Emerging Markets 2 - A shrug is not a shudder

Aug 23rd 2007 SÃO PAULO

From The Economist print edition

Brazil is the clearest example of Latin America's newfound financial stability

IN FINANCIAL circles, Latin America has long had a reputation as something of a “subprime” continent that periodically struggles to repay the money lent to it by reckless creditors. One might therefore expect Brazilians, who remember the crises of 2002, 1999 and 1998, to respond to America's current woes with empathy—and not a little fear.

Sure enough, Brazil's main stockmarket index, the Ibovespa, lost 17% of its value from July 23rd to August 16th. The Brazilian real has also fallen beyond the symbolic rate of two to the dollar. But despite this, investors and analysts seem to share the sunny attitude of the country's president, Luiz Inácio Lula da Silva. “Brazil is not afraid of this crisis,” he said this week. It is, he insists, “an eminently American crisis” caused by people trying to make a lot of “third-class money”.

Such contemptible folk have also left their mark on Brazil, of course. Its stockmarket has attracted foreign speculators, and its bonds have proved attractive to hedge funds, betting that Brazilian interest rates would continue to fall. Some of these investors have now been forced to pull out of Brazil to cover obligations elsewhere. But many are staying put. Yields on Brazil's sovereign debt have risen, but not by much. They remain just 2.17 percentage points above those on American Treasuries. And although foreigners were probably responsible for the bulk of Brazil's stockmarket losses, the Ibovespa is still up about 20% for the year in dollar terms.

That markets have not sunk further is testimony to Brazil's newfound macroeconomic buoyancy. The government's budget surplus, before debt payments, beat its first-half target this year. Thanks to booming commodity prices, the country also enjoys a healthy current-account surplus, which has helped the central bank to accumulate about $160 billion in reserves. In fact, Brazil is now a net dollar creditor, which means it has much less to fear from a fall in the real against the greenback. Indeed, a weaker Brazilian currency would help manufacturing exporters, who have been complaining of late that the real is too dear.

Nuno Camara of Dresdner Kleinwort, an investment bank, believes that the current turmoil may even hasten Brazil's attainment of investment-grade status. Once the dust has settled, he says, those countries that have “done their homework”, running up current-account surpluses and reserves, will see the money come back. This diligent group includes Chile, which has run bigger current-account surpluses than Brazil, and Peru. Mexico has been “medium-nice”, according to André Cappon of the CBM Group, a New York-based consultancy. It has kept its public finances in order and its prices stable, but it still has an external deficit and its economy is more exposed to a downturn in America. Other Latin American countries—namely Argentina, Ecuador and Venezuela—have been less strait-laced. Their risk premiums have risen significantly.

In the shakier past, a quick outflow of money from Brazil and its neighbours might have triggered weaker currencies, higher debt costs, faster inflation and punitive interest rates. But if Lula is right, that grisly economic plotline may no longer be so eminently Latin American.

Emerging Markets 1 - Full of Eastern Promise

Aug 23rd 2007 HONG KONG

From The Economist print edition

Could Asian shares provide a safe haven for global investors?

IT OFTEN seems that everything is made in China, but certainly not the latest turmoil in financial markets. Over the past four weeks, as world share prices have plunged, Chinese A-shares have leapt by over 20%. And as central banks elsewhere worry about a credit crunch, China's central bank this week raised interest rates for the fourth time this year.

Foreigners cannot buy A-shares, which means they cannot dump them either. The rest of Asia is less snugly insulated. Last week its markets suffered their biggest weekly fall for 17 years, and they remain 12% below their peak. Big financial losses in mortgage-linked securities have forced global investors to pull money out of emerging markets to raise cash and reduce the “risk” in their portfolios.

But the notion that all emerging-market shares are risky is looking out of date. Based on fundamentals, Asian shares are now arguably less risky than many American ones. Although Asian financial firms have suffered some losses from securities linked to American subprime mortgages, their direct exposure is thought to be relatively small.

Moreover, Asian share prices look good value compared with those elsewhere. Despite a surge over the past few years, most markets are still below their mid-1990s peaks in dollar terms, including the Chinese shares that foreigners can buy. Yet profits have soared since then. One legacy of the 1997-98 Asian crisis is that firms now focus on making money rather than maximising market share or assets.

The price-earnings (p/e) ratio for the region is below its 20-year average (see chart) and lower than that in America, even though faster growth in output and profits should justify a higher p/e. On many counts Asia is in a better position than other emerging markets, though some of them, too, are better prepared than they used to be (see article). Since the start of the global bull market in 2003 emerging Asian shares have gained 210% in dollar terms, compared with an average of 440% in Latin America. Yet Asia has by far the better growth prospects. The IMF forecasts that developing Asia will grow by an annual average of 8% over the next five years, Latin America by 4%.

Most Asian economies are also much less vulnerable to capital outflows than they used to be, enjoying a current-account surplus and a large hoard of currency reserves. Foreign investors need worry less about an exchange-rate loss than in the past as many currencies are if anything undervalued. Asia also shows few signs of excess. Bank lending is growing much more slowly than a decade ago, and Asia is one of few parts of the world not experiencing a housing bubble. A recent study by the IMF finds that in most Asian countries house prices have not kept pace with incomes since 1999.

The glaring exception to all of this is India, which unlike the rest of Asia has a housing bubble, a borrowing binge and a current-account deficit. By most measures, Indian shares also look pricier relative to their historical trend than anywhere else in Asia.

One big concern is that if Asian stockmarkets still dance to the same beat as Wall Street, they will also trip up if America sinks into recession. Economists continue to argue fiercely about whether Asia can decouple from the world's biggest economy. But to some extent it already has. The growth in America's domestic demand has slowed from 4.4% in 2004 to only 1.3% in the year to the second quarter, and imports fell in the second quarter. Yet Asia continues to boom, with most economies accelerating in recent months. Exports to America have slowed sharply, but this has been offset by faster growth in exports to the European Union and to other emerging economies, and stronger domestic demand. This year, for the first time, China and most other Asian emerging economies are exporting more to the European Union than to America.

Under its own steam
Nobody is suggesting that Asia would escape unscathed from a sharp American downturn. But it is less vulnerable than in the past thanks to a reduced dependence on the American market and stronger domestic spending. China's retail sales surged by over 16% in the year to July, and even without the boost from net exports China's GDP growth would still be an impressive 9% this year. On the other hand, domestic demand remains weak in Taiwan and Thailand.

If exports were to collapse, governments in emerging Asia could loosen their purse strings. Most have small budget deficits, some even have surpluses, giving them plenty of scope to ease policy to boost domestic demand. (India, again, is the big exception.) Central banks in India and South Korea, as well as China, have been tightening monetary policy this year to cool their economies. If need be, they could relax their grip.

