Morning comment: Italian deficit & services PMIs

Chris Scicluna
Emily Nicol

Wall Street shrugged off the Italy-related weakness seen in European markets yesterday, with the DJI rising 0.5% to a new record closing high. But, as was the case at the start of the week, smaller stocks lagged their largest counterparts, so the S&P500 closed little changed. And Treasury yields fell modestly in US time, benefiting from comments from Fed Chair Jerome Powell who seemed relaxed about possible upside inflation risks from a tightening labour market – he described stronger wage growth as “welcome” and “broadly consistent” with current inflation and labour productivity, and judged that it “therefore does not point to an overheating labour market”.

Setting the tone for this morning’s markets in Europe, reports overnight suggested that, while it’s sticking to its guns for an increased budget deficit of 2.4% of GDP next year, the Italian government has now pared back slightly its deficit targets for 2020 and 2021, to 2.2% of GDP and 2.0% of GDP respectively. As of yet, the detailed policies and economic assumptions underpinning those figures are unknown – one report suggests the GDP growth assumption for 2021 is 1.7%Y/Y, which in our view would imply a barely credible growth miracle for Italy at a time when euro area growth is likely to have slowed significantly further. And certainly, we would expect the final budget detail, when announced, to be unfit for purpose, leaving Italy’s deficit at risk of a blowout as and when growth slows further. Nevertheless, overnight the euro reversed yesterday’s losses on the news of that modest conciliatory gesture from the Italian government, while BTPs have opened significantly higher this morning – also effectively reversing yesterday’s losses – and euro area equities will likely do similarly.

In Asia, markets were closed for public holidays in mainland China and South Korea today. But despite the latest Italian news reports, those Asian markets that were open generally seemed to take their lead from yesterday’s developments in European markets. A slightly firmer yen – seemingly a consequence of diminished risk appetite – and a weak Japanese service sector PMI contributed additionally to a 1.2% decline in Japan’s previously high-flying Topix, while smaller losses were seen in Hong Kong, Taiwan and Indonesia. By contrast stocks rose in Australia as a weaker Aussie dollar offset another disappointing building approvals report (detail below). 

The most notable economic news in Japan today concerned the service sector and composite PMI reports for September. In contrast with the stability seen in the manufacturing PMI, overall business conditions in the service sector appear to have weakened over the past month, possibly in part due to the cumulative impact of natural disasters. The headline business activity index fell a disappointing 1.3pts to 50.2, which is the lowest reading in two years. In the detail, the new orders index fell 1.5pts to 52.1 – unwinding a good portion of the improvement recorded last month – and the employment index declined 1.2pts to 51.7. The future activity index declined a more restrained 0.5pt to a 5-month low of 55.5. The news regarding prices was mixed with the input prices index falling 0.9pt to 54.2 but the output prices index rising 0.2pt to 52.1. Combined with the final results from the manufacturing sector, today's outcome means that the headline composite PMI output index fell 1.3pts to a two-year of 50.7. The composite output prices index edged up a marginal 0.1pt to 52.3, which is slightly firmer than the average reading over the past year.

In other news, the BoJ released its latest estimates of potential GDP growth and the output gap. According to the BoJ, Japan’s potential growth rate stood at 0.78%Y/Y in H118 (a touch lower than previously estimated, but perhaps more notably also the lowest in five years), with around two-thirds of that growth attributable to an expanding capital stock. Meanwhile, the BoJ estimates that the economy was operating 1.9% above trend in Q2 – the largest positive output gap since Q407. Moreover, based on forecast data taken from the Tankan survey, the BoJ’s factor utilization index for Q418 pointed to the prospect of the tightest conditions since 1991 – conditions that the BoJ continues to hope will drive inflation expectations and inflation higher over time. 

Euro area:
Data-wise, further insight into the euro area’s economic performance in Q3 will come from August’s retail sales figures – following a weak showing in Germany, these are expected at best to report only a modest increase on the month to merely reverse the weakness in July, to suggest that consumer spending continues to grow at a weaker rate than overall GDP. Meanwhile, the final services and composite PMIs, due shortly, are also likely to suggest softening momentum. While the preliminary surveys reported a modest increase in the headline euro area services PMI (up 0.3pt to 54.7) led by an improvement in sentiment in Germany, the weaker manufacturing survey will mean that the composite PMI is still likely to  dip in September to 54.2, the lowest since November 2016.

After last year’s car-crash performance at the same event, all eyes in the UK will be on Theresa May’s Conservative Party Conference speech at 10am BST this morning. We don’t, however, expect any game-changers, whether for Brexit policy or her own weak standing in the party. Meanwhile, the September services PMI will be watched for further indications of the strength of GDP in Q3. The headline indicator for services activity is forecast to have edged slightly lower, albeit at 54.0 it would still signal steady expansion in the sector. And, overall, the composite PMI is likely to remain close to its level in August (54.2), which was bang in line with the average of the previous three years and consistent with our own forecast of UK GDP growth of 0.4%Q/Q.

The most notable US release today will also be the ISM non-manufacturing survey, with the headline index expected to have edged a little lower in September by 0.5pt to 58.0, broadly in line with the average of the past year. Today will also bring the final readings of Markit’s US services and composite PMIs and, ahead of Friday’s official labour market report, the ADP employment report, all for September. And, among the Fed speakers on the oche, Chair Jay Powell will again be speaking publicly in the afternoon, US time.

After declining 4.6% in M/M in July, the total number of dwelling approvals fell a further 9.4%M/M in August. This outcome was much weaker than market expectations and resulted in an annual decline of 13.6%Y/Y. As is usually the case, the main source of the surprise was in the volatile ‘other dwellings’ category (i.e. apartments), which fell 18.4%M/M and 24.2%Y/Y. The number of house approvals fell a more restrained 1.7%M/M and 4.2%Y/Y. As a result, the value of all residential approvals declined just 1.5%Y/Y in August. However, after growing strongly last year, non-residential approvals have also continued their recent weaker run and were down 18.4%Y/Y in value terms in August. As a result, the value of all building approvals issued in August fell 8.0%Y/Y to the lowest level since March last year. In other Aussie news, the long-running but volatile AiG services index rose 0.3pts to 52.5 in August – still the second lowest reading this year – with the new orders index rising 1.4pts to 53.4.

New Zealand:
The Kiwi news flow has also been somewhat downbeat today. First up, the latest GDT dairy auction resulted in a further decline in average product prices, with the price of whole milk powder – by far New Zealand’s most important exported commodity – declining to the lowest level this year. Second, annual growth in the QV house price index slowed 0.2ppts to an 11-month low of 4.6%Y/Y in September. And third, the ANZ Job Ads index fell 0.3%M/M in September, although annual growth remained solid at 5.1%Y/Y and the level of job advertising close to a record high (not least due to widespread labour shortages).


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