Inflation Report. October 2012

Transcription

1 Inflation Report October 212 The Inflation Report is prepared quarterly by staff of the Bank of Thailand with the approval of the Monetary Policy Committee (MPC). It serves two purposes: (1) to provide a clear forward-looking framework for economic and inflation forecasting to assist the MPC in making monetary policy decisions and (2) to give the MPC an opportunity to present the explanation for their decisions on various policy issues to the public. Although individual MPC members may have differing opinions regarding the assumptions on which the forecasts are based, as a group they are in agreement with the forecasts on the outlook for inflation and output as well as the risk factors involved as illustrated in the fan charts. The Monetary Policy Committee: Mr. Prasarn Trairatvorakul Chairman Mrs. Pongpen Ruengvirayudh Vice Chairman Mrs. Tongurai Limpiti Member Mr. Ampon Kittiampon Member Mr. Narongchai Akrasanee Member Mr. Siri Ganjarerndee Member Mr. Aswin Kongsiri Member Inflation Report October 212

2 Thailand Monetary Policy Strategy Monetary Policy Formulation The Monetary Policy Committee (MPC) sets monetary policy in order to attain price stability conducive to sustainable economic growth. The MPC also monitors factors contributing to external stability and financial imbalances. The Monetary Policy Instrument The MPC utilizes the 1-day bilateral repurchase transaction rate as the key policy rate to signal the monetary policy stance. The Target The MPC uses core inflation (excluding raw food and energy) as its policy target with the range of.5-3. percent (quarterly average). In the event that the target is missed, the MPC is required to explain the reasons thereof to the public. Forecasting Tools To assist the MPC in making monetary policy decisions, the Bank of Thailand has developed a macroeconomic model to forecast economic conditions and inflation outlook. The model is also employed to evaluate the impact of various factors on the economy and to offer guidelines for appropriate monetary policy responses. Inflation Report October 212

3 Contents 1. Growth and Inflation Prospects and Monetary Policy Growth and inflation prospects Economic outlook Inflation pressure Monetary policy decisions Appendix Recent Economic Developments The global economy The domestic economy Costs and prices Monetary and Financial Stability Financial markets Financial institutions Non-financial sectors 42 BOX: Quantitative Easing III and its impact on Thai economy 47 Inflation Report October 212

4 1. Growth and Inflation Prospects and Monetary Policy The Thai economy is poised to moderate in the second half of the year, after short-term factors fueling first half s demand pick-up dissipated. The impact of sluggish global demand on exports and related manufacturing production has also become more apparent, possibly weighing on investment going forward. The MPC, however, views well-supported domestic demand to help cushion against global economic risks to some degree. Looking ahead, inflation is viewed to soften further. Demand pressure subsides with domestic growth that is expected to lose some momentum due to the global slowdown, while cost pressure moderates with next year s softer global oil prices. The majority of the MPC deemed in its latest meeting that, with upside risks to inflation contained, monetary policy easing was warranted to shore up domestic demand in the period ahead and ward off the potential impact from the global economy, which remained weak and fragile. The MPC thus voted 5 to 2 to reduce the policy rate by.25 percent, from 3. to 2.75 percent per annum. 1.1 Growth and inflation prospects Thailand s growth starts to decelerate to normal amid softened inflation outlook. The Thai economy is poised to moderate in the second half, as short-term factors fueling first half s rebound dissipated (Chart 1.1). Flood reconstruction tapered off sooner than expected, while pent-up consumption demand has already been met. Meanwhile, the impact of sluggish global demand on exports has become more apparent. The MPC, however, assesses wellsupported domestic demand to help offset export weakness to some degree, thus keeping this year s growth forecast unrevised. But going forward, the global economy will likely weigh on exports and Chart 1.1 Thailand s GDP growth Quarterly percentage change (seasonally adjusted) Outturn IR Oct 12 forecast Source: Office of the National Economic and Social Development Board and calculation by Bank of Thailand Note: At 1988 prices (seasonally adjusted) Inflation Report October 212 1

5 Table 1.1 Forecast summary Percent 211* GDP growth (5.7) (5.) Headline inflation (2.9) (3.4) Core inflation (2.2) (1.9) Note: * Outturn ( ) Inflation Report July 212 Source : Office of the National Economic and Social Development Board and calculation by Bank of Thailand Chart 1.2 GDP growth forecast Annual percentage change Note: The fan chart covers 9 percent of the probability distribution Chart 1.3 Headline inflation forecast Annual percentage change Note: The fan chart covers 9 percent of the probability distribution private investment more than assessed, driving down next year s growth projection (Table 1.1). The global economy, given its weak prospects and high uncertainty, continues to be the major source of downside risks to growth. Recovery in the euro area and the U.S. will take time given lackluster momentum overall. On the other hand, Asian economies will suffer more visibly from the global economy in line with further signs of export slowdown. While recent monetary policy easing in Europe and the U.S. helps support near-term sentiment, the MPC deems that such efforts are unlikely to change the deteriorated global growth outlook. Unanticipated risks to Thailand s growth from the domestic front also exist, though somewhat balanced. Implementation uncertainty and disbursement delay pose some risks to public spending under the 35-billion-baht water management plan. But on the upside, the government may also manage to expedite its long-term infrastructure investment commanding a total sum of 2.27 trillion baht. Looking ahead, the MPC judges downside risks to growth to dominate, mainly from global economic risks. The fan chart for growth is thus skewed downward over the projection period (Chart 1.2). Inflation pressure is viewed to soften in the period ahead. Demand pressure subsides with (1) domestic growth outlook that is more affected by the global slowdown; and (2) flood reconstruction that tapered off early, while cost pressure also softens partly from next year s softer global oil prices. These views, altogether, 2 Bank of Thailand

6 result in lower core inflation forecasts. Additionally, the MPC also revises its assumption that the government would postpone the reintroduction of fuel excise taxes over the projection period, compared to the previous view that the taxes would resume in early 213. This changed assumption, in effect, drives down next year s headline forecast substantially. Looking ahead, the MPC judges risks to inflation to remain weighed to the downside, given greater risks to domestic growth due to the global slowdown. Accordingly, the fan charts for inflation remain skewed downward over the forecast period (Chart 1.3 and 1.4). 1.2 Economic outlook Thailand s growth momentum starts to decelerate back to normal, while the impact of slowing global economy on exports and investment may be more than assessed. The Thai economy is poised to moderate to its normal trend in the latter half of the year, after near-term factors fueling first half s demand surge waned off. Exports and investment are also viewed to suffer from the global economy more than assessed. Nonetheless, overall strength in domestic demand will help sustain nearpotential economic growth in the period ahead. Growth momentum decelerating to normal The Thai economy is poised to moderate to its normal trend in the latter half of the year, as near-term factors fueling first half s demand pick-up dissipated. In particular, private sector s reconstruction investment tapered off earlier than Chart 1.4 Core inflation forecast Annual percentage change Note: The fan chart covers 9 percent of the probability distribution. Inflation Report October 212 3