Asia's prudence in the past ten years now offers global investors a relatively safe haven. Investors who have recently dumped Asian shares may well kick themselves in a year's time. But then many of them are the same prescient investors who jumped into subprime mortgages.

Taiwan analysts lift 2007 forecasts after GDP data

Aug 24, 2007 - Taiwan's stronger-than-expected second-quarter economic growth has prompted some economists to raise their full-year forecasts, but others prefer to wait and see what fallout there might be from U.S. financial strains.

Five out of nine analysts, including DBS and KGI Securities, have either raised or plan to lift their forecast for this year's gross domestic product growth to reflect stronger capital spending by the private sector and recovering domestic demand.

Citigroup and Credit Suisse have made no changes, while JPMorgan and Forecast have lowered their forecasts, anticipating that softer U.S. domestic consumption due to the subprime mortgage crisis may hit Taiwan's exports, a key driver of growth.

"Taiwan's investments should register good growth in the second half of the year after rebounding strongly in the second quarter," said Ma Tieying, an economist at DBS in Singapore.

"In general, Taiwan's exports performance should still be quite stable. Although there are some worries over U.S. demand, China's growth is very robust," she said on Friday.

Taiwan's economy expanded by 5.07 percent in the second quarter from a year earlier, the fastest pace in 1-½ years, prompting the government on Thursday to lift its 2007 growth forecast to 4.58 percent from 4.38 percent.

Private investment was the main engine of growth, underlined by a turnaround in machinery imports.

These were up 5.2 percent in the second quarter from a year earlier, after dropping 5.4 percent in the first three months.

The government responded by raising its 2007 forecast for private investment growth to 5.7 percent from 1.7 percent.

Analysts said the upgrade was justified even if the new projection might be a tad optimistic.

"I don't read the Q2 number as meaning growth is on a faster recovery. Part of it is because Q2 is a little bit distorted by some investment spending being deferred from the first quarter," said Joseph Lau, an economist at Credit Suisse.

Lau is keeping his forecast for Taiwan's GDP growth intact at 4.5 percent for 2007, although he said he might nudge it up to 4.6-4.8 percent in future.

A major uncertainty is the fallout from an unfurling wave of defaults in the U.S. mortgage market, which has gummed up other parts of the credit market and prompted the Federal Reserve to cut its primary discount rate to try to restore liquidity.

"The risk has risen somewhat that external demand going into Q4 may be clouded by the spillover effect of the U.S. subprime market problem and credit tightening on real economic activities," said Grace Ng, an economist from JPMorgan, which has cut its 2007 GDP growth forecast to 4.5 percent from 4.7 percent.

Mexico holds key rate steady, eyes credit crisis

Aug 24, 2007 - Mexico's central bank held its key overnight interest rate steady at 7.25 percent on Friday, as analysts expected, but cautioned it would act if niggling food prices become a threat to its inflation goal.

But in a hint that it may have eased its bias toward worries about inflation, the central bank warned that the U.S. subprime mortgage crisis could lead to a slower economy in the United States, Mexico's top trading partner. The bank said it took that uncertainty into account in its monthly policy review.

Twelve-month inflation, which has been pushed up by higher fruit, vegetable and dairy prices over several months, is seen on path toward the bank's 3 percent target and should be near that goal by the end of 2008, the Banco de Mexico said.

Still, the future trajectory of food prices remains unnerving and the bank said it is worried that medium-term inflation expectations remain above its target.

"The board will continue to evaluate the balance of risks and will act if its deterioration compromises the inflation objective," the bank said.

UBS economist Guillermo Aboumrad, in a telephone interview with Reuters, said the central bank "is equally concerned with international events regarding credit restrictions and with the pace of world food inflation. It's trapped between two worlds."

A slowdown in the United States would hurt Mexico's economy and put pressure on the Banco de Mexico not to raise rates any further.

Mexico's annual inflation ticked up to 4.10 percent in early August, above the central bank's target range but still within expectations.

The bank said last month it expects annual headline inflation between 3.75 percent and 4.25 percent in the third quarter. But 12-month inflation should come back down to between 3.25 percent and 3.75 percent in the fourth quarter, the bank has said.

The bank did not comment about a possible price spike that could be caused by the implementation of a fiscal reform package being negotiated by the government with lawmakers.

While economists have long encouraged a tax overhaul to improve government revenues, they warn that its implementation could cause inflation as products become more expensive because of higher taxes.

Ruling party and opposition lawmakers say they are close to a deal on a tax reform package, which President Felipe Calderon wants passed soon so it can be included in the 2008 budget.

That might tempt the central bank to raise rates, but uncertainty about the U.S. economy will probably keep it in check for now, some analysts say.

"Barring a major unfavorable price shock in Mexico, a stabilization of (U.S.) credit market conditions seems to be a prerequisite for the central bank to tighten," said Credit Suisse economist Alonso Cervera in a report.

The central bank, which tries to keep annual inflation below 4 percent, surprised financial markets with a 25-basis-point interest rate hike in April. It has kept rates steady since then while warning it would hike if price pressures put its long-term inflation goal in danger.

All economists polled by Reuters had expected the central bank to hold steady on Friday.

Canada forecasts faster growth, bigger surplus

Aug 24, 2007 - Canada's economy is growing faster than expected this year and this should deliver a larger federal budget surplus than originally forecast, the Finance Department said on Friday.

"The budgetary surplus for 2007-08 is now expected to come in higher than the budget 2007 projection of C$3 billion ($2.9 billion)," the department said in its quarterly update of the fiscal outlook.

"The improved outlook stems from stronger-than-expected economic performance, as well as higher-than-anticipated revenues as suggested by year-to-date financial results. Program expenses are expected to be largely unchanged from the budget 2007 outlook."

It said the budget surplus in June was C$2.85 billion, up from C$2.26 billion in June 2006. The April to June surplus was C$6.36 billion, up from C$5.89 billion in the same period last year and more than twice the originally forecast surplus for the whole fiscal year.

It did not say how much more than C$3 billion it thought this year's surplus would be, noting that a comprehensive update would come in the autumn Economic and Fiscal Update.

Canada is the only country in the Group of Seven leading industrialized nations to be running budget surpluses.

The department released an updated economic forecast, which it takes from private-sector economists, to show real economic growth this year of 2.5 percent, up from the 2.3 percent forecast in the March budget. But the economists cut the forecast for 2008 to 2.7 percent from 2.9 percent.

The economists significantly boosted their projections for GDP inflation -- used to determine how much of nominal growth in gross domestic product is due to higher prices. For 2007 they saw GDP inflation of 2.7 percent instead of 1.5 percent, and for 2008 they boosted their forecast to 2.2 percent from 2.0 percent.

