Morning comment: Brexit, UK CPI , Euro IP, Japanese spending & the Fed

Chris Scicluna

Investors in the US and Europe were unmoved following yesterday’s seemingly positive meeting between President Trump and Chairman Kim Jong-un. And with the US CPI report for May printing bang in line with market expectations, and the first of this week’s big central bank meetings looming large, this made for a relatively quiet day in US markets. By the close the S&P500 was up just 0.2%, Treasury yields were just a smidgen higher (10Y yields are currently 2.96%) and the US dollar was just slightly firmer.

With Wall Street providing little direction, equity markets in the Asian region have had a mixed day. In Japan, the Topix rose 0.4%, probably assisted by a slight weakening of the yen. Equities also firmed slightly in Taiwan. By contrast, ahead of tomorrow’s important Chinese economic data, equity markets moved lower in mainland China and Hong Kong (ZTE Corp shares slumping after the company agreed to pay an immediate USD1bn fine).

Elsewhere, while Theresa May yesterday appeared to make a concession to rebel Conservative MPs that seems to reduce the chances of a disorderly ‘no-deal’ Brexit, sterling is barely any stronger, likely reflecting the fact that most knotty issues remain unresolved. UK inflation data will be closely watched this morning – we anticipate an upside surprise. But the main event today, of course, is undeniably the Fed’s announcement, with all eyes on the updated dot-plots of FOMC members’ views on the likely path of the FFR.

Theresa May appears to have averted potentially destabilising defeats on all key amendments on the EU Withdrawal Bill in the House of Commons – but only by offering (very) last-minute compromises, and by a narrow majority. Most crucially, the amendment concerning Parliament having a meaningful vote, seen as the hardest to defeat, was discarded, but only after Theresa May offered some kind of compromise, to be tabled in the House of Lords in due course, that would potentially involve MPs having a say on Brexit negotiation strategy if there is not a deal agreed by the end of November this year. Moreover, if there’s still no deal by mid-February next year, May would then have to ‘follow any direction’ voted upon by MPs.

While the precise details have yet to be hammered out – and the Remainers and hardcore Brexiters within the Conservative Party have different interpretations about quite what assurances Theresa May has offered – and then accepted in a new amendment, the latest moves would appear to represent a considerable climbdown by the government. This potentially gives MPs more power over the deal, but – most notably perhaps – also seems to have reduced very significantly the possibility of a highly disorderly no-deal scenario. 

Many other amendments will be voted on over the course of today – most significantly ones concerning seeking membership of a customs union and the EEA. But similar last-minute concessions – which effectively kick the can down the road again on key issues related to future customs arrangements and regulatory alignment with the EU – mean the government is likely to be able to throw them out too. So, an imminent political crisis appears to have been averted. But May has still been forced to make adjustments to her intended strategy. And plenty of crucial detail, that will have an important bearing on the UK economic outlook, remains unresolved. As such, we do not think that yesterday’s and today’s events in parliament will give sufficient comfort to the BoE to allow the MPC to ignore Brexit risks when judging the next steps for monetary policy.

Meanwhile, a busy week for top-tier UK economic data continues today with the May inflation figures. While the consensus is for no change from April’s rates (2.4%Y/Y headline, 2.1%Y/Y core), we anticipate an upside surprise. In particular, we expect the headline CPI rate to be nudged up by 0.1ppt to 2.5%Y/Y, partly in light of higher fuel prices. And we suspect that services inflation might cause core CPI to inch higher too. The rise in oil prices will also impact other parts of the inflation pipeline, boosting both producer price input and output readings, which are due out at the same time.

The main event today will obviously be the conclusion of the FOMC’s latest policy meeting. A further 25bp rate hike, lifting the fed funds rate target range to 1.75-2.0%, is fully priced by the market. So, most interest will centre on the Fed’s update projections and Chair Powell’s post-meeting press conference for clues on how policy is likely to evolve over the remainder of this year. The recent economic data-flow would suggest that the Fed’s median forecasts for GDP and inflation this year will be revised up, while the median forecast for the unemployment rate seems likely to be revised down. However, given the deterioration in the external environment over the past quarter, the dot-plots for the fed funds rate at end-2018 might yet prove to be a touch more dovish than those published three months ago. We also anticipate changes to the wording in the FOMC’s statement, with policy perhaps set to be described as approaching neutral rather than accommodative, and the sentence indicating that the federal funds rate is likely to remain below its long-run level to be dropped or weakened. Before the Fed announcement, May’s producer price data will likely show a further pickup in pipeline inflation on the back of higher prices of food, energy and core items.

Euro area:
Today will bring euro area IP figures for April. Given the data released from the largest member states, we expect this to show a decrease in output in excess of 1.0%M/M, potentially the steepest in almost two years. Q1 employment data are also due and – like yesterday’s French figures – seem likely to show ongoing jobs growth, albeit probably a touch down on the 0.4%Q/Q average rate in 2017. Final Spanish inflation figures for May are also due – the flash estimate of the headline annual CPI rate on the EU-harmonised measure saw a marked 1.0ppt rise on the month to 2.1%Y/Y, a thirteen-month high. In the bond market, Germany will sell 10Y Bunds while Italy will sell of bonds with a wide range of maturities.

There were no economic reports in Japan today. However, we note a statistic that was overlooked earlier this week – the Cabinet Office Synthetic Consumption Index for April – which, of all indicators, is the one that has the best correlation with the national accounts measure of private consumption. The good news is that the index rose 1.0%M/M in April. So, after declining 0.1%Q/Q in Q1 – now matching last week’s reported decline in private consumption – the index presently stands 0.8% above the average monthly level reported during that quarter. This provides a good base for a return to positive growth in Q2, even if some payback has occurred in May. 

Late yesterday China released its money and credit aggregates for May. The main point to note is that while bank lending was close to market expectations (and also similar to that in May last year), aggregate financing rose just CNY761bn – below market expectations and about CNY300bn less than a year earlier. This also meant that growth in the stock of aggregate financing slowed to a new low of 10.3%Y/Y in May, confirming that credit conditions are continuing to tighten gradually in the non-bank sector.  

Today’s Westpac-MI consumer confidence survey suggested little change in sentiment over the past month. The headline index rose just 0.3%M/M to 102.1 in June, thus remaining about in line with the survey’s long-term average. While respondents were a bit less optimistic about the general outlook for the economy, they were more pessimistic about recent and prospective developments in their family finances and slightly more inclined to buy a major household item.

In other news, RBA Governor Philip Lowe delivered a speech to a Melbourne audience on the topic “Productivity, Wages and Prosperity”. Lowe’s general description of the economic outlook remained consistent with the Bank’s recent commentary, noting that “…the Australian economy is moving in the right direction. If this continues to be the case, it is likely that the next move in interest rates will be up, not down.” Importantly, and consistent with market pricing, he added that “Any increase in interest rates, however, still looks to be some time away.” Before that increase occurs, Lowe noted that “The Board will want to have reasonable confidence that inflation is picking up to be consistent with the medium-term target and that slack in the labour market is lessening. At this stage, a sustained pick-up in inflation to around the midpoint of the target range is likely to require faster wages growth than we are currently experiencing.” Those remarks emphasise that the monthly labour force report – next due tomorrow – remains one of the most important releases in the economic calendar.

New Zealand:
The only report in New Zealand today was Food Price Index for May. The index was flat for the month and down 0.1%Y/Y, weighed down by a large drop in fruit and vegetables prices (down 10.2%Y/Y).

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