Forex Investment and Currency Trading

Hawkish BoT comments in the past week suggest the central bank is now ready to raise interest rates on July 16. However, near-term concerns will likely overwhelm shifting rate expectations, extending baht weakness into 3Q08. The USD/THB forecast is raised to 33.50 for 3Q08 from 31.50. Political risk would see an upward skew to this forecast in the coming months.

Inflation could reach double digits in 3Q08
Comments by BoT officials in the past week suggest the Central Bank is now close to raising interest rates. The next installment of the quarterly Inflation Report in late July will likely contain another sharp upward adjustment, with inflation peaking above 10% in 3Q08, against the April projection of a slight ease to around 5%.

Governor Tarisa was the first to brace the market for prospects of double-digit CPI when responding to a media question on June 13 following the unexpectedly strong 7.6% yoy rise in May headline CPI (a 10-year high). Expectations of a near-term rate rise were also reinforced by similar statements from another senior BoT official on the same day. Heightened speculation of an inter-meeting rate hike prompted BoT to call for an unscheduled press briefing on June 16.

During the press conference, Governor Tarisa repeated her warning that monthly inflation readings could reach double digits in 2008, but ruled out an inter-meeting MPC meeting before July 16. The Governor also emphasized that the inflation comments are not meant to signal a rate hike. However, her comments that a rate hike amid the negative real rates environment will unlikely have any significant impact on spending. Economic growth do suggest the BoT is ready to raise interest rates by 25bp as early as July, after holding the 1-day repo rate unchanged at 3.25% in the past six MPC meetings. Market continues to expect the BoT to raise the repo rate by another 25bp in 4Q08, with a further 75bp of tightening seen in 1H09.

Near-term concerns to overwhelm rate expectations

Notwithstanding the rise in rate expectations, near-term concerns will likely extend baht weakness into 3Q08. While coup rumors following the resumption of anti-government protests on May 25 have since subsided, political instability continues to weigh on sentiment near term. To be sure, the
government’s decision to temporarily withdraw the motion to amend the constitution and a cabinet minister’s resignation over alleged anti-monarchy remarks have diffused political tensions and the risk of military intervention substantially. However, the charter amendment process and the perceived poor handling of economic issues could continue to fuel the ongoing street protests for several more months before rally fatigue sets in. The unwieldy 6- party coalition is also showing some signs of instability, with major partner Chart Thai Party recently signaling its intention to exit the coalition.

The surge in inflation is also threatening the recovery in consumer demand. Indeed, the 5-month long rebound in consumer confidence has reversed in 2Q08 following inflation surprises in April–May. With headline CPI likely to drift towards the strong side of the 10% handle in the months ahead, private consumption could slip further below the trend rate of around 3.5% from 2.6% in 1Q08. With current account surpluses evaporating on rising oil prices, portfolio inflows betting on baht appreciation, and prospects of rate cuts and domestic demand recovery dissipating, terms of trade considerations will likely gain importance in the near term. In this regard, the THB will likely continue to under perform on a trade-weighted basis.

USD/THB is forecasted higher to 33.50 for 3Q08 from 31.50. Market expects the pair to end the year at 32.50. In addition to a widening interest rate differential, easing inflation towards year end (partly on base effect) and a seasonal rise in tourist arrivals in 4Q08 should ease upward pressure on USD/THB. However, political risk would see an upward skew to this forecast in the coming months, with the charter amendment process and economic performance holding the key to political stability
in the near term.