Consequently, nominal GDP growth, which has a strong correlation with tax revenues, has been revised up to 5.2 percent for 2007 from 3.9 percent. The figure for 2008 remains unchanged at 5.0 percent.

This would leave nominal GDP about C$20 billion higher in both 2007 and 2008 than projected in the March budget.

In its figures for what has already been spent in the first three months of the fiscal year, which started in April, the government showed that total spending had risen by 6.7 percent from the same period in 2006 to C$54.00 billion.

Flaherty has promised to limit spending to the rate of nominal growth in GDP on average over the mandate of the Conservative government, but he spent at a higher rate than that in the government's first year in office.

($1=$1.05 Canadian)

U.S. July new home sales, durables orders rise

Aug 24, 2007 - Sales of new single-family U.S. homes unexpectedly rose in July and new orders for durable goods posted strong gains that underlined the economy's strength just before a credit crisis socked financial markets.

New home sales rose 2.8 percent to an 870,000 annual pace last month, reversing two months of declines, and inventories eased, a Commerce Department report showed on Friday.

Analysts were expecting new home sales to dip to an 820,000 sales pace. Home sales in June were revised to an annual rate of 846,000 from the previously reported 834,000 rate.

"It's unexpectedly firm. So combined with durable goods data, this suggests that the economy was fairly sturdy heading into the market disruption in August," said Pierre Ellis, senior global economist at Decision Economics in New York.

An earlier Commerce Department report showed new orders for long-lasting U.S.-made manufactured goods surged a much bigger-than-expected 5.9 percent in July, the biggest gain since September, and a business investment gauge posted the first gain in three months.

Analysts were expecting orders of durable goods, which are meant to last three years or more, to rise 1 percent. Non-defense capital goods orders excluding aircraft, viewed as an indicator of business spending, gained 2.2 percent, the steepest climb since March.

Evidence of underlying economic strength was applauded by steadier markets. Stocks rose, sending the broader market to its best weekly close in five months. Treasury debt prices were mixed, with yields on shorter-dated securities rising as traders unwound safe-haven bets.

The dollar fell as calmer credit markets renewed interest in riskier overseas assets.

The Federal Reserve did not conduct any open market operations on Friday, only the second day it refrained from pumping money into the financial system since a credit crunch began two weeks ago.

However, analysts cautioned that Friday's data reflect activity prior to August's financial market turmoil over subprime mortgage loan delinquencies.

"It doesn't reflect the impact of the recent financial crisis," Hugh Johnson, chief investment officer at Johnson Illington Advisors in Albany, New York, said of the durables report.

Excluding volatile transportation orders, durables orders jumped 3.7 percent in July, the sharpest rise since August 2005 and the first gain in that category since April. With defense orders stripped out, durables orders advanced 4.9 percent, the strongest increase since March.

Analysts were expecting a 0.6 percent gain in durables orders ex-transportation and a 0.5 percent advance in durables orders ex-defense.

Transportation equipment orders rose 10.8 percent. Civilian and defense aircraft orders advanced by 12.6 percent and 15.8 percent respectively, while orders for cars, trucks and parts advanced 9.8 percent.

Orders for computers and electronic products and machinery posted their sharpest gains since November 2006.

The Commerce Department said the supply of homes available for sale eased to a seasonally adjusted 533,000, the lowest since January 2006. That represents a 7.5 months' supply of homes available at the current sales pace.

The supply of new homes available for sale is down 7 percent from July 2006, the biggest 12-month drop since January 1998.

The median sales price rose to $239,500 in July from $230,600 in June. That was down 3.4 percent from the same month a year earlier, the biggest 12-month decline since October 2001.

UK 2Q GDP +3.0% YOY; Household Spending Supports

Aug 24, 2007 - The U.K. economy grew at a robust pace in the second quarter of 2007, supported by household expenditure and government spending, data from the Office for National Statistics Friday showed.

In its second estimate of economic output, the ONS confirmed that gross domestic product grew 0.8% on the quarter and 3.0% on the year, unchanged from preliminary figures released last month.

The figures were in line with consensus forecasts of economists surveyed by Dow Jones Newswires, and show that the U.K. economy is still growing above its historical average, which economists believe to be around 2.75%.

The rapid growth, which suggests the U.K.'s economic performance is likely to meet the Treasury's forecast for economic growth of between 2.75% and 3.25% over the whole of 2007, comes despite five rate increases by the Bank of England since August 2006, to 5.75% from 4.5%.

The breakdown of the numbers showed that household expenditure is an increasingly powerful engine behind growth, rising 0.8%, compared with a 0.5% gain in the first quarter, on consumption of both goods and services, the ONS said. Spending was 2.6% higher than corresponding quarter in 2006.

Government spending also grew 0.8%, with the volume of spending now 2.1% higher in annual terms, it added.

Monetary Policy: Hazardous Times

Aug 23rd 2007

From The Economist print edition

The Fed has a new problem: convincing investors it does not need to cut interest rates yet

LEND freely but at penal rates was Walter Bagehot's advice to central bankers in a liquidity crisis. Lend freely and reduce interest rates has been the panicky demand of many investors shocked by the speed with which a crisis among low-quality mortgage borrowers in America has ricocheted around the world. So far the central banks, led by America's Federal Reserve, have tried to have it both ways. The Fed has lent freely, not always at penal rates. Meanwhile, it has talked a cautious game: no firm promise that any interest rate will be cut, but the odd hint that all the options are open in monetary policy, especially when it comes to protecting the real economy from the turbulence on the markets.

From many investors' point of view, this has worked a treat. Stockmarkets, which seemed in a state of panic on August 16th, have recovered some of their poise. More importantly, the credit markets, especially the ones where banks lend to each other, look more relaxed. Yet much of this relief is based on a single expectation: that the Fed will cut interest rates soon, perhaps even before its next rate-setting meeting on September 18th. This looks doubly dangerous: a rate cut is not certain; it would also, quite possibly, be the wrong thing to do. Hence, the increasingly urgent need for the Fed's chairman, Ben Bernanke, to let down his new admirers gently.

The willingness of investors to pin their hopes on a rate cut is understandable: after all, that has been the response of the Fed to every financial panic since the stockmarket crash of 1987. The Fed has also craftily encouraged that belief, while not yet committing itself. On August 17th, in addition to cutting the discount rate which banks pay it for emergency lending, the Fed's rate-setters acknowledged that financial turmoil now posed a risk to America's economy. The tone was so different from the Fed's statement just ten days before, when inflation was its biggest concern, that markets automatically assumed a rate cut was imminent. But was that wise?

