Morning comment: BoJ & data deluge

Chris Scicluna
Emily Nicol
Mantas Vanagas

Overview:
While euro area equities and BTPs were hit yesterday by the weaker than expected euro area and Italian GDP reports, Wall Street ran with the generally improved sentiment that had been expressed in Asian markets following President Trump’s suggestion that he still expected to do a trade deal with China. In a somewhat up and down session, the S&P500 closed on its highs with a solid 1.6% gain. Reduced risk aversion was reflected in a modest rise in UST yields, a slight tightening of credit spreads and a slightly firmer US dollar.

Against that background it has been a very busy day for data and events in the Asia-Pacific region, with the key developments set out in some detail below. While key data such as China’s PMI’s and Japan’s IP report were weak, investors seemed to brush off the disappointment with Asian equity indices adding to yesterday’s gains (or in a couple of cases rebounding from losses). In Japan, the TOPIX rose an especially solid 2.15%, assisted by a weaker yen, which moved above ¥113/$. After the dust had settled, the JGB market was unmoved by the BoJ’s latest Board meeting, Outlook Report, and Kuroda press conference, which offered no surprises. In China the CSI300 rose 1.4%, with the yuan remaining within yesterday’s range, while solid gains were seen in Hong Kong and especially Taiwan. Stocks also rose modestly in Australia and AUD bonds fell, where a softer-than-expected CPI report led to a slightly weaker Australian dollar.

Japan:
The main focus on a very busy day in Japan was the BoJ’s latest Board meeting and revised Outlook Report, with a number of important activity indicators and confidence indicators also released today.

As expected, the BoJ Board made no changes to its key policy settings i.e. the -0.1% interest rate on banks’ marginal excess reserves and pledge to keep 10Y JGB yields ‘at around zero per cent’. To achieve the latter goal it repeated that it would maintain its JGB purchases at an annual pace of “about ¥80trn” – more than twice the recent pace – with purchases continuing to be conducted “in a flexible manner” and with yields permitted to “move upward and downward to some extent mainly depending on developments in economic activity and prices”. The BoJ also retained its caveat that “In case of a rapid increase in the yields, the Bank will purchase JGBs promptly and appropriately.”

Similarly, the BoJ retained its forward guidance committing to “maintain the current extremely low levels of short- and long-term interest rates for an extended period of time”. Adding to the overwhelming sense of continuity, Goushi Kataoka again dissented in favour of the Bank pursuing an even more accommodative policy stance with the aim of driving bond yields lower. And Yutaka Harada maintained his dissent, again seeking clarification of the link between the forward guidance and its relationship with the price stability target. Finally, the Board unanimously re-committed to increase its ETF holdings at an annual rate of ¥6trn and its J-REIT holdings at an annual pace of ¥90bn. But given recent equity market turbulence, this was hardly going to be the meeting when those amounts were trimmed back.

Turning to the Outlook Report, the changes from the Bank’s prior assessment were relatively small and in an unsurprising direction. In summary, the BoJ’s updated economic forecasts continue to project above-potential GDP growth in the near term and core inflation to rise gradually towards the 2% target – albeit again falling short of 2% during the forecast horizon and by slightly more than was previously the case. Despite evidence of a very soft Q3 for GDP, the median projection of Policy Board members is that GDP growth will print at 1.4%Y/Y in FY18 – down 0.1ppt from the pace forecast in July. The median Board member expects growth to slow to 0.8%Y/Y in both FY19 and FY20, unchanged from the forecast made in July and consistent with the Bank’s current assessment of the economy’s potential growth rate. Not surprisingly, the picture for core inflation (i.e. CPI ex-fresh food) is again slightly weaker than depicted previously. Core inflation is expected to sit at 0.9%Y/Y in FY18, rather than the 1.1%Y/Y rate that had been forecast in July. Once the impact of the scheduled consumption tax hike is excluded, the forecast for FY19 now stands at 1.4%Y/Y (down 0.1ppt from previously) and that for FY20 is now 1.5%Y/Y (also revised down 0.1ppt).

The commentary regarding activity was generally also little changed from that published in July. The Bank’s forecast of above-potential growth in the near term continues to be underpinned by highly accommodative financial conditions and government spending, with business investment further bolstered by Olympic Games-related activity and the need to address labour shortages. Exports are forecast to continue their “moderate increasing trend” given that trading partner economies are judged to be growing “firmly on the whole”. And with the much-vaunted virtuous cycle between incomes and spending still seen as operating, private consumption is forecast to maintain a “moderate increasing trend” too. The expected slowdown in FY19 and FY20 continues to largely reflect the expected impact of the scheduled October 2019 consumption tax hike, with business investment growth also expected to slow in FY20 as Olympics-related investment peaks.