7 Billion baht 1,4 1,3 1,2 1,1 211 Chart 1.5 Level of GDP 1, Source: Office of the National Economic and Social Development Board and calculation by Bank of Thailand Note: At 1988 prices (seasonally adjusted) 212 IR Jul 12 forecast IR Oct 12 forecast Table 1.2 Forecasts for GDP and components Percent GDP growth Domestic demand Private consumption Private investment Government consumption Public investment Exports of goods and services Imports of goods and services Note: At 1988 prices Annual percentage change Chart 1.6 Growth assumptions for Thailand s trading partners Percentage point Left axis: Jul 12 (baseline) Right axis: Change in baseline Oct 12 (baseline) assumptions Oct 12 (worse case) Note: Weighted by each country s share in Thailand s total exports expected, and pent-up consumption demand has already been met. The impact of weak global demand on exports and relataed manufacturing production has also become more apparent, as reflected in slowing foreign orders and capital utilization for export-oriented industries such as hard-disk drives and integrated circuits, as well as in falling imports of capital goods and raw materials. The MPC, however, assesses domestic demand momentum to sustain, which will help offset the negative impact of the global economy and support near-potential economic growth in the period ahead (Chart 1.5 and Table 1.2). Overall, the MPC keeps its growth forecast for 212 unrevised at 5.7 percent, assessing domestic demand to retain traction despite some moderation hinted by investment and import indicators. For 213, growth is projected to continue, but at a pace slower than expected due to: (1) persisting weakness and concerns in the global economy, which are likely to affect exports and domestic spending more than expected; and (2) delayed disbursement for government s investment on water management projects. More weakness in global growth outlook Recent easing in major economies may help support near-term sentiment, but is unlikely to change the deteriorated global growth outlook. Thailand s trading partners economies are viewed to weaken from the previous assessment (Chart 1.6), especially for advanced economies where growth is likely to remain subpar given the prolonged and widespread impact of the European sovereign debt crisis. The MPC projects 4 Bank of Thailand

8 the euro area s economy to contract for the rest of the year as previously assessed (Chart 1.7). While the debt crisis is not expected to intensify much further, delayed resolution and implementation hurdles will continue to affect businesses and investors confidence. Core member countries exports to non-euro destinations have also started to show signs of slowdown following the weak global growth. Nonetheless, solid economic fundamentals of core countries such as Germany, as well as non-euro export demand that should improve slowly with the global economic recovery, will help shore up euro area s growth next year. But the euro area s recovery will be gradual, given that European governments still need to implement fiscal consolidation, while banks may need to recapitalize and are likely to maintain credit standards for households and businesses. These factors will put constraints on the euro area s demand recovery going forward. On the other hand, growth in the U.S. is viewed to remain subpar (Chart 1.8), with momentum slightly dampened from the previous assessment. Despite recent improvements in several sectors, the labor market remains weak overall. Businesses also seem to postpone investment and hiring, awaiting details on the reduction of fiscal deficits and the extension of stimulus expiring this year. Additional monetary policy easing by the European Central Bank (ECB) and the Federal Reserve (FED) helps support near-term sentiment to some degree, but is unlikely to improve much on growth prospects. The ECB has announced its Outright Monetary Transactions (OMTs), which involves unlimited bond purchases in secondary Annual percentage change Chart 1.8 Growth assumptions for the U.S. Annual percentage change Chart 1.7 Growth assumptions for the euro area Percentage point Left axis: Jul 12 (baseline) Right axis: Change in baseline Oct 12 (baseline) assumptions Oct 12 (worse case) 213 Percentage point Left axis: Jul 12 (baseline) Right axis: Change in baseline Oct 12 (baseline) assumptions Oct 12 (worse case) Inflation Report October 212 5

9 markets. While this measure should help reduce funding costs and support member countries fiscal deficit reduction, some concerns remain regarding implementation and possible delay. In the U.S., the FED has also introduced its third round of quantitative easing (QE3). However, this round of QE is not viewed to have an impact as strong as the first two rounds, given bond markets that are in better conditions than in and market s anticipation of the measure. Nonetheless, these easing efforts will help contain downside risks to global growth to some extent. In the worse-case scenario for the euro area, the MPC views it possible that Greece might fail to cut its public debt as stated in loan conditions, leading to Greece s default and eventual exit from the euro area next year. In such event, the OMTs would help limit contagion risks to vulnerable countries such as Spain and Italy, as also reflected in the euro area s worse-case growth that improves from the previous assessment. Meanwhile, Asian economies seem to suffer more visibly from global demand, with subdued growth projected going forward. Several countries exports have started to contract with exports to advanced economies, especially for manufacturing exports, where foreign orders start to decline. The impact of export weakness on production and consumption has also become visible already in some countries. China s growth, at the same time, is viewed to soften from the previous assessment, possibly weighing more on regional countries exports in the period ahead. Regarding recent easing in Europe and the U.S., the MPC assesses the impact on capital inflows to 6 Bank of Thailand

10 be benign due to (1) decreased returns on investment in Asia given already-high asset prices and (2) Asia s softened growth prospects along with the global economy. Global demand weighs on Thai exports more visibly The impact of global demand on Thai exports and export production has become apparent, while imports are likely fall more than expected. Merchandise exports are likely to soften given the stronger-than-expected impact from the global economy, before improving in the second half of 213 with global economic recovery. The impact of global demand on manufacturing exports have become more apparent, especially for electronic products and electrical appliances where foreign orders start to decline. Exports of automobiles and parts still manage to expand, but with some signs of moderation going forward. Meanwhile, agricultural exports are viewed to weaken partly due to rice exports, which suffer from high rice prices given the rice mortgage scheme. Rubber exports are also likely to soften with global demand conditions. Looking ahead, rice exports will continue to face challenges given that the rice mortgage scheme has been extended. The MPC anticipates export weakness to pass on to export production as well as private sentiment and spending more visibly in the period ahead. Imports are also likely to decelerate to the normal trend. A slight contraction is expected in the third quarter given falling imports of raw materials and intermediate goods, as well as Inflation Report October 212 7

11 Table 1.3 Forecasts for the external sector Growth in value of exports* (F.O.B., percent) Growth in value of imports* (F.O.B., percent) Trade balance (billion U.S. dollars)* Current account balance (billion U.S. dollars)* Note: *Data revision according to definitions in IMF s Balance of Payments Manual, 6 th edition (BPM6), and Ministry of Commerce s revised database slower imports of capital goods. This reflects flood reconstruction that tapered off early. Possibly, weakness in imports of raw materials may also signal softer demand momentum going forward. Relative to the previous assessment, the MPC expects the current account 1/ balance to improve, registering a surplus in 212. This owes to both (1) lower deficit in service account given higher tourism revenue and lower freight expense; and (2) improved trade balance with imports falling much faster than exports, in line with dissipated reconstruction demand. For 213, the current account surplus is expected to be lower than in 212, given lesser claim payouts from foreign insurance companies (Table 1.3). Private demand is projected to moderate, but with sustained momentum Consumption and investment start to moderate to normal in the second half, with nearterm boosts waning off. Major risks arise from exports given weak global demand conditions. Despite some deceleration to its normal trend, private consumption is viewed to retain momentum and continue to serve as the key growth driver in the period ahead. Consumption momentum in the second half of this year will moderate somewhat as short-term factors fueling first half s pick-up dissipated, including pent-up demand that has been fulfilled. But looking ahead, consumption prospects remain strong given several supporting factors. (1) Government s 1/ Including reinvested earnings 8 Bank of Thailand