House of cards
Begin with the fact that both the Fed and the markets have an overwhelming long-term interest in risk being priced correctly. The new model of financing, in which debt is repackaged and risk is dispersed through a web of derivative contracts, has much merit. But it plainly has had an unhappy consequence: when a problem emerged (in this case, in subprime mortgages), it was harder to work out whom it was safe to do business with. Banks became wary of lending to each other. The outcome was frighteningly similar to a bank run, but one that affected the entire wholesale money market.

From this perspective, it certainly made sense for central banks to stop that run by supplying short-term money. Nobody wants a temporary cash shortage to turn into a solvency crisis, where otherwise valuable assets are sold cheaply into a market gripped by fear. Temporary loans to the banking system should grease the market's wheels and enable it to grind out its own solutions.

However, a shift in the longer-term stance of monetary policy, by lowering the benchmark price of money, is a very different proposition. A rate cut does not just increase the supply of cash; it directly influences people's calculations about risk. Cheaper money makes other assets look more attractive—an undesirable consequence at a moment when risk is being repriced after many years of lax lending. It is not surprising that some investors think the Fed is setting a floor under asset prices. But letting that belief pass unchallenged blesses reckless speculation and reinforces moral hazard.

Let them down gradually
Clearly, there may be limits to a policy of tough love. If, for instance, the banking system were indeed in danger, then the Fed should step in. More realistically, if the current credit crunch were to intensify, economic growth show signs of faltering and inflation disappear as a threat, the Fed would also have reason to cut rates. But Mr Bernanke should be driven by his remit to support economic stability, not by the whiplash from financial markets. That, arguably, was the mistake that Alan Greenspan made when the Fed lowered rates three times in 1998 as financial markets seized up in response to the collapse of Long-Term Capital Management, a hedge fund.

This time, it is too soon to tell how deeply the financial crisis has affected the American economy. Some argue that it could benefit from some pain too (see article). In fact, plenty of the normal mechanisms markets have for correcting themselves have yet to swing into action: there is plenty of cash still hoping to pour into financial markets when they become cheap enough, whether from oil-rich governments, vulture funds, canny investors such as Warren Buffett or cash-rich companies still churning out profits. Already, Bank of America has snapped up a $2 billion stake in Countrywide, a troubled mortgage lender. To cut rates too soon would imply that the financial system cannot work without bail-outs. That would be the worst legacy of all.

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Weekly Indicators - Aug 23, 2007

Aug 23rd 2007
From The Economist print edition

In a bid to stabilise money markets, the Federal Reserve cut its discount rate, the charge it makes for emergency loans to banks, from 6.25% to 5.75% on August 17th.

In a separate statement, the Fed's rate-setters said the downside risks to economic growth had “increased appreciably” and that they were “prepared to act as needed” to prevent financial turmoil from hurting America's economy. Forty-five out of 63 economists polled by Reuters this week said they expect the Fed to cut its main policy rate by at least a quarter of a percentage point at—or even before—its next scheduled policy meeting on September 18th.

China's central bank unexpectedly raised its benchmark interest rate on loans from 6.84% to 7.02%. Deposit rates rose from 3.33% to 3.6%, a bigger increase. The changes came a week after official figures showed consumer-price inflation had jumped to a ten-year high of 5.6% in July.

The Bank of Japan kept its key interest rate at 0.5% on August 23rd.

Oil prices weakened on fears that financial turmoil might hurt the global economy. The price of a barrel of the benchmark Brent crude, which had briefly topped $77 last month, fell to $68.70 on August 22nd.

In Canada, consumer prices rose by 0.1% in July and by 2.2% from a year earlier.

GDP in Mexico rose by 2.8% in the year to the second quarter.

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Estonia Cuts 2007 GDP Growth Forecast To 8.1%

Aug 23, 2007 - Estonian authorities lowered their economic growth forecast for 2007 and 2008 and said inflation would accelerate, but the finance ministry said there was no need to worry.

Estonia's gross domestic product (GDP) is this year expected to increase by 8.1 pct compared with 2006, the country's finance ministry said, cutting back its earlier forecast of 9.2 pct.

And in 2008 the economy is expected to grow by 7.0 pct on the same basis, rather than the previously forecast 8.3 pct.

'There is no need to worry about Estonia's economy,' said Finance Minister Ivari Padar. 'Despite growth being less than predicted, the budget will be growing, and despite the decline of growth we still predict that we will get more money in the budget next year than we predicted this spring.'

Estonia's GDP grew by 11.4 pct in 2006, lagging just half a percentage point behind neighbouring Latvia, which topped the EU growth table last year.

But the ministry also said that inflation is set to be higher than expected.

Average annual inflation is likely to hit 6.1 pct this year, due to strong domestic demand and rising wages, outpacing the ministry's original forecast of 4.9 pct.

It is then expected to reach 7.4 pct in 2008, rather than the initially predicted 5.2 pct, but is likely to lose pace from 2009 and drop to 3.5 pct by 2011.

'The increase of prices is rapid but the increase of incomes continues also,' Padar said. 'We see it as a rather normal development that in a country with such a fast-growing economy, prices and salaries move closer to the EU average.'

But curbing inflation is a key plank of EU-set criteria for would-be eurozone members. Estonia's failure to keep its average annual rate under control put paid to the goal of adopting the European single currency at the start of this year.

Although no new date has been set for making the switch from the national currency to the euro, Estonian officials have suggested it may be possible by 2011.

Japan July trade surplus 671 bln yen, -21pct y/y

Aug 23, 2007 - Japan's trade surplus fell for the first time in nine months in July, prompting concerns about the outlook for the country's exports amid worries over a slowdown in the U.S. economy due to rising U.S. mortgage defaults.

But the data did little to alter market views that the Bank of Japan (BOJ) will keep interest rates on hold at a two-day policy meeting starting on Wednesday in view of a global credit squeeze that has sparked financial market turmoil.

Exports rose 11.7 percent from a year earlier to 7.0627 trillion yen ($61.40 billion), below economists' median forecast for a 13.0 percent rise, led by shipments of automobiles and steel products, customs-cleared data from the Ministry of Finance showed on Wednesday.

Japan's overall imports, on the other hand, rose 16.9 percent to 6.3915 trillion yen, against the market consensus for a 15.6 percent increase, due to rising crude oil and raw materials prices as well as the yen's weakness.

As a result, Japan's trade surplus fell 21.1 percent in July from a year earlier to 671.2 billion yen, against economists' median forecast for a surplus of 764.9 billion yen, or a year-on-year fall of 10.1 percent.

Exports to the United States, Japan's largest export destination, rose 1.3 percent from a year earlier to 1.4420 trillion yen, mainly on an increase in shipments of organic compounds.

