change by the Turkish central bank today, but if there is a change they take the first step towards narrowing of the corridor

Price action: The dollar was mixed on the day. Sterling is the clear outperformer on the back of higher inflation data, rising above $1.57 for the first time since early July. The euro is trading at $1.1070. The dollar is outperforming against the Norwegian krone, rising back to NOK8.26, and little changed again the yen at ¥124.25. The central reference rate for the yuan was little changed at CNY6.3966. Other EM currencies were mixed with MYR and SGD gaining against the dollar, but INR, RUB and THB losing. The Shanghai Comp fell 6%, the largest decline since the 8.5% move in late July. The Nikkei was down 0.3% and most other EM indices were lower. Of note, Thai assets underperformed following a deadly explosion in Bangkok. The baht was down 0.3% but the SE Thai index fell 3% on the day.

  • Firmer UK inflation has helped sterling recover from yesterday’s decline. Cable broke above $1.57, making $1.58 as the next resistance level. Headline CPI fell 0.2% in July. The consensus was for a 0.3% decline. This saw the year-over-year rate rise to 0.1% from zero. It has moved between -0.1% and +0.1% since February. What also caught the market’s attention was the jump in the core rate to 1.2% from 0.8%. This is the highest in five months. The consensus was for a 0.9% increase.
  • Recall that the UK measure of core inflation excludes not only food and energy, like the US, but also drops alcohol and tobacco prices. ONS explained that the firmer than expected inflation reflected the small decline in clothing prices and smaller discounts in summer sales than a year ago. The 1% increase in the RPI will translate to a 1% increase on average next year for regulated rail fares under the government’s five-year freeze on real rail fares.
  • The implied yield on the June 2016 short sterling futures has been flirting with the lower end of the four-month trading range near 90 bp prior to the inflation report.  It rose four bp and has scope to rise another 5-10 bp in the coming days, especially if Thursday’s report on July retail sales shows the modest strength (0.4% headline and excluding petol) that the consensus expects.
  • The Australian and Canadian dollars are under pressure.  The RBA minutes largely repeated what the central bank had said in its quarterly monetary policy statement.  Interest rate policy is on hold, and at the needed accommodation can be delivered through the weaker currency.   Separately, Australia reported a 1.3% decline in July auto sales.  It was the third monthly decline over the past four months.
  • The Australian dollar stalled near $0.7385.  It is the fourth session of lower highs.  The session low, just above $0.7330, is a three-day low.  Support is seen in the $0.7215-$0.7325 band.  The US dollar recovered from the intra-day decline to CAD1.3060 yesterday, perhaps encouraged by news that foreign investors bought CAD8.5 bln of Canadian securities in June, whereas the consensus expected a CAD6 bln liquidation and a small decline in the US two-year interest rate premium.  The US dollar recovered to almost CAD1.3130 today, but the upside momentum has stalled.  Of the dollar-bloc, the New Zealand dollar is faring best.  The market is cautious ahead GDT auction.  Fonterra has signalled a reduction of supply of whole milk powder by as much as a third, partly reflecting a change in the product mix.
  • The central reference rate for the yuan was little changed at CNY6.3966.  The dollar finished the Shanghai session a little softer at CNY6.3942.  It was the fourth consecutive close with a CNY6.39 handle.  The range was the widest in three sessions (CNY6.3871-CNY6.4160).
  • The yuan’s stability contrasts with the biggest drop in Chinese shares in three weeks.  The Shanghai Composite slid 6.2%.  More than 600 companies fell more than the daily limit of 10%.   There were two main catalysts that made many investors less sure of government support for prices.  First was news that July house prices rose for the third month, paring the year-over-year decline to 3.7%.  House prices rose in 31 of the 70 cities tracked; an improvement from June. The possibility that the Chinese economy is stabilizing was echoed by the Reserve Bank of Australia’s minutes that assessed the downside risks to the Chinese economy had receded somewhat.  The better house prices and the large liquidity injection via seven-day reverse repos (CNY120 bln vs CNY90 bln maturing) seemed to signal no imminent rate cut or reduction in reserve requirements.
  • Separately, the key regulator that is coordinating support for the stock market, the China Securities Finance Corp (CSF) was sidelined.  The three-week rally that ended with today’s drop had brought the Shanghai Composite toward the middle of the perceived approved range (3500-4500), and before the weekend, CSF had warned that it would reduce its operations as volatility fell.   Its failure to step in today exacerabated the sell-off.
    In Europe, the focus is on the German parliament vote on the Greek aid package tomorrow.  It will be approved.  The only question is how many CDU/CSU will vote against the government.   This, along with a couple of other parliaments’ approval, will allow the check to be cut that will allow Greece to pay its creditors, including the 3.2 bln euro payment to the ECB tomorrow.
  • Then the focus will shift to a possible vote of confidence in the Greek parliament.  The left-wing (fundis) of the Syriza coalition is expected to support the government pending the special party conference next month.   The traditional two parties that have supported the government through the negotiations (PASOK and New Democracy) are likely to return opposition and not support the government in a confidence vote.
  • The euro has slipped to a five-day low near $1.1050.  Support is seen in the $1.1025-35 area.  We note that the 100-day moving average comes in just below $1.1050 today.   We are more inclined to see some modest upside pressure that could lift the euro toward $1.1100-$1.1130.
  • The Turkish central bank announces its decision shortly and most expect no change in the policy rate. There has been some recent speculation that they may do something to contain the falling lira, but we don’t think so. Turkey’s benchmark main policy rate is 7.50% and despite the government’s pressure for further cuts, high inflation (just under 7%) and the risk of pass-through will keep policy makers at bay. One possibility is that the bank begins its process of simplification of monetary policy tools, with a narrowing of the corridor. Yet the central bank already noted that this is more of a technical matter and should not be interpreted as a change in the policy stance.
  • The central bank of Indonesia kept rates on hold as expected. The reference rate is set at 7.5% since its one off rate cut in February. The other two policy rates, the FASBI and lending rate, were also left unchanged at 5.5% and 8.0%, respectively. The Indonesia economy is lukewarm with growth at 4.6%, but in gradual decline. Today’s trade data was a case in point. Imports collapsed to -28% y/y and exports were at -19%, both far worse than expected. However, CPI still elevated at 7.26% y/y. Moreover, the central bank has shown no intentions to use its policy rates to contain the weakening rupiah, so we don’t see any move in rates in the horizon.