12 stimulus measures remain, especially the first-car scheme with tax rebates starting from October 212 onward. This will help support consumption through the first half of 213. (2) Households income prospects are favorable, given the increase in minimum wage and civil servant s salary, along with the government s intervention for key products such as rice, rubber, sugar cane, and cassavas. (3) Overall monetary conditions remain supportive, with banks unlikely to tighten their household credit standards soon. Private investment shows signs of slowdown given reconstruction spending that waned off early. Private investment in the third quarter is bound to moderate from the preceding quarter from machinery and equipment investment, along with slowing imports of capital goods. However, over the medium- and longterm, the MPC still views investment outlook to remain favorable thanks to (1) businesses overall confidence and commitment to long-term plans; (2) continued demand for investment in Thailand, as reflected in high demand for investment loans and high amount of investment promotion requested; (3) Thailand s strengths in infrastructure, skilled labor, and well-established supply chains especially for automobiles and parts; and (4) investment in 3G projects starting from 213 onward. Supportive factors and high investment demand will continue to benefit investment in the period ahead. Nonetheless, some key challenges still need to be monitored. (1) Businesses remain concerned about labor shortage and increased Inflation Report October 212 9

13 Percentage of GDP Chart 1.9 Budget balance Fiscal year Outturn IR Oct 12 forecast Source: Bureau of the Budget and calculation by Bank of Thailand Table 1.4 Assumptions on public sector expenditure Unit: Billion baht General government consumption Asof Jul 212 Asof Oct 212 FY 212 FY 213 FY 212 FY 213 1, , , ,57.4 Public investment Total 2, , ,82. 2,334. Note: FY denotes fiscal year. wage costs, both affecting businesses decisions to base production in Thailand. (2) Implementation uncertainty and delayed disbursement pose some risks to government s investment especially on long-term water management and infrastructure projects. (3) Protracted global slowdown may also weigh on investment decisions in export-oriented industries over the period ahead. Some delay in fiscal spending Part of fiscal stimulus is viewed to soften given delayed disbursement for investment expenditure and spending on water management. But overall, fiscal spending will continue to play a key role in supporting private demand. Fiscal spending continues to provide stimulus over the projection period, with budget deficits for fiscal year 212 and 213 amounting to a high percentage of GDP (Chart 1.9). But relative to the previous assessment, the MPC views fiscal stimulus to soften from delayed investment spending both in the budget and on water management projects (Table 1.4). For fiscal year 212, disbursement of investment budget is likely to be further delayed, since priority is given to the central budget alloted for flood rehabilitation and prevention (12 trillion baht in total), which has a designated deadline. This, in effect, causes some delay on other investment projects. And in light of flood devastation, several government offices also have to revise their investment plans and projects, thus adding more time to the process. The MPC expects the delayed investment to be carried over to fiscal year 213. On the other hand, disbursement of current expenditure 1 Bank of Thailand

14 should be as expected. Regarding the 35-billionbaht water management plan, disbursement will start gradually from the second half as anticipated earlier. However, expecting some additional delay, the MPC lowers its disbursement assumption for this portion of spending, and delays the spending more into future fiscal years. 1.3 Inflation pressure Inflation outlook softens from the previous assessment, given the stronger impact of global economic slowdown on domestic growth and government s policy on retail energy prices. Risks to inflation remain weighed to the downside. Softer inflation pressure overall Both demand and cost pressures are likely to soften from the previous assessment. Demand pressure subsides with domestic growth outlook that is more affected by the global slowdown, as well as flood reconstruction that tapered off early. Nonetheless, the MPC still expects some demand pressure to remain given near-potential economic growth, as reflected in the output gap that opens slightly over the projection period (Chart 1.1) Cost pressure is also viewed to subside, partly from next year s softer-than-expected global oil prices (Chart 1.11) due to persisting weakness and concerns in the global economy. However, global oil prices will remain supported by existing supply concerns, given tensions in the Middle East and low OPEC spare capacity. Besides oil prices, other costs remain relatively benign. Nonfuel commodity prices (Chart 1.12) are likely to grow slowly due to global growth concerns. On Percent U.S. dollars per barrel Chart 1.1 Output gap IR Oct 12 forecast Chart 1.11 Assumptions on Dubai oil price U.S. dollars per barrel Left axis: Jul 12 (baseline) Right axis: Change in baseline Oct 12 (baseline) assumptions Oct 12 (high case.5 S.D.) Oct 12 (low case.5 S.D.) Annual percentage change Chart 1.12 Assumptions on non-fuel commodity prices Percentage points Left axis: Jul 12 (baseline) Right axis: Change in baseline Oct 12 (baseline) assumptions Inflation Report October

15 Chart 1.13 Assumptions on fresh food prices Annual percentage change Percentage points Left axis: Jul 12 (baseline) Right axis: Change in baseline Oct 12 (baseline) assumptions the other hand, domestic fresh food prices (Chart 1.13) will be weaker than expected for the rest of this year given abundant supply in almost all products. However, prices are expected to edge up gradually next year, partly from the impact of the recent drought in the U.S. on global crop prices, which passes on to fodder prices and, in turn, gives some upward pressure to domestic prices of meats, eggs, and dairy products. Additionally, the MPC s new assumption on government s energy price policies also drives down 213 s headline forecast considerably (Table 1.1). This time, the MPC assumes the government to postpone the reintroduction of fuel excise taxes over the forecast period to help cushion energy and transportation costs, compared to the previous view that the taxes would start in early 213. This changed assumption also implies no increase in transportation costs over the forecast period. However, the gradual increase in prices of liquefied petroleum gas (LPG) for the transport sector is likely to be implemented as expected. Looking ahead, the MPC judges downside risks to inflation to outweigh upside risks. Downside risks arise from weakened domestic growth outlook given global economic concerns. In particular, the impact of the global economy on exports and investment may be stronger than assessed, especially in case of disrupted fiscal stimulus in the U.S., intensified debt crisis in the euro area, or protracted slowdown in emerging market economies. Still, some upside risks to inflation also remain from tensions in the Middle East that may pressure global oil prices, and from 12 Bank of Thailand

16 the impact of minimum wage hike on domestic prices that may be more than estimated. 1.4 Monetary policy decisions Additional monetary policy easing The MPC voted to reduce the policy rate in its latest meeting, deeming that an easing was warranted to shore up domestic demand and ward off the impact from the global economy. In its meeting on 5 September 212, the MPC assessed overall risks to the global economy to remain elevated. Recovery in the U.S. continued to be tepid, while the euro area s economy had entered recession and was projected to weaken further in the latter half of the year. The impact of weaker global demand on Chinese and Asian economies also became more apparent. On the other hand, the Thai economy grew faster than expected in the second quarter, with consumption and investment momentum projected to sustain. Nonetheless, the impact of slowing global demand on Thai exports would become more apparent. Meanwhile, inflation pressure moderated and inflation forecasts stayed within the target range. The MPC viewed the impact of global demand on the Thai economy to have increased to some extent. However, domestic demand remained firm and current monetary conditions were accommodative enough to support economic expansion. The MPC thus voted 3 to 2 to hold the policy rate at 3. percent per annum, with two votes in favor of a.25 percent decrease. Two members were unable to attend this meeting due to obligations abroad. Inflation Report October