U.S.-bound exports had fallen in April for the first time in more than two-years but showed signs of recovery in the following months, while solid demand for Japanese goods in Asia and Europe has cushioned a slowdown in U.S. bound shipments.

Exports to Asia climbed 13.8 percent from a year earlier to 3.4236 trillion yen, rising for the 65th month in a row, and those to China increased 20.6 percent to 1.1018 trillion yen, led by shipments of electronic parts.

EU-bound exports rose 13.1 percent to 991.1 billion yen, up for the 21st straight month, led by shipments of automobiles.

On a seasonally adjusted basis, the overall customs-cleared trade surplus increased 0.1 percent from the previous month to 822.6 billion yen, the data showed.

Exports have been a key driver of growth in the world's second-largest economy, which is enjoying its longest growth cycle of the postwar period, albeit at a slower pace than in previous booms, on the back of robust corporate spending.

Japan's economic growth slowed to an annualised rate of 0.5 percent in April-June from 3.2 percent logged in the previous quarter, due in part to sluggish export gains.

The BOJ has left monetary policy unchanged since raising the key policy rate to a decade-high 0.50 percent from 0.25 percent in February, which was the first rate hike since July last year.

Bernanke's Strategy of Increasing Liquidity Survives

By Craig Torres

Aug. 22 (Bloomberg) -- The Federal Reserve's strategy of increasing liquidity rather than resorting to a cut in the benchmark interest rate survived a third day.

Yields on Treasury bills rose yesterday after the New York Fed lowered the cost of borrowing securities from its own portfolio to ease a shortage in the market. The action followed a reduction in the Fed's rate on direct loans to banks on Aug. 17, the impact of which officials said they need time to assess.

Chairman Ben S. Bernanke wants to avoid an emergency easing of monetary policy, contrasting with predecessor Alan Greenspan, who cut the federal funds rate target three times in 1998 after the collapse of Long Term Capital Management LP. Richmond Fed Bank President Jeffrey Lacker said yesterday that policy must be guided by the outlook for economic growth and prices, not entirely by markets.

"We did use the fed funds rate and that may have been a mistake,'' said former Fed Vice Chairman Alice Rivlin, who voted for the 1998 rate cuts. "It might have been smarter to try what they are trying.''

Lacker said in a speech to a conference in Charlotte, North Carolina, yesterday that while the credit crunch and gyrations in financial markets have the potential to hurt growth, signs so far indicate business and consumer spending will continue.

In response to a question, Lacker also underscored the Federal Open Market Committee's determination not to insure poor investments with a cut in the federal funds rate. Ten-year U.S. Treasury notes fell in response, pushing the yield up 7 basis points to 4.66 percent at 9:45 a.m. in New York.

'Market Determined'

"The Federal Reserve isn't responsible for the size of credit spreads,'' he said. "We leave those to be market determined. Our responsibility and what we are capable of influencing on a sustained basis is inflation and growth.''

Some financial markets offer encouraging signs to policy makers. The Standard & Poor's 500 stock index has held the gains posted on Aug. 17, when the benchmark had its biggest one-day jump in four years. Lenders are also starting to write more "jumbo'' mortgages as the market for loans above $417,000 improves, Treasury Secretary Henry Paulson said yesterday.

"When we look at the markets over the last couple of days, I've been encouraged to see signs that there's more liquidity in the jumbo'' mortgage market, Paulson said in an interview with CNBC. "We're looking at all the markets, and you know, obviously, the equity markets, the sovereign-debt markets, the high quality credit markets, are all fully operational.''

1998 Criticism

After the rate cuts in 1998, the economy strengthened and stock prices soared, Rivlin noted, leaving the Fed open to criticism that the reductions were a mistake. Rivlin is now director of the economic studies program at the Brookings Institution in Washington.

The Fed's current strategy showed some signs of success yesterday as yields on three-month Treasury bills climbed the most since 2000 and those on commercial paper backed by assets such as mortgages slipped.

The three-month bill yield increased 0.52 percentage point to 3.61 percent late yesterday as demand for the shortest-dated government debt waned. Top-rated asset-backed commercial paper maturing in one day yielded 5.92 percent, down from 5.99 percent, posting the first drop in three trading days.

"The flight to safety may be diminishing a bit,'' said Holly Liss, a bond saleswoman in Chicago at Citigroup Global Markets Inc. "We're seeing more calming of the market as T-bill rates come back to normal.''

Jury 'Still Out'

Lacker said the "jury is still out'' on whether the Fed has done enough to improve trading in the $1.1 trillion market for asset-backed commercial paper.

"The markets that are under more stress are the high-yield market, non-agency mortgage markets, collateralized debt obligations and collateralized loan obligations markets and extendible asset-backed paper,'' said Paulson, a former Goldman Sachs Group Inc. chief executive officer. "Those are markets that we're watching closely.''

Investors and economists still bet that Bernanke will have to reduce the benchmark lending rate between banks, now at 5.25 percent, by at least a quarter point on or before the Sept. 18 meeting.

"Financial volatility and the seizing up of credit markets raises the probability'' of a recession, said Steven Einhorn, vice chairman of New York hedge fund Omega Partners Inc. "The Fed needs to be proactive and not wait.''

Einhorn said slowing inflation and growth of around 2 percent to 2.5 percent give the Fed room to cut interest rates.

'All' Tools

Senate Banking Committee Chairman Christopher Dodd said Bernanke agreed to use "all of the tools at his disposal'' to restore stability in markets roiled by the subprime mortgage crisis. He added that he didn't ask Bernanke to cut the federal funds rate and that the Fed chief didn't pledge to do so.

Dodd, a Connecticut Democrat who is seeking his party's presidential nomination, said banks should take advantage of lower borrowing costs at the discount window. He spoke after meeting with Bernanke and U.S. Treasury Secretary Henry Paulson.

Yesterday, the New York Fed reduced the so-called minimum fee rate that bond dealers pay to borrow its Treasuries to 0.5 percent from 1 percent.

"We are doing it to provide additional liquidity to the Treasury financing market,'' said Andrew Williams, a spokesman for the New York Fed. He said the rate was the lowest in the history of the program, which has existed in its current form since 1999.

Discount Rate

The central bank on Aug. 17 cut the so-called discount rate half a percentage point to 5.75 percent to direct more cash to companies starved for short-term financing while avoiding an emergency reduction in its broader lending-rate target.

Banks can borrow at the discount rate with a wide variety of collateral, including everything from mortgages -- the market that sparked the credit crunch after defaults rose to the highest in five years -- to municipal bonds.

