Morning comment: BoE, Brexit and manufacturing PMIs

Mantas Vanagas
Emily Nicol

Overview:
Equity markets rallied in both Europe and the US on Wednesday, with sentiment perhaps reinforced by a statement issued by China’s Politburo. The statement said that China should be more pre-emptive and take measures in a timely manner to counter weakening economic conditions, thus raising the prospect of additional stimulus measures over coming months to buttress those already in train. Europe’s Stoxx600 closed up 1.7%, attaining its highest level in almost two weeks. Meanwhile, the S&P500 finished with a 1.1% gain, during the last hour of trade paring an earlier advance of 2%. The improved risk environment was reflected in a modest rise in Treasury yields and a modest tightening of credit spreads, although the commodity complex was notably weaker suggesting lingering concerns about China. 

Against that backdrop, overnight Chinese equities maintained the upward trend of the last couple of days, with the CSI300 gaining 0.7%. The positive sentiment seems to have supported Hong Kong and Taiwan too - they reported increases of 1.8% and 0.4% respectively. Following a volatile day in Australia and despite an improved trade surplus, gains there were modest, while the South Korea’s equity market reversed its earlier increase and reported a small drop of 0.3% at the close. Japanese equities were more disappointing, with the final manufacturing PMI failing to inject optimism following yesterday’s weak IP report to the TOPIX down 0.9%.

Sterling was also boost overnight up around 1.2% against the USD after newspaper reports suggested that a deal on financial services had been sealed. But this leaves sterling back to its level a week ago. And in our opinion, the story does not stand up to any scrutiny (see below).Aside from these political noises, the focus today will be on the announcement of the BoE policy decision and the publication of its inflation report. In the euro area it should be a quiet day for major economic news, with many European markets shut for the All Saints’ holiday. And following the Japanese and Chinese manufacturing PMIs, the flow of manufacturing surveys continues, with the UK manufacturing PMI and US manufacturing ISM due.

Japan:
A much quieter day in Japan saw this week’s schedule of key economic reports conclude with the final results of the manufacturing PMI survey for October. Perhaps not surprisingly, especially in light of recent financial market developments, the headline business conditions index was revised down 0.2pts from its preliminary reading to a final reading of 52.9. Nonetheless, this is still 0.4pts above the previous month’s reading and the best result since June – an outcome that is consistent with perhaps a modest rebound in industrial output in Q4 following yesterday’s confirmed contraction in Q3. Within the detail the output index was also revised down 0.2pts to 52.8 (but still up 0.9pts for the month) while the employment index was revised down 0.4pts to 53.0 (up 1.1pts for the month). The new orders index ended October at 52.6 – revised down 0.1pts and so halving its modest preliminary gain. The new export orders index rose 1.3pts to a 5-month high of 51.1, although this was 0.5pts below the preliminary reading. Elsewhere in the survey, despite also seeing downward revisions, the pricing indices remained especially strong this month. The input prices index rose 2.4pts to a final reading of 62.6 and the output prices index rose 1.8pts to 54.5 – the latter revised down 0.5pts from its preliminary reading but still the strong outcome in 10 years.

UK:
An article in today’s Time newspaper, claiming that Theresa May has “sealed a deal on financial services” with the EU has seen sterling rise. The article claims that the “deal” would allow financial services firms based in London the same access they currently enjoy under an “enhanced equivalence” framework. But the story does not stand up to any scrutiny. For a start, the UK and the EU are not negotiating in any detail the future relationship between the UK and the EU – they are negotiating the withdrawal agreement only, with only a non-binding political declaration on the future relationship being hammered out. As such, there is no “deal” to be done at present – the serious talks on the future trading relationship only start once the UK has left the EU. Second, while the EU has said that it is willing to discuss the UK’s proposal for “enhanced equivalence”, the likelihood that it would allow such a regime without the UK permitting significant regulatory and legal oversight of the UK’s financial services sector, something that the Government will find difficult to agree to, is slim indeed. Finally, enhanced equivalence would not offer UK-based financial services firms the same access rights they currently enjoy – equivalence is only available in the EU acts that contain “third-country provisions” and exclude many important services, including deposit taking, lending, payment services, mortgage lending and insurance mediation and distribution. So while No 10 may have got a good headline this morning by spinning this story to a naïve journalist, the reality is very different, and will do nothing to change the plans underway by financial services firms to shift large amounts of capital and operations to the EU in advance of the Brexit date.