As regards core inflation, the Bank again acknowledged that this has seen “relatively weak developments”. The Bank continues to attribute this to a “deeply entrenched” expectation that wage and prices will not increase easily, while noting that some areas of the economy are also facing downward price pressure due to intensifying competition, productivity growth and technological progress. Nonetheless, as reflected in the Bank’s forecasts, most members remain optimistic that firms' wage- and price-setting behaviour will grow slightly less cautious as pressure on spare capacity continues to build and price increases become observed more widely. The Bank is also hopeful that inflation expectations will respond to its strong commitment to achieving its inflation target.

Meanwhile, the Bank still characterises the risks to economic activity as being skewed to the downside, particularly regarding developments in overseas economies, with the negative skew also seen in the risk distribution around the inflation outlook not least due to concerns surrounding the formation of medium- to long-term inflation expectations. With regard to domestic financial risks associated with the continuation of ultra-easy policy, the Bank again concluded that “…there is no sign so far of excessively bullish expectations in asset markets or in the activities of financial institutions.” However, the Bank remains aware that prolonged downward pressure on financial institutions' profits could create risks of a gradual pullback in financial intermediation and of destabilizing the financial system. And while the Bank continues to judge that these risks are “not significant at this point, mainly because financial institutions have sufficient capital bases”, on this occasion it chose to add that “it is necessary to pay close attention to future developments”, referring to the analysis contained in last week’s semi-annual Financial System Report.

Turning to today’s other economic news, METI’s IP report for September revealed a disappointing 1.1%M/M decline in output – a weaker outcome than the market had expected and a sharp contrast to the unlikely 2.7%M/M increase in output that firms’ had forecast in last month’s survey. With output having declined in four of the last five months, the seasonally-adjusted series points to an decline in output of 0.9%Y/Y while METI’s headline unadjusted series reports a much sharper 2.9%Y/Y decline. In the industry detail, manufacturing output was down a slightly sharper 1.3%M/M in September, with larger-than-average declines recorded for iron and steel (3.6%M/M), communications and computer equipment (4.2%M/M) and transport equipment (2.5%M/M). Assuming no major revisions, today’s outcome means that industrial output declined 1.7%Q/Q in Q3, more than unwinding the 1.3%Q/Q growth reported in Q2.

With today’s result clearly influenced by Typhoon Jebi and the Hokkaido earthquake early in the month, METI chose to retain an unchanged on-balance positive assessment of the manufacturing sector i.e. “Industrial production is picking up slowly, but shows signs of decrease in part”. In this regard, METI may have taken some heart from the latest survey of manufacturers which continues to indicate no wavering in firms’ optimism. Indeed, undoubtedly in part due to response of firms impacted by last month’s natural disasters, in aggregate firms now forecast that output will rebound 6.0%M/M in October – an improvement on the 1.7%M/M increase that firms had forecast last month – albeit followed by an expected 0.8%M/M decline in output in November. While firms’ forecast for October will doubtless prove far too optimistic – METI’s bias-corrected estimate suggests that a 0.9%M/M rebound is more likely – modest growth in output in Q4 might still seem a reasonable prospect.

That said, other details within today’s report continue to suggest that output might struggle to post much increase at all without a sudden and – in the current environment – seemingly unlikely step up in demand. While production fell 1.1%M/M, shipments declined 3.0%M/M in September. It is not possible to say with any certainty whether Japan’s natural disasters had a more pronounced impact on shipments than output, but regardless this outcome meant that firms’ inventory levels rose 2.3%M/M in September and were up 5.5%Y/Y. Inventories of electronic parts and devices rose a further 9.6%M/M to be up a whopping 51.9%Y/Y, while double-digit annual growth in inventories was also seen in the iron and steel, non-ferrous metals and communications sectors. By contrast, inventories were lower than a year earlier in the electrical machinery and transport sectors. Meanwhile, the overall inventory-shipments ratio rose 7.8%M/M to be up 11.5%Y/Y – a statistic that continues to suggest that inventories will remain a weight on output in the near term at least.