Lacker told risk managers yesterday that the Fed's district banks would even accept boat loans as collateral. It's up to the banks to establish a value for the assets as they make the loan, he said.

source

Taiwan Q2 GDP growth beats forecasts at 5.07 pct

Aug 23, 2007 - Taiwan's economy expanded in the second quarter by a higher-than-expected 5.07 percent from a year earlier, prompting the government to raise its 2007 growth forecast due to strength in private investment.

Analysts expect growth to be supported in coming quarters by a recovery in domestic consumption but exports, the mainstay of the island's economy, will depend to a great extent on U.S. demand, which may be slowing.

The growth in gross domestic product reported on Thursday -- the fastest rate since the fourth quarter of 2005 -- compared with a median forecast of 4.2 percent in a Reuters poll and a revised figure of 4.18 percent in the first quarter.

"To get to 5.07 percent means that consumption is better than what we expected," said Citigroup economist Cheng Cheng-mount. "We think this year GDP will improve quarter by quarter. This is in keeping with our forecasts."

Taiwan's economic growth had trended lower since hitting 5.05 percent in the third quarter of 2006, mainly due to weak domestic demand and high tech-sector stockpiles that weighed on exports.

Its second-quarter growth compared with rival South Korea's 4.9 percent and Hong Kong's 6.9 percent in the same period.

The statistics agency, which does not provide seasonally adjusted GDP data, forecast the tech-reliant economy would grow 4.51 percent next year and revised up this year's forecast to 4.58 percent from a 4.38 percent estimate in May.

DOMESTIC DEMAND VITAL

"Looking ahead to the second half, domestic demand will be the key, as it must rise as the uncertainties in the United States could mean that exports are impacted slightly," said KGI Securities analyst Fang Wen-yen.

"The chance for private investment growth in the second half is pretty good as the financial stimulus measures announced by the economic ministry will be implemented, and as next year is an election year, there should be more in store."

Orders for exports to the United States in July were only 6.5 percent higher than a year before, according to separate official data on Thursday. Orders from Europe grew by 32.5 percent.

The government now expects overall exports to grow by 6.9 percent this year, up slightly from a previous forecast of 6.8 percent.

Taiwan is home to the world's two biggest contract chip producers and makes about 80 percent of the world's laptops and around 40 percent of flat panel displays.

Private consumption, which is recovering after a credit card crisis last year, will probably increase by 3.0 percent in 2007, unchanged from the previous estimate, and by 3.14 percent in 2008, the statistics agency said.

It expects Taiwan's consumer price index (CPI) to rise 1.48 percent in 2007, up from a 1.46 percent estimate in May, and it sees inflation at 1.46 percent next year.

Mexico trade deficit $762 mln in July

Aug 23, 2007 - Mexico's trade deficit shrank to $762 million in July, the government said on Thursday, but it was still higher than expected.

Analysts surveyed by Reuters had forecast the monthly trade deficit at $500 million, compared with an $827 million deficit in June.

Exports rose 14.1 percent year on year, of which non-oil exports increased 13.2 percent, the government said.

Imports in July rose 15.8 percent over the same month a year ago. Of that total, intermediate imports climbed 16.4 percent, imports of consumer goods rose 17.1 percent and capital goods imports increased 10 percent.

Fiscal 2008 budget deficit seen at $155 billion

Aug 23, 2007 - The U.S. budget deficit for this fiscal year will shrink to $158 billion, the Congressional Budget Office said on Thursday, much lower than a March estimate of $177 billion due mainly to strong economic growth.

In its August review of the budget, the nonpartisan agency forecast the deficit for fiscal 2008, which begins October 1, to be at $155 billion. In March the CBO estimated a fiscal 2008 budget deficit of $113 billion.

The agency cited economic uncertainty due to housing market problems, but said the most likely outlook was for a "sound" U.S. economy. The agency said the long-term budget outlook was "daunting," however, due largely to rising health care costs.

Inflation as measured by the consumer price index for urban consumers is projected to decline to 2.3 percent next year from 2.8 percent this year, the report said.

"Prices for food and energy, which increased during the first half of this year, are expected to moderate, keeping overall inflation lower than in the recent past," it said.

Norway Q2 GDP Growth Slows To 1.3%

Aug 23, 2007 - The economic growth in Mainland Norway came in at 1.3% sequentially in the second quarter, the statistical office said Thursday. The economy expanded 1.6% in the first quarter. The report noted that that production of services contributed most to the GDP growth. The growth rate was strong in the household consumption. The wholesale and retail trade climbed 2.7% in the second quarter.

Germany's GDP growth slows in Q2

Aug 23, 2007 - The pace of growth in Europe's biggest economy slowed from the first quarter to the second quarter, the German government said Thursday as it issued its final numbers on growth for the country of 82 million people.

The Federal Statistics Office, or Destatis, said that gross domestic product rose 0.3 per cent in the April-June period from the first three months of the year. Year-on-year growth slowed to 2.5 per cent from 3.3 per cent in the second quarter of 2006, the agency said.

The quarter-to-quarter and year-on-year figures were in line with the expectations of analysts polled by Dow Jones Newswires and mirrored the preliminary figures that were released August 14.

GDP in the second-quarter was driven in part by exports abroad, not surprising given that Germany is the biggest exporter in the world, ahead of China and the United States.

The statistics office said growth in the second quarter was driven mainly on the export side, with its contribution to GDP growth a lot higher than that from domestic demand, which also grew.

Growth in exports was 9.4 pct compared with the 6.1 pct in imports, with the net result from external trade contributing 1.7 percentage points to GDP growth.

Expenditures of private households posted an increase of 0.6 pct compared with the first quarter while those from the state were "somewhat lower" from the first quarter.

Investments in machinery were up 2.5 pct while in construction, it was down 4.8 pct. Inventories were down 0.6 pct.

The persistent strength of the euro which recently has hovered around record highs against the US dollar carries the risk of European exports becoming more expensive and less competitive.

Germany has been emerging over the past two years from a lengthy period of economic stagnation that pushed up unemployment and prompted Germans to tighten their purse strings.

Brazil posts current account deficit in July

Aug 23, 2007 - Brazil posted a current account deficit of $717 million in July compared with a surplus of $3.05 billion in the same month a year ago, the central bank said on Thursday.

The result was weaker than the $100 million surplus median forecast of 16 economists surveyed by Reuters. The estimates ranged from a deficit of $750 million to a surplus of $785 million.

In June, the current account -- the widest measure of a country's trade in goods and services -- was a surplus of $696 million.

In the 12 months through July, Brazil posted a current account surplus equal to 0.99 percent of gross domestic product compared with 1.33 percent through June.

The current account balance tracks a country's net flow of external transactions, including foreign trade, interest payments and services such as tourism. It is used to gauge a country's dependence on foreign capital.

Foreign investment, which falls under the capital account of the balance of payments, has surged as falling interest rates and accelerating economic growth prompt companies to invest in plants and machinery to produce more goods.

