Despite softening, inflation remains above the 2% target in the US and Japan while China faces deflation risk
US
US Fed officials have reiterated the need to restrain from rate cuts until they have confidence that inflation is back to the long-term 2% target. In January, the ISM Services PMI climbed to a 4-month high of 53.4 on the strength of the new orders component, which rose from 52.8 in a prior month to 55.9. At the same time, initial jobless claims slipped by 9,000 to 218,000, lower than the 227,000 anticipated by the market.
Stronger-than-expected growth is showing up in: (i) the healthiest Services PMI in 4 months; (ii) the lowest unemployment figures since October 2023; and (iii) the sharpest growth in 11 months in non-farm payrolls and average hourly earnings. This is likely restraining the decline in inflation, and the Fed is thus under pressure to deliver rate cuts on a slower timetable than the market expectation. This is reflected in the recent slew of interviews given by Fed officials, which have underscored their commitment to waiting for clearer evidence that inflation is back to the 2% target over the long term before rates are cut. December inflation was still above the target at 3.4%, despite a slowdown from the June 2022 peak of 9.1%. We expect the Fed Funds rate will remain at 5.25-5.50% until mid-2024, with cuts potentially beginning at the start of Q3.
Japan
Strong exports and rising tourist arrivals in 4Q23 have reduced the risk of recession in Japan. In December, household spending contracted -0.9% MoM and -2.5% YoY, but the Consumer Confidence Index climbed to its highest since December 2021 and nominal wages grew 1.0% YoY, up from 0.2% a month earlier. Likewise, growth in M2 money supply edged up from 2.3% to 2.4% in January.
Although data on consumption remains soft, strength in the tourism sector (7.69m arrivals were recorded in 4Q23) and recovery in exports (+4.1% YoY in 4Q23) likely helped Japan avoid a recession at the end of 2023. Consumption should also strengthen from 2Q24 onwards following the spring ‘Shunto’ wage negotiations and an expected minimum 3% wage rise, which will then help to shore up sentiment and underpin growth in domestic spending power. Moreover, although inflation is currently at 2.6%, down from the January 2023 high of 4.3%, these pay hikes will likely keep this above the 2.0% target over the mid-term, opening the way for the Bank of Japan to unwind its ultra-loose monetary policy and to abandon negative interest-rate policy during 1H24.
China
China remains under pressure from deflationary risks and weak financial indicators. Headline inflation fell from -0.3% YoY in December to -0.8% in January, marking its 4th consecutive month in negative territory and its lowest level in 15 years. This decline is partly due to food price volatility, especially the drop in pork prices (-17%), declining car prices, and a base effect. Services inflation also slipped from 1% to 0.5%. The Producer Price Index (PPI) continued to fall by -2.5% (vs -2.7% in December), marking the 16th consecutive month of decline. At 10.1%, growth in yuan-denominated loan was its slowest since records began in 2005.
Demand during the Chinese New Year is expected to lift inflation in February, and for all of 2024, a gradual recovery in food prices and stabilization of car prices may help raise inflation to a forecast 1%. PPI should also show signs of improvement in 2Q24 as spending on infrastructure materializes, and for 2024 this is expected to average 0.2%. However, low inflation for a longer period reflects the ongoing risk of deflation. In addition, a looser monetary policy, including cuts to some interest rates and to the reserve requirement ratio, may not be sufficient to stimulate growth in credit given the continuation of the core problem, i.e., weak business sentiment.
Government assistance for energy bills will help to contain inflation through 2024. Krungsri Research sees possible rate cuts later in the year if there is clear signs of economic weakness
January’s headline inflation print was its lowest in 35 months, and for 2024, government measures may keep average inflation below the target range. In January, headline inflation weakened from December’s -0.83% YoY to reach -1.11%, its 4th month in negative territory. This was a result of ongoing government subsidies targeting energy costs, in particular the extension of the THB 30/liter cap on diesel prices and limits on the cost of electricity of THB 3.99/unit for qualifying households. In addition, improved supply has undercut fresh food prices, especially for vegetables and pork. Meanwhile, core inflation, which excludes raw food and energy prices, inched down to 0.52% from 0.58% in December.
Partly thanks to the impact of government controls on diesel prices and (for some consumers) electricity bills, there is a chance that inflation may remain negative through 1Q24, which might then keep the average annual inflation for the whole year below the lower bound of the target range. However, there is also a chance that going forward, inflation may climb higher than currently expected. Factors pushing in this direction will include the effect on prices generally of more expensive commodities, prices of which may themselves be impacted by drought and worsening geopolitical tensions, especially in the Middle East. In addition, inflation in some months will also be affected by the ending of government help with the cost of energy.
In a split vote, the MPC agreed to leave rates unchanged but the 2024 outlook for growth and inflation have both been revised down. At its 7 February meeting, the Monetary Policy Committee (MPC) voted 5 to 2 to keep the policy rate at 2.50% given likely lower-than-expected growth resulting from a combination of structural problems and external factors. The MPC stated that low inflation is not a reflection of any weakness in domestic demand. The MPC also cut Thailand’s 2024 growth forecast from 3.2% to 2.5-3.0% (excluding the effects of the digital wallet policy), with forecast headline inflation also down from 2% to close to 1%, though this is expected to pick up again in 2025, while expectations for core inflation are largely unchanged. The two dissenting members of the MPC proposed a 25-bp cut in policy rate to bring this closer into alignment with the economy’s growth potential, which they see being negatively impacted by structural issues.
While the MPC’s statement reaffirmed the committee’s belief that the policy rate is supportive of economic growth and is at a level that will maintain economic stability over the long term, the lack of unanimity and the significant downward revisions to inflation and GDP growth have encouraged markets to believe that there is now a greater possibility of rate cuts this year. Nevertheless, the MPC has also stated that “Monetary policy has a limited ability in addressing structural headwinds. Monetary policy primarily influences aggregate demand.” Krungsri Research sees the Thai economy recovering only slowly and faced with a range of challenges, growth will remain sluggish. We thus expect that the BOT will leave its benchmark rate unchanged but will promptly adjust the policy rate to be more accommodative if it sees greater evidence that the economic outlook is deteriorating.