17 14 Bank of Thailand In its subsequent meeting on 17 October 212, the MPC viewed the global economy to remain weak, although economic indicators in the U.S. improved somewhat and monetary policy easing in advanced economies helped support near-term sentiment. Weak global demand had also weighed on Chinese and regional economies more than expected. Going forward, fiscal risks in the U.S. and challenges in resolving the European sovereign debt crisis still posed significant risks to the global economy. Meanwhile, the Thai economy continued to expand in the third quarter. Domestic spending and investment continued to grow, but at a moderated pace since flood reconstruction had tapered off. Softened global demand also affected exports and related production more apparently, and global economic uncertainty could hamper export recovery in the period ahead. In addition, inflation pressure stabilized at an acceptable level. With upside risks to inflation contained, the majority of the MPC deemed that monetary policy easing was warranted to shore up domestic demand in the period ahead and ward off the potential impact from the global economy, which remained weak and fragile. The MPC, therefore, voted 5 to 2 to reduce the policy rate by.25 percent, from 3. to 2.75 percent per annum. Two members voted to hold the policy rate at 3. percent per annum, deeming current growth momentum to be adequate and that further policy action could await greater clarity in the economic outlook.

18 1.5 Appendix Table 1.5 Forecast assumptions Dubai oil price (U.S. dollars per barrel) Non-fuel commodity prices (%YoY) Fresh food prices (%YoY) Minimum wage in the Bangkok Metropolitan Region (baht per day) Government consumption (%YoY) 1/ Public investment (%YoY) 1/ Fed Funds rate (% at year-end) Trading partners economic growth (%YoY) 2/ Regional currencies vis-à-vis the U.S. dollar (Index) 3/ Note: 1/ Including spending on water management plans 2/ Weighted by each country s share in Thailand s total exports 3/ Appreciation against the U.S. dollar indicated by a decrease Table 1.6 GDP growth forecasts by research houses HSBC JP Morgan NESDB 1/ n.a. Goldman Sachs BOT FPO 2/ DBS Bank Tisco Securities UBS Deutsche Bank Morgan Stanley Phatra Securities Credit Suisse Kasikorn Research Standard Chartered Note: Compiled and published by Reuters on October 11, 212, except: 1/ Published on August 2, 212, with the release of GDP data for 212 Q2 2/ Published on September 25, 212 Presented in descending order of 212 s forecast Table 1.7 Headline inflation forecasts by research houses Credit Suisse Kasikorn Research FPO 2/ HSBC DBS Bank Tisco Securities NESDB 1/ n.a. Goldman Sachs Deutsche Bank Phatra Securities UBS BOT Standard Chartered Morgan Stanley Note: Compiled and published by Reuters on October 11, 212, except: 1/ Published on August 2, 212, with the release of GDP data for 212 Q2 2/ Published on September 25, 212 Presented in descending order of 212 s forecast Inflation Report October

19 Table 1.8 Probability distribution of GDP growth forecast Percent Q3 Q4 Q2 Q3 Q4 Q2 Q3 > (-3) < (-3) Table 1.9 Probability distribution of headline inflation forecast Percent Q4 Q2 Q3 Q4 Q2 Q3 > (-1) < (-1) Table 1.1 Probability distribution of core inflation forecast Percent Q4 Q2 Q3 Q4 Q2 Q3 > < Bank of Thailand

20 2. Recent Economic Developments The global economy deteriorated further owing largely to the impact of prolonged and highly uncertain European sovereign debt crisis. The slowdown in major economies resulted in a decline in exports in many countries, which was even more apparent in Asian economies. This led to additional monetary easing in many countries to foster economic recovery, going forward. The Thai economy in 212 Q3 was projected to decelerate from the preceding quarter following the contraction in exports and export-related manufacturing against the backdrop of the global economic slowdown. Meanwhile, headline inflation in 212 Q3 accelerated as a result of last year s low base effect in energy prices and an increase in electricity fee. However, core inflation trended down as a result of an excess supply. Going forward, inflationary pressure would soften, thanks to the slowdown in domestic economy owing to the weakening global outlook. 2.1 The global economy The recession in the euro area continued to be protracted with risks to growth remaining elevated. Although the announcement of the European Central Bank (ECB) s Outright Monetary Transactions (OMTs) operation to purchase government-issued bonds in secondary markets would help ease economic and financial conditions, risks that countries with sovereign debt problems may not be able to lower their budget deficits to the level specified by the EU remained. The prolonged and uncertain sovereign debt crisis resulted in a continued recession in the euro area economy. In 212 Q2, the euro area economy contracted by.2 percent from the previous quarter (Chart 2.1), owing importantly to fiscal consolidation measures and worsened Chart 2.1 Economic growth rate in the euro area (Change from the previous quarter) Percent (Seasonally adjusted) Q2 211 Q3 211 Q Q Euro area Germany France Italy Spain Source: Eurostat Inflation Report October

21 Chart 2.2 Purchasing Managers Index (PMI) and Economic Sentiment Indicator in the Euro area Index Purchasing Managers' Index 4 Economic Sentiment Indicator (RHS) Jan 21 Jul Jan 211 Jul Jan 212 Jul Source: European Commission, Markit Economics Sep Index consumer and investor sentiments as a result of heightened uncertainty of the sovereign debt crisis (Chart 2.2). Looking ahead, the weakening of the euro area economy was expected to continue in 212 H2 as reflected by a worsening of economic indicators in many countries from the second quarter, including (1) low economic confidence; (2) a slowdown of production in core countries, reflected by the average of German industrial orders during the first 2 months of 212 Q3 which contracted by 1.2 percent from the previous quarter; and (3) rising unemployment rates in member countries, which, in some were at their historical high. However, the ECB s announcement of an OMTs operation to unlimitedly purchase government-issued bonds in secondary markets with full sterilization may help improve market sentiments. The operation would start when a member requests for financial assistance through the European Stability Mechanism (ESM) and complies with agreed fiscal consolidation measures and economic reforms. It was anticipated that this operation would lower costs of funding in financial markets and allow a return to normal of monetary policy transmission mechanism, which would eventually support fiscal adjustment process to some extent. Going forward, risks to growth from the sovereign debt problem would likely remain high, resulting in a further slowdown in the euro area economy before recovery could gradually firm up. Major risks to the fiscal adjustment process 18 Bank of Thailand