So, the main focus in the UK today will be on the BoE, with its latest policy decision and publication of its updated Inflation Report due at midday. Having at its August meeting raised Bank Rate to 0.75% and signalled the likelihood of further gradual tightening ahead, the MPC seems unlikely to make any further changes to policy this time around, or indeed any time before the nature of Brexit becomes significantly clearer. So, with the latest indicators having provided a somewhat mixed picture, the main focus will be on policy makers’ views on the economy, with their assessment of Brexit risks also of interest. Employment growth has lost some steam in recent months, with the three-month rate falling to around zero. But consumer spending, as suggested by elevated retail sales, has remained strong. We forecast that GDP growth will have risen in Q3 to 0.5%Q/Q, which would be the strongest pace in seven quarters and 0.1ppt higher than the BoE expected in August. So, the MPC might nudge up its projection for GDP in 2018, although the outlook for 2019 and 2020 will likely be little changed. With regard to inflation, while September’s CPI figures surprised on the downside, the number for Q3 as a whole was still in line with the BoE forecast. But with energy prices set to continue rising, inflation in coming months might remain relatively stable, and we therefore might see a modest upward revision to the Bank’s inflation forecasts.

On the data front, the October manufacturing PMI will be the most interesting. In particular, the headline index is expected to reverse the 0.8pt increase reported in September, to match the near-two-year low hit in August. 

US:
In the US, meanwhile, the data focus today will be the manufacturing ISM for October, which is expected to see another decline in the headline measure, albeit remaining close to recent highs. The final Markit manufacturing PMI for October, construction spending data for September and the first estimates of labour productivity and unit labour costs for Q3 are also released on Thursday.

China:
Following yesterday’s disappointing official manufacturing PMI report, today’s Caixin manufacturing PMI, which is more focused on the SME sector, provided limited relief. After declining to a 16-month low last month, the headline index rose 0.1pts to a barely expansionary 50.1 in October. Within the very mixed detail, the output index fell 1.0pts to also sit at 50.1 – the lowest reading since June 2016 – while the future output index fell a further 0.9pts to an 11-month low of 53.1. After declining to a 25-month low last month, the new orders index rose a modest 0.3pts to 50.4. And while the new export orders index reversed last month’s 1.2pt decline, the October reading of 48.8 marked a 7th consecutive reading below the crucial 50 mark.

Australia:
The key economic report in Australia today was the trade balance for September, which revealed a trade surplus of AUD3.0bn – the largest surplus in 18 months and a substantial AUD1.3bn above market expectations. In addition, the August surplus was revised up to AUD2.3bn from AUD1.6bn previously. Exports rose 0.8%M/M in September so that annual growth stood at a very robust 15.9%Y/Y. The growth in September was driven by a 3.0%M/M lift in receipts from the non-rural sector, with increased exports of iron ore accounting for most of that growth. Imports fell 1.1%M/M – driven by a reversal of the previous month’s sharp lift in capital goods – causing annual growth to slow to a still solid 9.2%Y/Y. Imports of intermediate goods rose 1.9%M/M and 21.3%Y/Y, while imports of consumer goods rose 0.6%M/M and 6.0%Y/Y.

As a result, using the seasonal factors from the balance of payments, a surplus of AUD6.4bn was recorded in Q3, up from AUD4.2bn in Q2. Most of that improvement appears to reflect a favourable development in the terms of trade. Indeed, in other trade-related news, the ABS reported that Australia’s export prices rose a larger-than-expected 3.7%Q/Q in Q3 to be up 14.0%Y/Y. Assisted by a weaker Australian dollar, prices rose for most categories of exports but particular for mineral fuels (up 7.2%Q/Q). Meanwhile, import prices rose a less robust 1.9%Q/Q in Q3 and were up 9.8%Y/Y. As with export prices, a rise in the price of mineral fuels was a key driver of higher import prices, and was offset only partially by lower prices for crude materials.

Turning to the day’s other economic reports, Corelogic reported that the median house price across Australia’s eight capital cities recorded a 0.6%M/M decline in October, extending the run of monthly declines to a full year. As a result prices are now down 4.6%Y/Y, compared with a revised decline of 4.1%Y/Y in September (previously 3.7%Y/Y). Prices fell 0.7%M/M in both Sydney and Melbourne – the former now down 7.4%Y/Y – and 0.8%M/M in Perth. By contrast prices were stable in Brisbane and also little changed from a year earlier. Finally, Australia’s twin manufacturing PMI reports contained mixed news. The CBA manufacturing PMI rose 0.5pts to a 4-month high of 54.5 in October – 0.2pts firmer than last week’s flash reading – while the much longer-running but volatile AiG manufacturing index fell 0.7pts to a relative sturdy 58.3.

New Zealand:
Following a subdued winter, in aggregate the housing market seems to have lifted in the early spring with QV reporting a 1% rise in prices in the three months through October, lifting annual growth to 5.4%Y/Y from 4.6%Y/Y previously. This improvement came despite a 0.3% decline in prices in the major (and expensive) city of Auckland over the past three months, where prices are now up just 1.1%Y/Y. In other news, following a modest decline last month, the ANZ Job Ads index rose a solid 1.4%M/M in October, raising annual growth to 6.1%Y/Y. This represents a new record high for the series, notwithstanding the lacklustre hiring intentions reported in Wednesday’s ANZ Business Outlook Survey. Repeat advertising due to widespread labour shortages is likely to be explain some of the apparent discrepancy. The household employment survey for Q3 will be released next week, casting more light on what is really happening in the labour market.

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