Moving to the day’s other economic news, housing starts fell 1.5%M/M in September – a marginally weaker result than the market had expected – and were down 1.5%Y/Y. The number of starts also declined 1.6%Q/Q in Q3, although this did follow an 8.4%Q/Q rebound in Q2. Meanwhile, Japan’s largest contractors reported that construction orders in rose sharply in September. However, this is a typical annual development – the data are not seasonally adjusted – and so annual growth firmed only marginally to 1.0%Y/Y from 0.5%Y/Y previously. Domestic orders rose 3.0%Y/Y, with strong growth from the manufacturing sector countered by weak orders from the government sector. Finally, the Cabinet Office consumer confidence survey for October suggested that sentiment has weakened over the past month, with the headline index declining 0.4pts to 43.0 – the lowest level since January last year. Within the detail, respondents’ indicated slightly less comfort regarding developments in employment and income growth but were no less willing to purchase durable goods. And despite recent market developments there was little change in respondents’ perception of their overall likelihood.

China:
The economic focus in China today was on the release its official PMI reports for October. The official composite PMI fell 1.0pt to 53.1, marking the lowest reading since February. More worryingly, the closely-watched manufacturing PMI fell a larger-than-expected 0.6pts to a barely expansionary 50.2, the lowest since July 2016. Weaker readings were recording across all sizes of firms with both the medium-sized and small-sized firm PMIs now back below 50. In the detail, the production index fell 1.0pt to 52.0, but remained well above the recent February low of 50.7. However, the overall new orders index fell 1.2pts to 50.8 – also the lowest reading since July 2016. And in a further sign that US tariffs are impacting the economy, the export orders index fell a further 1.1pts to 46.9 – a level last reached in January 2016. Meanwhile, the non-manufacturing PMI slipped 0.1pt to 53.9 in September – still clearly expansionary but a 14-month low, nonetheless. Within the detail the new orders index fell 0.9pts to a 7-month low of 50.1, providing additional cause for concern.

Euro area:
After yesterday’s flash German and Spanish inflation figures aligned with expectations, this morning’s French figures came in a touch softer than expected, with the headline rate on the EU-harmonised measure unchanged at 2.5%Y/Y. The detail on the national measure signalled weaker inflation of manufactured products but slightly stronger services inflation, suggesting little change to underlying French inflation. Nevertheless, the developments in German inflation reported yesterday will likely be reflected clearly in the flash euro area figures due later this morning. We currently expect a rise of 0.1ppt to 2.2%Y/Y in the headline euro area CPI rate, and perhaps a rise of 0.2ppt in the core CPI rate, albeit to a still-subdued 1.1%Y/Y.  That increase in core inflation will likely reflect higher services inflation, principally related to a temporary leap in package holiday inflation.

While we still don’t have an official estimate for German GDP in Q3, events in the euro area’s largest member appear to have been a major factor driving the slowdown in euro area growth to 0.2%Q/Q, the lowest rate in more than four years. Indeed, Germany’s retail sales figures, released this morning, were very weak, with growth in September of just 0.1%M/M coming in well below expectations. Compared to the same month a year ago, the volume of sales was down 2.6%Y/Y, which represented the biggest drop since mid-2013. And looking at Q3 as a whole, the drop of 1.0%Q/Q was the steepest since the global financial crisis. It is worth noting that this dip followed a strong result in Q2, when sales were up 1.5%Q/Q. However, that increase did not translate into big increase in Q2 in overall household consumption, which rose a below-average 0.3%Q/Q. With new car sales also appears to have provided a negative contribution in the third quarter, we expect a much weaker reading for consumption in Q3, likely below zero, which will probably leave the overall German GDP up no more than 0.1%Q/Q.

Spanish GDP figures released this morning brought no surprises, with the headline pace of growth coming in at 0.6%Q/Q, unchanged from the last two quarters. Major domestic demand components – household consumption (up 0.6%Q/Q), investment (up 1.0%Q/Q following a 3.5%Q/Q rise in Q2) and government consumption (up 0.8%Q/Q) – were the main drivers, while foreign trade disappointed, with exports and imports falling by, respectively, 1.8%Q/Q and 1.2%Q/Q.

UK:
Following a downbeat retail survey yesterday, today’s UK household and business sentiment indicators reinforced the impression of weakness at the start of the fourth quarter. In particular, the GfK consumer confidence survey aligned with expectations with the headline index down 1pt in October to -10, the bottom of this year’s range. While this indicator has edged lower this month in each of the past eight years, today’s survey highlighted that, against the backdrop of ongoing Brexit uncertainties, households have become more downbeat about the economic outlook over the coming twelve months. And so, perhaps unsurprisingly, they assessed the current climate to be less favourable for major purchases than recent months. Meanwhile, the Lloyds Business Barometer today also showed its headline index declining, with a drop of 10pts in October to 19, the lowest level for fourteen months, with a notable drop in the current economic optimism.  With major Brexit uncertainty persisting less than five months to go before the UK is supposed to leave the EU, there certainly seems little cause for business optimism.