22 included a larger-than-expected economic contraction and an inability to implement planned fiscal consolidation measures due to public protests. This could potentially lead to a suspension of financial assistance from the European authorities which could threaten recovery, going forward. In addition, risk of Greece s exit from the euro area remained, especially should the Greek government fail to lower its fiscal deficit and Troika cease additional supportive measures. The United States: Overall, the U.S. economy in 212 Q3 improved from the previous quarter and would likely expand moderately in the periods ahead, supported by ongoing accommodative monetary policy. In 212 Q3, the U.S. economy improved in many aspects, especially in employment and private consumption. Non-farm payrolls increased by an average of 146, positions per month in the third quarter compared to an average increase of 67, positions per month in the previous quarter (Chart 2.3). The unemployment rate dropped to 7.8 percent in September the lowest rate since January 29. This was in part attributable to an increase in temporary employment during the election period. However, the underutilization and long-term unemployed rates (ratio of workers unemployed for over 27 weeks to total unemployed workers) remained elevated at 14.7 percent and 41.2 percent respectively, compared to the long-run average of 8.9 percent and 17.8 percent, respectively, persons (Change from previous month) 1, 5 Chart 2.3 U.S. labor market conditions -5 Change in non-farm payrolls Unemployment rate (RHS) -1, Jan Jan Jan Jan Jan Source: Bureau of Labor Statistics, US Department of Labor Percent 12 Sep Inflation Report October

23 Chart 2.4 U.S. retail sales Percent (Change from previous month) 3 2 Aug Jan Jan Jan Jan Jan Source: U.S. Census Bureau, U.S. Department of Commerce reflecting weak labor market conditions that would take time to recover. Private consumption also picked up from the second quarter, reflected by a resumption of growth in retail sales after three consecutive months of contraction during the second quarter (Chart 2.4). In particular, automobile sales rose continuously in line with the consumer confidence index in September 212, which rose to its 7-month high. Even though the above consumer confidence level was considered low relative to its long-run average, it was considered high enough to support private consumption growth, going forward. The U.S. economy was expected to grow moderately, supported by ongoing accommodative monetary policy. In the September 212 meeting, the FOMC announced additional stimulus packages which comprised of (1) an announcement to keep the federal funds rate at -.25 percent per annum until at least mid-215; and (2) an open-ended purchase of Agency Mortgage-Backed Securities (MBS) of $4 billion per month until the labor market improves. The program aimed to lower long-term interest rates, specifically mortgage rates, in order to further support recovery of the labor market and the housing sector, which had shown some notable improvement. In this regard, by keeping the federal funds rate at a low level and lowering mortgage rates, households debt service burden would be lowered, thereby increasing disposable income and consumption, which would eventually lend support to economic recovery, going forward. 2 Bank of Thailand

24 However, there remained risks to growth, both from domestic and abroad, including (1) the transmission of fiscal stimulus to the housing sector which may take time, as banks continued to be cautious in mortgage lending and businesses postponed new investments due to economic uncertainty; (2) lack of clarity regarding the extension of fiscal stimulus measures due to expire at the end of 212, such as personal income tax relief and extension period of unemployment benefits, together with uncertainty on fiscal deficit reduction (Fiscal Cliff); (3) trade and financial spillovers stemming from the European sovereign debt crisis; and (4) the global economic slowdown, especially in the euro area, Japan and China. The Japanese economy expanded at a slower rate due to contractions in domestic and external demand. In 212 Q2, the Japanese economy grew by.2 percent from the previous quarter, decelerating as a result of a slowdown in private consumption particularly that of eco-cars coupled with a decline in exports to major trading partners, namely China, the euro area and Asia, which were all affected by the global economic slowdown and the European sovereign debt problem. In the periods ahead, the Japanese economy would likely decelerate further as a result of (1) weakening producers and investors sentiments regarding weak economic prospects, as reflected by the manufacturing PMI index which had been below 5 for four consecutive months Inflation Report October

25 Index 54 Chart 2.5 Manufacturing Purchasing Managers Index (PMI) in Japan Jan May Sep Jan May Sep Source: Bloomberg since June 212 (Chart 2.5), as well as a downward revision in the Business Confidence Index by the BOJ s Tankan Survey; (2) lack of additional fiscal stimulus packages after an expiration of the eco-car subsidy in September 212; (3) a slowdown in exports following the European Sovereign debt crisis, which not only led to weaker global demand, but also created an upward pressure on the yen, which was regarded as a safe asset, thereby potentially worsening competitiveness of Japanese exports; and (4) the conflict between Japan and China over the Diaoyu or Senkaku Island which could impose risks on manufacturing and exports through a supply disruption in the automobile and electronic industries, as well as affect the tourism sector. In response to deteriorating outlook, the Bank of Japan conducted further monetary policy easing. In mid-september 212, the BOJ extended the size of its Asset Purchase Program by 1 trillion yens to slow down the rate of yen appreciation as well as boost the slowing economy. However, the effect of such program was expected to be moderate as households continued to be cautious in their spending as a result of weakening global prospects. In the last monetary policy meeting in October, no further stimulus measures were announced. China and Asian economies continued to slow down due mainly to contractions in exports to major trading partners. 22 Bank of Thailand

26 In 212 Q3, economic activities in most Asian economies decelerated (Table 2.1) as a continued contraction in exports to major trading partners began to weigh on manufacturing and consumption in some economies, particularly the export-dependent economies including Hong Kong, South Korea, and Taiwan. This was reflected by consecutive declines in Industrial Production Indices of these countries. However, the domestic demand-led economies, namely Indonesia and Malaysia, were able to maintain growth, thanks to solid consumption and investment. Going forward, the MPC anticipated that in the second half of 212, Asian economies would slow down further, owing to the weakening export sector. This was indicated by the continued decline in leading indicators of Asian exports such as China s and Taiwan s New Export Orders and the North American Semiconductor Book-to-Bill ratio. In 212 Q3, the Chinese economy grew by 7.4 percent, decelerating from 7.6 percent in the previous quarter, on account of weak exports amid the global downturn (Chart 2.6). As a consequence of dimming growth prospects, the Chinese authorities announced additional stimulus packages in September 212, which included (1) approval of RMB 1 trillion (2.1 percent of GDP) investment projects in transportation system and underground railway construction, part of which had already been incorporated in the 12th Five Year Plan ( ) for National Economic and Social Development; and (2) a RMB 14 billion Table 2.1 Asia s export growth (Annual percentage change) Country Jun Jul Aug Sep Year-to-date 212 China South Korea Taiwan Hong Kong Indonesia Singapore Malaysia Philippines Thailand Chart 2.6 China economic indicators Percentage change from the previous year (% YoY) Jun Jul Aug Sep 2 Fixed asset investment (YTD) Source: CEIC Retail trade Industrial production Export Import Inflation Inflation Report October

27 (.3 percent of GDP) subsidy for purchases of energy-saving electrical appliances for a period of 1 year starting from 1 October 212 until 3 September 213. However, due to the package s small size, the impact on overall economy was expected to be limited. For the remaining of 212, the MPC assessed that the Chinese economy would grow at a moderate pace as export growth remained subdued and the Chinese authorities would likely be more cautious in adopting additional stimulus measures due to risks of speculations in the property market. This was evidenced by house prices and sales which had been increasing for three consecutive months. 2.2 The domestic economy The Thai economy in 212 Q2 picked up gradually from the previous quarter in all sectors. A rapid recovery from the flood led to a strong rebound in manufacturing production to compensate production loss during the previous periods as well as accommodate domestic demand expansion. In addition, the government continued to play an important role in stimulating the economy. Although the European sovereign debt crisis and the global economic downturn had not yet affected tourism, impacts on the export sector, export-oriented industries, and the import sector became more apparent toward the end of this quarter. 24 Bank of Thailand