Foreign direct investment in Brazil, Latin America's largest economy, jumped to $3.58 billion in July from $1.59 billion in the same month a year ago. In June FDI had surged to a monthly record of $10.32 billion.

Singapore July CPI up 2.6 pct yr-on-yr on consumer tax hike

Aug 23, 2007 - Singapore's consumer price index rose 2.6 percent from a year earlier in July after the government raised the tax on goods and services to seven percent from five percent effective July 1, the Department of Statistics said Thursday.

Compared to June, CPI was up 2.1 percent, it said.

Consumer prices rose due to higher costs of healthcare services, recreation, food,

transportation and communications, the statistics agency said. The cost of housing also edged higher, reflecting rising rents, electricity tariffs and maintenance costs, it said.

In the seven months to July, CPI was up one percent compared to the year-ago level, in line with government estimates.

Argentina's July primary surplus jumps 23 pct yr/yr

Aug 22, 2007 - Argentina's July primary budget surplus widened 23 percent to 2.58 billion pesos ($804 million), due in part to pension contributions shifted to the state system, the government said on Wednesday.

The figure, which excludes interest payments on Argentina's debt and is seen as a gauge of the country's credit-worthiness, was well below the median forecast of 3.0 billion pesos given in last month's central bank survey.

After debt servicing, the budget surplus was 1.52 billion pesos, the Economy Ministry said in a statement.

A reform to the pension system allowing Argentines to switch from private plans to the government program has boosted state revenues. Sales, income and export taxes also contributed to higher income, the government said.

Spending on social security rose in July, as did capital spending. Payments to the body that administers the wholesale electricity market also rose as especially-cold weather during the austral winter caused demand for power to surge.

Argentina's primary surplus totaled 2.09 billion pesos in July 2006. ($1 = 3.2075 Argentine pesos)

Fed Moves To Calm Investor Panic

Fed Moves To Calm Investor Panic
Evelyn M. Rusli, 21 August 2007, 6:00 PM ET

The Fed moved to soothe the savage Wall Street beast on Tuesday.

Droves of wary investors fled risky investments and not-so-risky investments for the safe haven of Treasury bills on Tuesday morning. To quell the stampede, the New York Fed slashed a fee bond dealers pay to borrow Treasuries to 0.5% from 1.0% during afternoon trading. By lowering the borrowing cost, the Fed made Treasury bills easier for banks to acquire, helping to satiate frenzied demand for these securities.

Before the Fed action, the yield on the three-month Treasury bill had plunged to 2.93% in morning trading, the first time it was below 3% in two years. Investors were exhibiting a lack of confidence in commercial paper, the mainstay of money-market funds and one of the safest private-sector investments. These short-term loans to corporations are trading at about 5.34% for three-month maturities, far above the slightly safer T-bill rate. After the Fed acted, the three-month Treasuries rebounded to 3.64%, up from 3.18% late on Monday.

The recent exodus from bond-market investments with practically any risk underscores a systemic trust crisis plaguing U.S. markets. The credit crunch that arose from the meltdown in the subprime mortgage market has hit a swath of financial institutions hard and fast, leaving investors with sky-high losses. As the hemorrhaging continues, investors have grown leery of the banks, the rating agencies, mortgage players, and even the Federal Reserve itself.

"The public has lost confidence in the integrity of investment and mortgage bankers," University of Maryland Business Professor Peter Morici said on Tuesday. "A lot of people with conflicting interests exaggerated the quality of the paper they were selling."

Mortgage-backed securities created from loans to borrowers with limited creditworthiness were treated as relatively safe investments by the ratings agencies and financial firms that packaged the bonds in the past few years. Early this year, when some borrowers began defaulting on their loans and housing prices started to fall -- meaning that the homeowners couldn't sell their homes at profits to pay off their debts -- investors began fleeing subprime-backed securities and then all kinds of mortgage-backed bonds.

In this era of skepticism, investors have rushed to place cash in the safest vehicles. Suddenly, low-yielding but highly dependable government bonds look like a hot investment. On Tuesday, yields across the Treasury maturity spectrum extended their recent tumble. The return on the six-month bill fell to 3.79% on Tuesday from 3.89% on Monday, while the benchmark 10-year note dropped to 4.60% from 4.63%. But the most notable decline was the three-month issue at 2.93%, down from 3.18% on Monday and around 4.80% a month ago.(See: "Wall Street Sidelined By Flight To T-Bills." )

Read full article here

Subprime Infects $300 Billion of Money Market Funds, Hikes Risk

By David Evans
Aug 20, 2007 (Bloomberg)

Money market funds were invented 37 years ago to offer investors better returns than bank savings accounts while providing a high degree of safety. Most of the $2.5 trillion sitting in these funds is invested in such assets as U.S. Treasury bills, certificates of deposit and short-term commercial debt.

Unlike bank accounts, money market funds aren't insured by the federal government. They almost never fail.

Unbeknownst to most investors, some of the largest money market funds today are putting part of their cash into one of the riskiest debt investments in the world: collateralized debt obligations backed by subprime mortgage loans.

CDOs are packages of bonds and loans, and almost half of all CDOs sold in the U.S. in 2006 contained subprime debt, according to a March report by Moody's Investors Service.

U.S. money market funds run by Bank of America Corp., Credit Suisse Group, Fidelity Investments and Morgan Stanley held more than $6 billion of CDOs with subprime debt in June, according to fund managers and filings with the U.S. Securities and Exchange Commission. Money market funds with total assets of $300 billion have invested in subprime debt this year.

The danger of owning even highly rated CDOs containing subprime loans was thrown into sharp relief in June, when two Bear Stearns Cos. hedge funds that were holding subprime CDOs collapsed.

Under SEC rules, money market managers must invest in securities with "minimal credit risks.'' Joseph Mason, a finance professor at Drexel University in Philadelphia and a former economist at the U.S. Treasury Department, says subprime debt in money market funds is far from safe.

"This creates tremendous risk for today's money market investors,'' says Mason, who wrote an 84-page report on CDOs this year. "Right now, I'm not comfortable investing anything in CDOs.''
Global financial markets were rocked in July and August, first by the collapse of the Bear Stearns hedge funds and then when banks and insurance companies worldwide disclosed their U.S. subprime debt holdings.

On Aug. 9, BNP Paribas SA, France's biggest bank by market value, froze withdrawals on three investment funds with assets of 2 billion euros because the bank couldn't find a way to value its U.S. subprime bonds and other assets. CDOs aren't bought and sold on exchanges and their trading has little transparency.

