Brexit doubts remain; China to look past higher inflation

Doubts over Brexit deal. China will look past rising inflation to maintain accommodative policy.
Philip Wee, Nathan Chow16 Oct 2019
    Photo credit: AFP Photo

    FX: Major doubts remain over Brexit despite recent optimism

    The British pound has appreciated 4.5% in the past week to 1.2760 this morning. On the surface, optimism has increased for British Prime Minister Boris Johnson and the EU to put together a draft Brexit deal by the European Council meeting scheduled for October 17-18. Realistically, the higher sterling probably reflected speculative bets on a Brexit extension and the UK averting a no-deal Brexit on October 31.

    It remains to be seen if PM Johnson can secure a majority in the UK parliament for his deal which is said to be worse than the thrice-rejected withdrawal agreement struck by his predecessor with the EU. The Democratic Unionist Party (DUP), which supports the Conservative Party with 10 seats, has been uncomfortable that the current deal has been brokered between PM Johnson and his Irish counterpart. Expelled Tory rebels have previously urged the DUP to think very carefully about supporting a second referendum on Brexit.

    In fact, support has increased for a second referendum amongst the opposition MPs especially the Liberal Democrats. The Scottish National Party (SNP) wants Scotland to be part of the EU and sees Brexit as the reason for a second Scottish independence referendum. Labour Party leaders are under pressure from their MPs to support a referendum before an election. None of these opposition parties want to give PM Johnson the advantage to hold an election on his “do or die” pledge to take the UK out of the EU on October 31 with or without a deal.

    According to the Benn Act, PM Johnson will be required to request, on October 19, the EU for a Brexit extension to January 31, 2020 if MPs do not approve a deal or no-deal Brexit. The EU has indicated its willingness approve a longer extension to June 2020 if UK lawmakers agree to hold new elections or a second referendum. While the British people have voted for Brexit, they did not vote on how to achieve one. Similarly, almost everyone wants to avoid a no-deal Brexit but the path to avoiding one is not as clear as the past week suggested. Profit-taking on the pound before October 19 should not be discounted.
    China: PBoC to look past higher inflation and keep accommodative stance

    China’s policymakers are facing a rise in inflation. While surging pork prices are pushing up consumer price index, deflation has returned to the industrial sector. CPI inflation rose by 0.2 percentage point in September, reaching 3.0% for the first time since November 2013. Once again, disruption to pork supply caused by African swine flu were mostly to blame. Pork price inflation surged 69.3% YoY, from a 46.7% gain in the previous month.

    In contrast, core inflation remained sluggish at 1.5%, the 13th consecutive month of a reading below 2%. Factory gate deflation worsened, with the producer price index falling 1.2% YoY last month after declining 0.8% in August. This was in part due to a drop in the commodity prices. Looking ahead, CPI will likely stay above 3% in Q4, and could rise to 4% around the Lunar New Year holiday. Yet the weaknesses of both underlying inflation and PPI inflation suggest that demand remains lackluster.

    The People’s Bank of China will look past the headline inflation and maintain an accommodative monetary policy stance, in our view. The reserve requirement ratio cut, effective Tuesday, has released about RMB40bn of long-term funds. PBoC is expected to lower the reserve ratio by another 50-100bps in Q4. We also see the authority cutting MLF rates to guide the one-year loan prime rate lower.

    Philip Wee

    FX Strategist - G3 & Asia

    Nathan Chow

    Strategist - China & Hong Kong

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