28 Economic conditions in 212 Q2 The Thai economy in 212 Q2 expanded by 3.3 percent from the previous quarter (Chart 2.7), following expansions in the manufacturing and service sectors. Manufacturing production continued to rise by 2.4 percent from the preceding quarter as industrial production accelerated to compensate production loss during the flood. Nevertheless, the European sovereign debt crisis began to affect manufacturing production toward the end of this quarter, particularly export-oriented industries such as Hard Disk Drives (HDD) and Integrated Circuit (IC). The services sector continued to expand from the previous quarter by.4 percent. Tourism activities grew at a satisfactory level. The European debt crisis had not yet affected the tourism sector since some European tourists viewed Thailand as a good-value-for-money destination. In addition, the majority of tourists were from the East Asian region whose economies continued to grow, albeit moderating. The transportation and trade sectors also expanded in tandem with economic activities, particularly the manufacturing sector which continued to recover from the previous quarter, together with the pressing need for reconstruction and repair services following the flood. Furthermore, agricultural outputs grew by.5 percent from the previous quarter, especially rice output on account of improvement in water supply. Moreover, other agricultural productions such as rubber and cassava continued to expand Chart 2.7 Contribution to GDP growth (QoQ, seasonally adjusted) Percent 12 Agriculture Manufacturing 8 Trade Services 4 Others GDP Source: National Economic and Social Development Board Inflation Report October

29 Table 2.2 GDP growth rate Change from the previous quarter (seasonally adjusted, percent) Q2 Q3 Q4 Q2 GDP Domestic demand 1/ Private consumption Private investment Government consumption Public investment Exports of goods and services Imports of goods and services Note: 1/ Domestic demand excluding changes in stocks Source: National Economic and Social Development Board and calculations by Bank of Thailand owing to favorable weather condition and an increase in planting areas. The continued recovery of manufacturing production resulted in a low level of unemployment rate of.6 percent in 212 Q2. The impact of minimum wage increase on 1 April 212 and a civil servants salary increase to 15, baht per month for bachelor s degree holders in January 212 was limited. Nevertheless, such measures led to pay rises in other salary ranges and caused average earning to rise by 17.5 percent over the same period last year, higher than the 1-year average increase of 4.4 percent 1/. The recovery in manufacturing production in almost all sectors led to continued growth in private consumption and investment as well as exports. However, towards the end of the quarter, the weakening global economy began to weigh on exports of some industries. Meanwhile, government spending remained a crucial economic stimulus. The resumption in manufacturing production helped propel domestic demand expansion. Private consumption grew by 1.2 percent from the previous quarter (Table 2.2) owing to pent-up demand, particularly for automobiles and electrical appliances. This was largely attributable to robust consumers purchasing power following (1) back-to-normal employment conditions; (2) an increase in minimum wage and 1/ Current average earning is between 25-3 baht per day, higher than the former range of between 15-2 baht per day. 26 Bank of Thailand

30 civil servants salary; (3) government stimulus packages, especially the tax rebate scheme for first-time car buyers; (4) accommodative monetary policy; and (5) improving consumer confidence. Private investment expanded by 3.8 percent from the preceding quarter from investment in construction, machinery and equipment. The robust investment spending was partly due to ongoing investment for flooddamaged replacement and repair work, as well as production capacity enhancement to accommodate domestic demand expansion as reflected by an increase in imports of machinery and equipment, especially machinery for industrial plants and office equipments. In addition, some investments were due to acceleration of construction projects that had been disrupted during the flood. Increased private spending and manufacturing production led to growth in imports of goods and services by 6.2 percent from the previous quarter, particularly imports of capital goods such as telecommunication equipment and machinery as well as imports of consumer goods such as food and beverages, electrical appliances, and furniture. Nevertheless, imports of raw material and intermediate goods contracted slightly, specifically imports of base metal materials, chemicals, and integrated circuits, following a decline in manufacturing production due to the weakening global economy at the end of the quarter. In contrast, imports of services expanded from the preceding quarter, owing to rising transport receipts following an increase in import volume. Inflation Report October

31 Exports of goods and services expanded by 3.6 percent thanks to recovery in manufacturing production, especially exports of automobiles, metal products, machinery and equipment, computer equipment and parts, and electrical appliances. Nonetheless, in the last month of the quarter, exports of manufacturing products in export-oriented industries contracted sharply, owing to sluggish external demand following the global economic slowdown. Meanwhile, exports of textile and garments continued to contract, mainly due to the impact of European sovereign debt crisis and deteriorating competitiveness. However, exports of services continued to pick up as reflected by an increase in the number of tourists, especially from China, Russia and Japan. In addition, transport receipts also increased in tandem with rising international trade volume. The fiscal sector maintained its role in stimulating the economy as reflected by an increase in government expenditures from the previous quarter, particularly in wages and salaries, purchases of goods and services, as well as disbursement for flood restoration and prevention. 28 Bank of Thailand

32 The outlook on the domestic economy in 212 Q3 2/ The Thai economy in 212 Q3 would likely grow modestly from the previous quarter owing chiefly to the sluggish global economy, which started to have a more pronounced effect on the Thai economy than the preceding quarter. Exports and production of export-oriented industries continued their declining trends, which may cause imports of raw materials for exportoriented industries to also decline. In addition, private investment began to show some signs of softening after investment in flood-related restoration had subsided. Nevertheless, the economy was projected to expand continuously in 212 Q3 thanks to robust momentum from private consumption and tourism activities partly due to accommodative fiscal policies, particularly the tax rebate for firsttime car buyers, as well as favorable employment conditions and income level. 2/ Economic indicators used in assessing the outlook for 212 Q3 were computed by the Bank of Thailand, except data on the Manufacturing Production Index and capacity utilization rate, which were computed by the Office of Industrial Economics. The number of tourists and the occupancy rate were, in part, compiled by the Tourism Authority of Thailand. Data on the labor market were obtained from the National Statistical Office. The government expenditure data were provided by the Comptroller General s Department, which compiled by the Fiscal Policy Office, the Ministry of Finance. Economic outlook were obtained from the Economic/Business Information Exchange Program between the Bank of Thailand and business sector. Inflation Report October