During the first two weeks in August, central banks in Europe, Japan and Australia and the U.S. Federal Reserve lent more than $300 billion to banks to stem a collapse in credit markets.
On Friday, the Federal Reserve lowered the interest rate it charges to banks to 5.75 percent from 6.25 percent in an attempt to contain the subprime mortgage collapse.

Until recently, CDOs had been the fasted-growing debt market -- outpacing corporate and municipal bond sales by dollar total -- with about $500 billion sold in 2006, up from $99 billion in 2003, according to Morgan Stanley.

CDO Slump

About a quarter of the content of all CDOs sold last year in the U.S. was made up of securitized subprime mortgage loans. CDO sales slumped to $11.9 billion in July from $36.9 billion in June, according to JPMorgan Chase & Co.

Each time a bank or financial firm creates a CDO, it forms a free-standing company incorporated offshore, usually in the Cayman Islands, which doesn't tax corporations. All CDOs have a trustee, usually a bank, that prepares monthly reports on the changing contents of the debt package.

The trail that connects subprime debt to money market funds usually starts with a mortgage broker who makes a loan to a homebuyer with poor credit. A middleman then bundles hundreds of these subprime mortgages into so-called asset-backed securities.

Next, a CDO manager buys hundreds of these securities for collateral for a CDO. Some CDOs issue commercial paper, and brokers can then sell that paper to money market funds.

Commercial paper, which is typically issued by banks and large companies, is debt maturing in less than 270 days.

Commercial paper pays relatively low interest rates, which averaged about 5.3 percent in June and July, because it rarely defaults. There have been occasional exceptions, such as paper issued by Enron Corp. and WorldCom Inc., both of which filed for bankruptcy earlier in this decade.
CDO commercial paper, often loaded with subprime debt, pays higher returns than corporate paper, and it paid as much as 6.5 percent in August.

This year, CDOs have sold more than $11 billion in the form of investment-grade commercial paper to money market funds, SEC filings show. The paper has the highest credit rating because Fitch Ratings, Moody's and S&P give AAA or Aaa ratings to the top portions of CDOs, which are the source of all CDO commercial paper.

Investors are accustomed to treating money market funds as if they were bank savings accounts. The last thing they expect is that the subprime debt turmoil would enter their safe cash havens. And now it has.

Read full article here

Hong Kong July CPI Up 1.5 Pct Yr-on-Yr Vs Up 1.3 Pct in June

Aug 21, 2007 - The composite consumer price index (CPI) in July was up 1.5 pct from a year earlier, compared with a 1.3 pct increase recorded in June, the government said.

A government spokesman said the larger year-on-year increase in consumer price inflation in July, compared with June, was due mainly to bigger hikes in the prices of pork, private housing rentals and the cost of meals bought away from home.

Mexico foreign investment up 39.2 pct in 1st half

Aug 21, 2007 - Foreign direct investment in Mexico was $13.244 billion in the first half of the year, up 39.2 percent from the same period in 2006, the government said on Tuesday.

The government also increased its estimate for foreign direct investment over the whole of 2007 to $23 billion from $18.3 billion.

The government's previously estimated investment had 2007 foreign direct investment slowing slightly from the $19 billion that investors sank into Mexico last year, when the economy was growing at a faster pace.

Mexico's economy is seen growing about 3.6 percent this year, down from 4.8 percent in 2006.

Canada July inflation steady, rates seen on hold

Aug 21, 2007 - Canada's annual inflation rate held unchanged at 2.2 percent in July and the core rate fell to 2.3 percent from 2.5 percent in June, a steady performance that analysts said makes an interest rate rise in September highly unlikely.

Statistics Canada said on Tuesday that lower energy prices countered the fact that a sales tax cut on July 1, 2006, dropped out of the annual inflation calculations. The tax cut had reduced inflation by an estimated 0.6 percentage points in July last year. Energy prices fell 1.7 percent from July 2006.

"At the very least you can say it will give the Bank of Canada a bit more comfort in standing on the sidelines in September as it waits out the financial market squalls," BMO Capital Markets deputy chief economist Doug Porter said of the July figures.

BMO changed its interest-rate forecast on Tuesday and said that instead of raising rates in September, as had been widely expected earlier this summer, the Bank of Canada would stay on hold until next year.

The central bank targets inflation at 2 percent and tries to keep it between 1 and 3 percent. In July it said overall and core inflation was higher than projected, but should decline to 2 percent by early 2009.

The bank last month forecast total inflation of 2.6 percent in the third quarter, rising to 3.0 percent in the fourth. It saw core inflation, which strips out volatile items, at 2.3 percent in the third quarter and 2.2 percent in the fourth.

Before the latest financial market turmoil, the bank had said further rate hikes may be required, but analysts now increasingly expect it will stand pat on Sept. 5, its next scheduled interest rate announcement date. There's even been talk of a quick rate cut.

Another indicator came in soft on Tuesday. Retail sales in June declined by a greater-than-expected 0.9 percent from May, when sales rose by a decade-high 2.6 percent. Overall for the second quarter, retail sales rose by 3.0 percent.

TD Securities forecasts the Bank of Canada will hike rates in October after giving September a miss, pointing out rising wage growth and low unemployment.

"I think the market perspective is if inflation gets sufficiently soft that opens the door to rate cuts, and I don't think this number is sufficiently soft to really support that," TD Securities strategist Eric Lascelles said.

The central bank also faces the challenge of uneven performance across Canada. Prices rose a year-on-year 5 percent in the oil-boom province of Alberta, but they were up only 1.0 percent in Newfoundland, and 1.3 percent in Quebec.

A closer look at Fed Rates

On Aug 17, 2007 before the US markets open, the Fed surprised everyone by reducing its discount rate from 6.25% to 5.75%. The Fed Funds rate remained at 5.25% and the Prime rate has also not changed, and stayed at 8.25%. As a result, the markets were greatly encouraged and rallied.

What do these rates mean?

Fed Funds Rate: The Fed Funds Rate is the overnight interest rate at which U.S. banks lend to each other their excess reserves held on deposit at the U.S. Federal Reserve.

Discount Rate: The Discount Rate is the overnight rate at which U.S. banks can borrow from the U.S. Federal Reserve.

Prime Rate: The Prime Interest Rate is the interest rate charged by banks to their most creditworthy customers (usually business customers). The rate is almost always the same among major banks. Adjustments to the prime lending rate are typically made by banks at the same time.

What does the discount rate reduction mean?

The cost to banks for borrowing from the Fed has dropped, while the rate they earn loaning to each other and the rate they charge their customers has not dropped. That means they make more money when they loan today than they did last week. That means banks are somewhat more likely to lend and that the economy will be somewhat more liquid. That presumably will help reduce investor worries in the bond and stock markets over the liquidity aspects of the current debt crisis.

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