US:
The most notable US data release tomorrow will be the Q3 employment cost index – the best guide to price pressures emanating from the labour market. Against the backdrop of continued firm jobs growth, wages look set to have accelerated in Q3 after a below-average reading of 0.5%Q/Q in Q2. But growth in overall compensation might be reduced slightly by more modest growth in benefit payments. Today will also bring the ADP employment report, which will be worth watching ahead of Friday’s official payroll data release, and the latest Chicago Purchasing Managers’ Index.

Australia:
Inflation – or perhaps more correctly continued lack thereof – was the key focus in Australia today with the release of the CPI report for Q3. The headline index rose 0.4%Q/Q, causing annual inflation to decline to 1.9%Y/Y from 2.1%Y/Y previously. The quarterly outcome was 0.1ppt below market expectations but annual inflation was nonetheless in line with market expectations. Non-tradeables prices rose just 0.3%Q/Q, lowering annual inflation for this indicator of domestic inflation to 2.2%Y/Y from 3.0%Y/Y previously, albeit in part due to developments in administered prices (child care prices fell 11.8%Q/Q following the introduction of the Child Care Subsidy). More importantly for monetary policy, both of the RBA’s favoured statistical measures of core inflation – the trimmed mean and weighted median – remained inconsistent with inflation moving back inside the RBA’s 2-3% target band. Indeed, the weighted median rose a less-than-expected 0.3%Q/Q and 1.7%Y/Y, with a downward revision to this measure in Q2 adding to the disappointment. The trimmed mean rose 0.4%Q/Q in Q3 – in line with market expectations – but again a downward revision to the Q2 outcome means that annual inflation was steady at a lower-than-expected 1.8%Y/Y.

Market reaction to the CPI report – which on balance was clearly slightly softer than expected – was relatively modest, reflecting the market’s already restrained enthusiasm for pricing rate hikes over the coming year. Moreover, the RBA’s most recent published forecasts envisage year-end annual headline and core inflation of just 1¾%Y/Y (in quarter-point rounded terms) – a forecast that is not obviously contradicted by today’s CPI report. The RBA will likely remain optimistic of a gradual strengthening of inflation over coming years, with the economy presently growing at a decent clip, the unemployment rate already at a more than 6-year low, wage growth showing signs of rising and a weaker Australian dollar likely adding upward impetus to prices for traded goods. That said, today’s outcome reinforces the RBA’s mantra that, while the likely next move in policy will be a tightening, there is no strong case for a near-term adjustment of policy.

In other news, the RBA released its money and credit statistics for September. Private sector credit rose 0.4%M/M, nudging annual growth up 0.1ppt to 4.6%Y/Y. As was the case last month, growth was driven by a 0.6%M/M increase in business credit, lifting annual growth by 0.6ppt to 4.4%Y/Y. Housing credit rose just 0.3%M/M, so that annual growth slowed by 0.2ppt to 5.2%Y/Y. While owner-occupier housing credit rose 0.5%M/M and 7.3%Y/Y, investor housing credit rose just 0.1%M/M – the third consecutive such rise – causing annual growth to nudge lower to just 1.4%Y/Y. These outcomes will doubtless continue to please Australia’s prudential regulators.

New Zealand:
After improving modestly from dismal levels last month, the ANZ Business Outlook Survey for October pointed to little change in business sentiment over the past month. The headline business confidence index rose 1pt to a still historically depressed reading of -37. Meanwhile, more importantly, a net 7% of firms were positive about their own firms’ activity outlook – down just 1pt from last month but unfortunately 22pts below the average reading for the survey. Firms’ hiring intentions were similarly little changed (on net firms expect no change in hiring) but the net proportion of firms expecting to reduce spending on plant and machinery declined to 3% from 9% last month. Meanwhile, firms’ average year-ahead inflation expectation rose 0.10ppt to a 3-month high of 2.22%.

In other news, the number of dwelling approvals rose 1.5%M/M in September but was still down 7.6%Y/Y (house approvals fell 9.2%Y/Y). In value terms approvals for residential buildings fell 9.5%Y/Y, but approvals for non-residential buildings edged up 1.7%Y/Y. As a result, the value of all construction approvals, including non-building construction, fell 6.5%Y/Y in September and was down 5.5%Y/Y in Q3. The weaker trend largely reflects macro-prudential measures taken to slow investor activity in the housing market and the associated reduced prospect of steep capital gains in light of previous growth in house prices, together with the wind-down of the post-quake rebuild in the Canterbury region.

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