Forex Investment and Currency Trading

The BoT’s quarterly Inflation Report (IR) released on April 22 reinforced the view that the scope for rate cuts is limited by the already accommodative monetary conditions and rising inflationary pressure. In
fact, market sees increased prospects for BoT to raise the benchmark repo rate in 2H08 on growing concerns over price stability. In addition, concerns over political stability will likely limit THB gains in the near term.

Increased scope for rate hikes in 2H08

While Governor Tarisa signaling a growth accommodative bias during the annual policy outlook briefing on January 28 was widely seen as a precursor to rate cuts, the April IR has all but reversed market expectations over BoT’s next policy move. In the latest quarterly review released on April 22,
the Central Bank raised its 2008 GDP forecast slightly to 4.8%–6%, citing better-than-expected performance in the external sector. The CPI trajectory was raised again to 4%–5%, up sharply from the 2.8%–4% and 1.5%–2.8% ranges predicted in the past two reports. While core CPI projections were raised only modestly for 2008–09 and remained well within the policy target range of 0%–3.5%, the balance of risk factors appeared to have shifted towards price stability. The IR noted that the BoT will now “analyze and evaluate in depth relevant risks to changes in the prices of raw foods and energy”, suggesting increased policy concerns over the impact of non-core items on inflation expectations.

While we continue to see no material change in BoT’s neutral stance in the near term, marekt believes the case for monetary tightening in 2H08 has strengthened. To be sure, BoT’s own version of the Taylor Rule suggests current monetary conditions are overly accommodative. All three BoT models suggest the repo rate should rise above 5% by end-2009, with the trajectories roughly 60bp higher than they were in January. In view of the postelection recovery in domestic demand and the noticeable
deterioration in the trade balance in 1Q08, BoT will likely be increasingly concerned about the risks of maintaining the negative real interest rate environment.

However, eliminating the negative rates will require the policy rate to be raised by at least 200bp, which may be too drastic when viewed against the relatively stable core inflation trend and uncertainties over the external outlook. Moreover, the recovery in domestic demand could also be
reversed if the push by the People Power Party-led administration to amend the constitution heightens political risk and instability in the coming months. On balance, the increased risk to price stability should prompt the BoT to begin normalizing interest rates in 2H08, versus initial expectation of rate hikes starting in 1Q09. Market now expects BoT to the raise the repo rate by 25bp in 3Q08 (likely in late August), with another 25bp increase taking place in 4Q08.  A further 75bp of tightening to 4.5% is expected in 1H09.

Slower pace of baht appreciation seen

While we had expected the lifting of capital controls in March to trigger a sharp rise in capital inflows that would have paved the way for a faster pace of THB appreciation in 2Q08, inflows appear to have slowed in April. USD/THB has since stabilized in the 31.30–31.80 range, up from 31.00–31.50 in the first two weeks following the lifting of controls. The weekly changes in FX reserves further indicate a significant cutback in FX interventions in recent weeks, as rising political uncertainty reduced capital inflows With the details of the constitution amendments still unclear and the possibility of a snap
election in the next 6–9 months, prospects for strong THB gains appear limited in the near term. Market revises USD/THB forecast for 2Q08 to 31.30 from 30.50. Support from rising yields should be constructive for further THB gains to 30.50 by end year.