In our last quarterly report we debated when, rather than if, currency reform would take place in China. Shortly thereafter (on 21 July) China announced an adjustment of 2.1% to the Yuan (CNY 8.11 / $ from being pegged at CNY 8.28 / $ since 1997). At the same time, they confirmed the replacement of their fixed exchange rate system against the US Dollar with a managed floating exchange rate system against a basket of global currencies. The basket is dominated by the Euro, US Dollar, South Korean Won and Japanese Yen, while the British Pound, Russian Rouble and Thai Baht have also been included. A daily trading band of 0.30% has been implemented to prevent volatility over the short term. Future economic and financial conditions will determine when this band will be adjusted. The main factor here is not necessarily the size of the revaluation, but rather the fact that the Chinese authorities have now taken the first step in addressing this critical issue.
Following on from the announcement in Beijing, Yu Yongding of the People’s Bank of China’s monetary policy committee stated “in the short term, pressure for Yuan appreciation will increase further.” The Business Day recently reported, “Yu was quoted by the China Securities Journal as saying a gradual, controlled appreciation of the Yuan in tight ranges could win time for the Chinese economy to adjust.” Furthermore, the “revaluation would also boost domestic demand and give China more leeway to craft its own monetary policy.” This should also serve to “boost imports of capital equipment and resources.” In 2004 China reported a trade surplus of $32bn. The trade surplus for the first six months of this year has been reported at $39.7bn and is expected to reach in excess of $100bn for the full calendar year.
Over the years, the weaker fixed exchange rate benefited Chinese exports, allowing China to maintain high levels of competitiveness in the global trade arena. However, this strong growth in exports resulted in an inefficient allocation of capital in the region, creating a large trade surplus. The question now is what the likely impact of the currency reform will be on the Chinese economy? In essence, economic growth is expected to slow (due to a drop in exports), thereby reducing the trade surplus. Inflation is also expected to decline slightly. A stronger currency is likely to benefit imports and domestic growth (rather than export growth, which is expected to decline), fuelled by increased domestic demand. The revaluation of the currency could well be the catalyst needed to bring the current investment boom in China under control and to more sustainable levels.
| UNITED STATES OF AMERICA |
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The Federal Reserve continued to increase rates at a measured pace (ten consecutive increases of 0.25% since June 2004). Rates were increased by 25 basis points at both meetings (held in June and August) to 3.50%. The economy in the US has continued to deliver strong growth and the Federal Reserve are comfortable that rates at these levels remain “low enough not to slow economic growth.” However, inflationary pressures cannot be ignored. In a statement following the interest rate hike in June, the Federal Reserve indicated that the pressures on inflation “have stayed elevated” but went on to state that “longer-term inflation expectations remain well contained.”
The latest round of interest rate increases has been brought about amidst concerns that the oil price and the robust housing market are fuelling inflationary pressures. According to a report by the BBC, “with US gross domestic product rising at an annual rate of 3.4% in the three months to June, and both the labour market and consumer confidence continuing to grow, the Fed does not want the economy to overheat and cause general inflation.” Interest rates are expected to peak at between 4% and 4.50% in the current interest rate cycle.
July saw the biggest gains in new jobs in more than five months, with 207 000 new jobs being created. Unemployment levels are reported to being at 4 year lows – and have remained at 5% for a second consecutive month. Following on the release of the July figures, the chief economist at Comercia (Dana Johnson) stated “this is a crystal clear indication that the labour markets are very healthy and it reinforces the notion that the economy is growing in a healthy, sustainable way.”
In his testimony to Congress in July, Alan Greenspan warned of the impact of rising fuel prices and the boom in the housing market. “A further rise [in fuel prices] could cut materially into private spending and thus damp the rate of economic expansion.” Commenting on the US housing market, he stated “we certainly cannot rule out declines in home prices, especially in some local markets” and there are “signs of froth in some local markets where home prices seem to have risen to unsustainable levels.” He concluded by saying “thus our baseline outlook for the US economy is one of sustained economic growth and contained inflation pressures. In our view, realizing this outcome will require the Federal Reserve to continue to remove monetary accommodation.”
| EUROPE |
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Interest rates remained at 2% during the quarter under review. Recent appeals to the ECB by government officials in some of the regions (Germany, Italy and Austria) to reduce rates have gone unheeded. Many of these countries are suffering from high unemployment levels and low productivity. According to the president of the ECB, Jean Claude Trichet “we feel, given our judgment on inflationary pressures and on price stability in the medium term, that these rates are exactly what we need.” The International Monetary Fund has revised growth forecasts for the region to 1.3% for 2005 (down from 1.6%) and down to 1.9%, from 2.3%, for 2006. Growth for the quarter to June was 0.30%, which was marginally down from 0.50% in the first quarter of 2005.