33 Chart 2.8 Manufacturing Production Index (MPI) classified by sectors (seasonally adjusted) MPI Vehicle January 21 = 1 19 HDD IC 17 Electrical appliances Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Source: Office of Industrial Economics, Ministry of Industry Percent Chart 2.9 Capacity utilization rate (seasonally adjusted) 4 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Source: Office of Industrial Economics, Ministry of Industry Aug 64.9 Manufacturing production in 212 Q3 was projected to decline from the previous quarter. The production of export-oriented industries, especially HDD and IC, was poised to slow down due to the impact of sluggish global economy. Nonetheless, the automobile industry was anticipated to continue to grow strongly for the rest of the year thanks to the tax rebate for firsttime car buyers, thereby causing the Manufacturing Production Index for automobiles to remain at a high level. (Chart 2.8) Despite the sluggish global economy, the manufacturing sector would be well supported by strong domestic demand. As a result, capacity utilization in 212 Q3 would likely remain stable compared to the preceding quarter. (Chart 2.9). In this regard, capacity utilization of export-oriented industries such as HDD and IC was anticipated to decline while that of domestic consumption industries including automobile, chemical, rubber, and plastic was expected to increase from the last quarter in line with ongoing robust domestic consumption. The services sector would likely expand in line with the tourism, transportation, and trade sectors. The tourism sector grew continuously and was not affected by the global economic slowdown. The seasonally-adjusted number of tourists was expected to increase from the last quarter, particularly from the East Asian region tourists. The number of European tourists was also anticipated to rise. An increase in the number of tourists would thus lead to a gradual rise in the seasonally-adjusted hotel occupancy 3 Bank of Thailand

34 rate (Chart 2.1). In addition, the transportation and trade sectors were expected to expand well in line with robust domestic consumption. Other services sectors such as real estate and construction would likely expand favorably also, as a result of flood-prevention construction projects and the government s mega-projects such as the extension of sky train routes. Agricultural output in 212 Q3 was projected to grow from the preceding quarter in almost all product categories, especially the second-crop rice output due to favorable water supply from both natural sources and major dams. Moreover, production of cassava which had not been affected by pest outbreaks was anticipated to rise from favorable weather condition. In addition, production of palm oil would also tend to expand following a period of palm tree recovery. Employment was anticipated to improve from the previous quarter and the unemployment rate would likely remain low. (Chart 2.11) Employment in the agricultural sector was anticipated to increase in line with favorable expansions of agricultural output. Meanwhile, employment in the manufacturing sector was projected to remain unchanged notwithstanding the impact of sluggish global economy. On the demand side, exports would likely contract in 212 Q3 following the global economic slowdown. Nonetheless, private consumption would be able to expand further, partly owing to government stimulus packages as well as accommodative monetary policy. Thousand persons 2,5 2, 1,5 1, 5 Chart 2.1 Number of foreign tourists and hotel occupancy rate (seasonally adjusted) Hotel occupancy rate (RHS) Number of foreign tourists Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Source: Department of Tourism and Bank of Thailand Percent Chart 2.11 Unemployment rate (seasonally adjusted) Percent 8 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Source: National Statistical Office, and calculations by Bank of Thailand Aug.7 Inflation Report October

35 Chart 2.12 Export volume index classified by products (seasonally adjusted, 3-month moving average) Index (January 28 = 1) 12 Export volume index (including gold) Agricultural products 11 Manufacturing products 1 Fishery products Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Source: Bank of Thailand Chart 2.13 Private Consumption Index (PCI) Index (2 = 1) Jan Apr Jul Oct Jan Source: Bank of Thailand Index (2 = 1) Jan Apr Jul Oct Jan Source: Bank of Thailand (Seasonally adjusted) Apr Jul Oct Jan Apr Jul 212 Chart 2.14 Private Investment Index (PII) (Seasonally adjusted, 3-month moving average) Apr Jul Oct Jan Apr Jul 212 The weakening external demand following the global economic slowdown would continue to weigh on exports (Chart 2.12), particularly exports of integrated circuit and parts, hard disk drive and electrical appliances. Concurrently, agricultural exports was poised to contract from the previous quarter following an anticipated fall in rice exports as a result of deteriorating price competitiveness, as well as depressed rubber export prices due to the weakening global economy. Nevertheless, exports of automobile and parts was expected to expand continuously. Meanwhile, exports of services was projected to improve from the preceding quarter following an increase in the number of tourists from almost all regions, particularly China and Russia. Moreover, as concerns over security measures began to abate, the number of tourists from Malaysia would increase toward the end of the quarter after having declined continuously as a result of the bombing incident in Songkla province in March. Domestic demand was anticipated to grow continuously. The Private Consumption Index in the first two months of 212 Q3 (Chart 2.13) increased as reflected by VAT collection, increasing imports of consumer goods, especially food and beverages, coupled with continued growth in automobile sales. However, private investment would likely decrease from the previous quarter as reflected by a decline in the Private Investment Index in the first two months of 212 Q3 (Chart 2.14), partly as demand for post-flood reconstruction tapered off. In addition, some businesses were more concerned 32 Bank of Thailand

36 over the heightened risk of the global economic slowdown. Nonetheless, there remained supporting factors for private investment going forward, including strong business confidence in the Thai economy as reflected by the Business Sentiment Index in the next three months which continued to be above 5, as well as rising values of application and issuance of investment promotion certificates by the BOI. Deteriorating exports and manufacturing production as a result of the weaker global economic outlook, together with declining private investment would result in a drop in imports of goods and services (Chart 2.15), especially imports of raw material and intermediate goods such as electronic parts. In addition, waning imports of capital goods, particularly machinery used in the electrical appliance industry, stemmed from decelerating private investment and the base effect. Meanwhile, imports of services would likely decrease in line with a decline in freight payments as a result of imports contraction. Fiscal stimulus would continue to maintain its crucial role in supporting the economy in this quarter as reflected by increased government disbursements (Chart 2.16) of both current expenditures, especially purchases of goods and services, as well as capital expenditures on investment for flood restoration and prevention program, for example. Nonetheless, total disbursement of the 212 budget would likely be lower than the target of 93 percent due mainly to a less-than-expected disbursement of current expenditures. Chart 2.15 Import volume index classified by products (Seasonally adjusted, 3-month moving average) Index (January 28 = 1) 17 Import volume index 15 Consumer goods Raw material and intermediate goods 13 Capital goods Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Source: Bank of Thailand Chart 2.16 Disbursement of government budget Billion baht Budget 211 Budget 212 Budget Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Note: Excluding principal repayments and replenishments of the treasury reserve Source: Comptroller General s Department, Ministry of Finance Inflation Report October

37 Percent Chart 2.17 Contribution to headline inflation Core inflation Energy Raw food Headline inflation Source: Trade and Economic Index Bureau, Ministry of Commerce and calculations by Bank of Thailand. On the whole, the Thai economy in 212 Q3 was poised to moderate from the preceding quarter, largely attributable to contracting exports and manufacturing production of export-oriented industries. Nonetheless, tourism and private consumption would continue to grow robustly while fiscal stimulus would still be present. In this light, the bright outlook for domestic demand would continue to provide momentum to support Thai economic growth, going forward. 2.3 Costs and Prices Inflation In 212 Q3, headline inflation stood at 2.94 percent, accelerating from 2.52 percent in the previous quarter due chiefly to a surge in prices of energy and raw food. (Chart 2.17) Energy prices in 212 Q3 increased by 7.54 percent from the same period last year, sharply accelerating from 3.3 percent in the previous quarter. This increase was caused by 1) a low base effect due to an exemption of oil fund levy last year; and 2) a rise in electricity fees for the periods of June to August 212, and September to December 212, respectively. Prices of raw food in 212 Q3 edged up by 4.8 percent from the same period last year, slightly accelerating from 4.21 percent in the previous quarter as a result of elevated prices of vegetables and fruits from the previous quarter following a decrease in supply due to unfavorable weather conditions. 34 Bank of Thailand