The labour market in the Eurozone is weak, while both business and consumer confidence remain low. Inflationary concerns are being fuelled by the high oil price.
According to a recent article by the BBC, “most analysts believe that the ECB will leave rates unchanged until well into next year as the central bank awaits solid evidence of an expanding economy. Although the Eurozone is suffering low growth, with many of its largest economies faltering, the ECB is keen to keep inflation in check.”
| UNITED KINGDOM |
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In line with expectations, the Monetary Policy Committee reduced rates by 0.25% to 4.50% at their meeting in August. Rates had been at 4.75% since August last year. The rate cut came amidst growing concerns about slowing consumer spending and growth in the region. Manufacturing has also been declining. According to a recent report by the BBC “the UK economy has grown below trend for four successive quarters – its worst performance in a decade.” Second quarter year-on-year growth was recorded at 1.7%, which is the weakest quarterly growth rate since the first quarter of 1993. The Bank of England is expected to reduce its growth forecast to 2% (from 2.5%) for 2005, despite the official growth projection being 3% per annum over the next three years. Business leaders welcomed the decision saying that the Bank had made “the right decision”. According to Steve Radly, chief economist of the EEF, “this cut is a timely and proportionate response to an economic situation which is now flashing amber.” The head of the Confederation of British Industry, Digby Jones, reacted positively to the news by saying that “this cut will be the catalyst for growth and will provide an essential boost to consumer and business confidence.”
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The bomb attacks in London in July have had a negative impact on both business and consumer confidence. The largest impact has, of course, been in central London. According to a recent survey by Lloyds TSB “property firms, hotels and catering firms showed the steepest drop in confidence.”
While another rate cut is possible before year end, economists are of the opinion that a quick succession of rate cuts are unlikely at this stage as these could serve to re-kindle inflationary pressures.
Inflation is currently at 2%, which is in line with the target. Contributing to this inflation number have been seasonal food prices, more specifically meat and fruit, together with increasing shoe and clothes prices. The rising oil price has also been a contributing factor.
Data released by the Office for National Statistics (ONS) shows that the labour market is weakening. According to Peter Dixon of Commerzbank “… the unemployment rate continues to rise whether it be the ILO or claimant count measure, and it is just a clear indication that one of the key supporting props of the UK economy is weakening slightly.” Despite the United Kingdom having one of the lowest jobless rates in the world, a recent BBC article recently indicated that “the number of people out of work and claiming benefits in the UK increased for a sixth month in a row in July, the longest stretch of rises for 13 years.” The manufacturing sector appears to be the hardest hit, with this sector down 86 000 jobs from the same time last year.
| JAPAN |
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Domestic demand in Japan, which has been plagued by periods of deflation and recession in the region over the last 14 years (currently recovering from its fourth recession since 1991), appears to be showing signs of improvement. Both corporate investment and private consumption have increased. The economy is reported to have grown by 0.30% in the quarter to June (which is equivalent to 1.10% over the full calendar year). Imports have risen by some 13.1% for the 12 months to June this year. Certain economists, however, caution that the recent increase in imports is largely due to the rising cost of energy. Their view is supported by the fact that “Japan has no indigenous hydrocarbons, and is therefore entirely reliant on oil imports – the cost of which is up more than 50% since the start of the year.”
As alluded to before, exports to China (now Japan’s second most important trading partner) have slowed as the “government in Beijing tries to cool its white-hot economy.” Bank of Japan Governor, Toshihiko Fukui, appears unconcerned, as in his view “things may appear a bit fuzzy, but I think we can say that for the most part the economy is out of its lull.” The jobless rate in Japan has fallen to its lowest level in more than 7 years (currently at 4.2%).
The market was surprised recently when the Prime Minister, Junichiro Koizumi called for an election to be held on the 11th September, after the upper house voted against his postal privatization bill. Those who voted against the bill believe that it will be detrimental to the bank’s customers and will also remove an important source of cash flow for the government. Signs of discontent appear to be emerging in the Liberal Democratic Party, which has governed the region for almost 50 years. It appears as if Koizumi “has staked his political future on re-election and successfully implementing post office reform.” Commenting on the announcement, Takahira Ogawa, director of sovereign and international ratings at Standard and Poor’s, said “overall, Japan’s economy is in much better shape to weather a political storm than a few years ago.” It is interesting to note that, according to a recent article by the BBC, “Japan Post does far more than deliver letters and sell attractive stamps. It is also a state-owned savings bank with more than $3 trillion in assets, making it by some measures the largest financial institution in the world.”
| SOUTH AFRICA |
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In line with expectations, the Monetary Policy Committee kept rates unchanged during the quarter under review. The prime interest rate is currently at 10.50%, while the Repo rate has remained at 7%.
Second quarter GDP growth was 4.8%, quarter on quarter, on a seasonally adjusted annualised basis. This is much better than the consensus expectation of 4.2% and significantly higher than first quarter growth (of 3.5%). The sharp rise in growth is reported to largely be attributable to a recovery in the manufacturing sector. Following on from the announcement, Nedbank Group Economist Dennis @#!*% said that “today’s GDP figures suggest that no major monetary stimulus is needed to boost economic growth, probably reducing the chances of any further rate cuts during the rest of the year.” Commenting on the likely impact of the recent strike action, Rudolph Gouws (chief economist of Vector Securities) said “while recent strike action will have a detrimental impact on third quarter output growth in the case of the mining sector in particular, we remain cautiously optimistic that an overall real GDP growth rate of 4% for 2005 is attainable.”
July PPI and CPIX numbers released at the end of August came in significantly higher than market expectations. PPI rocketed to 3.6% year on year from 2.3% in June, while CPIX increased to 4.2% for the year to July. This is much higher than the expected 3.8% for July and the actual June CPIX number of 3.5%. Commenting on these figures, Nico Kelder, economist at the Efficient Group, stated “this is the final nail in the coffin of any hope of a rate cut. It might indicate that the next rate movement will be to the upside in early 2006.” The high oil price, which has prevailed for much of the year, is now filtering through into the numbers and is the largest contributing factor.
The size of the Current Account deficit (currently at 3.8% of GDP) could also pose a risk to interest rates in the future and will need to be monitored closely.
The Rand ended the quarter at R5.50, R7.95 and R11.64 to the US Dollar, Euro and Sterling, respectively.
| GENERAL – OIL AND GOLD |
The oil price reached record highs during the period under review, ending the quarter at $66.26 a barrel from a level of $50.23 at the end of May 2005. Supply and demand issues, as well as concerns relating to refinery problems in the United States, remain the main drivers of the price spikes. Security fears continue to prevail in OPEC’s largest regions – Iran and Saudi Arabia. Concern about supply interruptions due to tropical storms have also impacted on the price. The most recent tropical storms, Irene and Katrina, threatened supply from the US Gulf Coast. It is worrying to note that stockpiles in the US are reported to have declined by 3.2 million barrels in the third week of August alone. Global growth, particularly in the US and China, is expected to keep the oil price under pressure.
The gold price showed renewed strength over the quarter, increasing to $431.45 an ounce from $416.65 at the end of May. This translates into an increase of some 3.55% over the quarter. The appreciation in price was prompted, to a degree, by renewed interest from both hedge fund and long only fund managers. An unusual pattern appears to have emerged regarding the movement of the gold price in the last quarter. Typically, the price of gold tends to rise when the US Dollar weakens. However, the gold price has continued on an upward trend, despite periods of US Dollar strength. Commenting on this “pattern” a recent report by HSBC indicated that “not surprisingly this has led to calls that the gold price is “decoupling” from the currency markets as investors shun paper currencies in favour of hard assets. …gold has also outperformed most other major currencies, suggesting the recent strength is not just a rejection of the dollar and the euro, but is perhaps the beginnings of a more sustained independence from the currency markets.”
| CONCLUSION |
We are delighted to have finally moved into our new offices at the Redlands Estate. The new office building, which has just been completed, is directly across the road from the offices that we occupied in Techno House at Redlands. We invite you to pop in for a cup of tea and a tour of our new offices.
QUARTERLY QUOTE
“It’s not enough that we do our best, sometimes we have to do what’s required”
Sir Winston Churchill
This report is based on information sourced from various institutions, both local and international. The report reflects a variety of views and is not intended to convey investment advice. Please consult us to obtain specific advice relevant to your investment portfolio.