38 Core inflation in 212 Q3 decelerated slightly from 2. percent in the previous quarter to 1.84 percent, thanks chiefly to a decline in prices of food and beverages (Chart 2.18), especially prices of prepared food which decelerated in line with lower costs of meats and eggs as a result of the excess supply. Meanwhile, prices of non-food and beverages accelerated from the previous quarter owing to 1) an increase in excise taxes on tobacco and alcoholic beverages at the end of August 212; and 2) a base effect of the decrease in prices of public transportation services following the reduction in domestic oil prices last year. The pass-through from costs to prices in 212 Q3 trended down towards its normal level owing to the softening domestic demand. Such change was reflected by the deceleration of the quarter-on-quarter core inflation to.4 percent which was a level consistent with the 5-year average rate after standing slightly above for the first two quarters of 212 a period of strong rebound from the flood. (Table 2.3) Production costs conditions Producer Price Index (PPI) increased by.3 percent in 212 Q3, slightly decelerating from.5 percent in the previous quarter, (Chart 2.19) reflecting moderate production costs as a result of the global economic slowdown. In this regard, prices of manufactured products (excluding petroleum products) contracted while those of agricultural, mining and petroleum products stabilized from the preceding quarter. Chart 2.18 Contribution to core inflation Percent 4 Non-food and beverages 3 Food and beverages Core inflation Source: Trade and Economic Index Bureau, Ministry of Commerce and calculations by Bank of Thailand Table 2.3 Quarterly inflation Unit: Percent 211 Percentage change from the previous year (%ΔYoY) Q3 Q4 Q2 Q3 - Headline Consumer Price Index Core Consumer Price Index Raw food Energy Percentage change from the previous quarter (%ΔQoQ) - Headline Consumer Price Index Core Consumer Price Index Raw food Energy Source: Trade and Economic Index Bureau, Ministry of Commerce Chart 2.19 Contribution to producer price index Percent Producer Price Index : Manufactured products Producer Price Index : Mining products Producer Price Index : Products of agriculture Producer Price Index Source: Trade and Economic Index Bureau, Ministry of Commerce, and calculations by Bank of Thailand. Inflation Report October

39 Chart month ahead inflation expectation (August 212) > 6% 4-6% 2-4% < 2% Median (RHS) Share Percent 1% 7 8% 6 5 6% Long-term average 4 4% 3 2% 2 1 % Source: Bank of Thailand s Business Sentiment Survey Inflationary pressure in the period ahead Inflationary pressure would likely weaken in tandem with the softening domestic economy which stemmed from weakening global prospects, coupled with a slight decline in inflation expectations. Nonetheless, cost pressures were poised to remain moderate, going forward. (1) Demand pressure would likely soften following the slowdown in domestic economy, mainly due to weakening global prospects. (2) Inflation expectations would slightly decline as reflected by the 12-month ahead inflation expectation in August 212 of 3.3 percent, which decreased slightly from 3.4 percent in the previous month, though remaining close to its 5-year average (Chart 2.2). (3) Cost pressures would likely to remain moderate in line with global oil and commodity prices. However, prices of meats and eggs might increase in the period ahead due to higher costs of animal feed as a result of the drought in the U.S. Nevertheless, the pass-through from such costs to overall prices of fresh food should only be modest as an excess supply situation was expected to persist, going forward. 36 Bank of Thailand

40 3. Monetary and Financial Stability Risks to Thailand s overall financial stability increased owing to the weak global economy and monetary policy easing in major countries. Contraction in exports weighed more heavily on the corporate sector, while equity and bond prices rose steadily. Meanwhile, debt servicing abilities of low-income households began to show signs of weakness. Nonetheless, stability in other sectors remained sound. Financial institutions continued to be robust and the real estate sector showed no risk of a housing bubble. Going forward, key risks to be monitored included (1) a possible adverse impact of the overall economic slowdown on income and debt servicing abilities of households and corporates, thus potentially leading to loan quality being compromised; and (2) volatility in the Thai financial markets and the Thai baht arising from the Federal Reserve s third round of Quantitative Easing (QE3). 3.1 Financial Markets Improvement in global financial market conditions due to monetary policy easing in major countries boosted investor confidence and led to an increase in equity and bond investment. As a result, equity and bond prices rose steadily and the Thai baht edged higher at the end of 212 Q3. Money and bond markets Short term interest rates continued to stabilize in 212 Q3 before falling after the MPC reduced the policy rate by.25 percent, from 3. percent to 2.75 percent per annum at the meeting on 17 October 212. The overnight interbank rate and the 1-month government bond yield on 18 October 212 were at 2.65 and 2.79 percent per annum, respectively (Chart 3.1). Overall, government bond yields exhibited some degree of volatility in 212 Q3 due to Chart 3.1 Money market short-term interest rates Percent 3.5 Jan 25 Mar 21 May 2 Jun 13 Jul 25 Sep 5 Oct day repurchase rate 2.7 Overnight interbank rate 2.5 Government bond yields Jan 212 Feb Mar Apr May Jun Jul Aug Sep Oct Source: Bank of Thailand and The Thai Bond Market Association (ThaiBMA) Inflation Report October

41 Percent Chart 3.2 Government bond yields 2.75 Jan Feb Mar Apr May Jun Jul Aug Sep Oct 212 Source: The Thai Bond Market Association (ThaiBMA) Oct 18 1 Y Y 3M 1M Chart 3.3 The Stock Exchange of Thailand index Index 1,4 1,2 1, 8 6 Net buy/sell of foreign investors (RHS) SET index 4 Jan Jul Jan Jul Jan Jul Source: Stock Exchange of Thailand. Times Billion baht 6 Chart 3.4 Average Price to Earnings by country Q2 212 Q3 5 South Korea Singapore Malaysia Thailand (SET index) Philippines Source: Bloomberg changing global financial market and bond supply conditions (Chart 3.2). At the end of the quarter, yields of all maturities fell as a result of nonresident inflows into the Thai bond market, partly due to further monetary policy easing in major countries. Nonetheless, the overall impact of QE3 on the Thai economy continued to be limited (more details in BOX: Quantitative Easing 3 and its impact on Thai economy). The overall government bond yields decreased following the MPC s decision to reduce the policy rate on 17 October 212 (Chart 3.2). Equity market Thailand s stock exchange index in 212 Q3 increased steadily from the previous quarter which was mainly due to return of foreign investment to the Thai and other stock markets in the region after sentiment regarding the European sovereign debt crisis improved. In 212 Q3, foreign investors net sell in the stock market totaled at 1.48 billion baht compared with the net buy of billion baht in the previous quarter (Chart 3.3). Going forward, the rising SET index would be closely monitored as the Price to Earnings Ratio (P/E ratio) in 212 Q3 rose to a level higher than the historical average (28-212) while the ratios in other regional stock markets started to stabilize (Chart 3.4). Moreover, the effect of QE3 together with risks associated with global financial conditions on stock market volatility also warranted monitoring in the periods ahead. 38 Bank of Thailand